5 Most Common Financial Mistakes that Startups Make
I have been a CFO for over 25 years (I know, must have been 14 when I started) and have worked with 30+ early stage companies. Typically, these are venture-backed companies or newly formed companies seeking to obtain venture financing. I am constantly amazed by the brilliance and dedication of these entrepreneurs who are laser focused on their products, but so often have a blind spot when it comes to financial matters.
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There are those who are like ostriches and think that by hiding their heads in the sand, they won’t have to grapple with things like 409a valuations, revenue recognition, collections or sales taxes. Others consider finance to be of secondary importance and believe they can fix things after they have built and launched their products. In many cases, the end result is disarray in the finance function which can delay or prevent a company from raising money or doing a deal – or from being as successful as they had hoped.
The reality is that a little planning goes a long way and does not create a distraction for the management team or cost a lot of money to intelligently build the financial foundation for growth. The following are the five most common mistakes that companies make when it comes to building their finance function.
1. Lack of focus on cash management. Sources and uses of cash — How much money do we have and how far will it take us? What’s plan B (and C and D) for raising cash? Debt, equity, equipment financing? These are questions that CEOs should be able to answer with precision, but to do so requires a good cash forecast that includes a realistic view of inflows, outflows and the likelihood of achieving milestones in a specified timeframe.
2. A dysfunctional budgeting process. Budgeting not only provides a roadmap, but the process of putting together a budget serves to align the management team and engenders important and sometimes difficult discussions. It’s a key part of team building. Too often, a team will overestimate their sales and underestimate the time it will take (and therefore the $s) to achieve their targets. Budgets should reflect reality and not aspirations, though it’s okay to have a couple scenarios (e.g. upside, base case, downside).
3. Failure to perform a “variance analysis”. It’s not enough to have a budget. Management must use the actual financial results as a critical feedback loop to refine its budgeting and forecasting efforts. Using actual results and comparing those against the assumptions your team worked so hard to develop is the best way to figure out what’s working and what’s not – and then taking decisive action to reinforce the good and correct the bad.
4. No metrics or using the wrong metrics. Developing a set of metrics (or key performance indicators “KPIs”) is another effective team building exercise. We all have a hundred things on our to-do lists, but only 5 to 10 will truly turn the needle and make an impact on the business. It’s crucial for the team to discuss what those 5 to 10 metrics should be and then agree on a plan for reporting on their metrics in a timely and accurate fashion. This is often done in the form of a dashboard on a daily, weekly or monthly basis to help the team steer the ship. It’s also a great tool for managing the company’s board of directors and holding the team accountable to an agreed set of priorities.
5. Not knowing when to seize the day. Since the tech bubble burst in 2000, most entrepreneurs have learned to treat each investment as if it will be their last. They scrap and save and hold off on hiring in order to extend the runway and give themselves the best chance possible to develop and sell their product. But there comes a time in a successful company’s lifecycle where the opportunity opens up and the team must flick the switch from conservative to aggressive. This is the “make-or-break moment” and not many companies get it right. The decision has to be made and communicated to the entire company. Resources need to be allocated to take advantage of the opportunity whether it’s by investing in people, marketing, sales or the next generation product. Being able to identify when that window of opportunity opens and taking advantage is the difference between a great company and a merely good one.
And now the commercial. At TechCXO, our CFOs help companies manage these issues and avoid the pitfalls. We’ve all done it multiple times and learned, sometimes the hard way, from our experiences. Drawing on our resources gives companies a critical advantage as they lay the foundation for growth.