Three sad facts about startup money
Money, money, money.....
The second part of this How To Startup sequence is about funding and cash in all its forms, and more particularly the lack of it. Especially:
Money that doesn’t appear when it was meant to
Money that comes with unexpected strings attached
Money that becomes a full-time job its own right
Cashflow is the most important thing to master when you start small because there will be times when you are walking such a tight line that your past thriftiness or fast invoicing and payment terms may just make the difference that lets you survive to fight another day. This is why I have a boring obsession with good financial management practices.
Spending too long failing to raise money isn’t an affordable option because the opportunity cost to your business is often simply too high. And while sales do indeed solve everything, only if you can get the cash in that you need to spend to deliver on that sale. (Welcome to the wonderful world of working capital). Sales also have a nasty habit of not being as big and profitable as they first seemed once the details of the deal are finally hammered out. As I used to say about consumer retail sales: “it is not a sale until the customer decides to keep it.” The same is true of B2B - it is not a completed sale until the customer has accepted your work, kept up their end of the deal and the full payment cycle has been completed. (I know, SaaS is different - but the general principles hold true).
I have been burned in every business I have ever run by at least one customer not paying or by them breaking agreed payment or contract value terms.
Sad fact number 1 - selling something isn’t the same as getting paid for it
Do not assume people will pay you when they say they will or when you ask them to. Build upfront payment, obsessive invoicing and cash chasing into your plan from day one. Avoid incurring substantial project costs before you invoice on that project if you can possibly help it, especially in the very early days. Clients, even established ones, can go and do bankrupt, others have crazy, inflexible payment terms that you may simply be unable to service in your early days. (Hello global tech giant who used to have 180 - 365 day payment terms… not cool.)
Never, ever be afraid to have the invoicing/payments term conversation before starting work - a serious, professional client will expect it. Evasiveness is a sign that the company is either exploiting your keenness as a startup or is going to do whatever it takes to avoid actually paying.
If you take credit cards understand how refunds, chargebacks and fraudulent payments will be priced and handled so so you can forecast in what this is likely to cost you. (With chargebacks you are also likely to lose your goods as well as the payment for those goods - it is no wonder retailers dread them and some customers use them as a threat). When researching what the different payment methods will cost you, don’t just look at the sales costs, but the refund and chargeback fees too. Don't ever overspend on the promise of money - wait until you have the cash, or at least a formal purchase order and contact with the finance team (so you know you are in their payments system). I have made the mistake of hiring to service a big new deal in order to be ready for the client on day one, only to see that deal and my credibility fall apart.
Sad fact 2 - money that comes with strings attached can strangle you
Loans and personal guarantees - I have raised most kinds of early-stage money, but by far the most stressful was a £20k bank loan taken as a bridge ahead of other revenues and funding sources coming in. This required my Chair and I both signing personal guarantees, essentially putting our houses on the line - this was both divisive and an intense pressure on our personal relationship, not least because her house was way more valuable than mine. At the time, I didn't really know why we both hated this arrangement as much as we did - the bank wanted us to have skin in the game, but we were already both invested, I had downsized from a house to flat to fund the business, so skin there most certainly was.
It was only later talking to other female entrepreneurs that I kept hearing the same thing come through - women really really hate debt backed against family assets. One theory I heard, which feels plausible, is that the family home simply doesn't feel like an asset we can risk. It was one of the lowest sums we raised, yet for me, it remains the most problematic. I am not averse to risk, but personally backed debt (especially someone else's house!) is not my kind of risk. The emotional cost/benefit trade-off feels off. We didn't have a lot of options at the time, but I do regret this one.
Grants - while I am a very big fan of free money, and especially talented at finding quite a lot of it down the back of the sofa, public money can tie you up in knots if you are not prepared. Firstly, it is nearly always a requirement that you spend first and claim back an agreed percentage later, usually quarterly in arrears. This can worsen not help your cashflow. Secondly, you can find yourselves all focused on doing the work dictated by the funding, rather than funding the work you originally needed to do. Plus there’s a fair bit of paperwork. But, on balance, if your business is of the type that attracts grants, this is very attractive money if you are organised and not relying on it as your only source. Because you are growing future value without diluting your shareholding.
Investor/lender expectations - when someone invests their cash in you or lends you their money, you are entering a contractual agreement, with expectations on both sides. With equity investment, this takes the form of term sheets and shareholder agreements, and into this will be built directors and voting rights, share classes and preferences. Essentially the terms of engagement from here on. Mistakes, misunderstanding or naivete around this can cost you your company, your job, or both - as I have written about previously. Read and learn is all I can say on this one - there are no mistakes someone else hasn't made first.
Sad fact 3 - raising money is a full-time job (on top of your other one)
Raising money - especially equity funding - is a full-time job. Even pursuing "traditional financing" - loans, invoice financing, factoring - often has a very low success rate relative to the effort for startups and young companies. (IT services, SaaS and software companies are usually excluded from mainstream bank's invoice financing completely). If all this effort and energy is not remotely aligned with the other day job, your company will suffer. This is why I think we should be talking more about customer/sales driven financing along with other alternative sources of funding. For example:
Peer to peer lending, both formal and informal. I feel informal peer to peer lending is both overlooked and undervalued, yet at its broadest can include everything from paying it forward, microlending, goods gifting and offers a new twist on the friends and family round. This benevolence of friends and supporters is the way so many people started first time round, because it works. Whether its a computer or a free desk in a corner, investing in a person by supplying the tools they need to start is typically low risk and high impact because most people will work hard and diligently to repay the faith their peers have shown in them.
Crowdfunding (equity and rewards based). Crowdfunding allows startups to interact directly with their target market and with potentially thousands of backers, supporters, customers and potential partners. Rewards-based crowdfunding platforms enable supporters to directly fund the creation, launch or development of new businesses, products and services where backers pay upfront for a product, service or project. Interestingly, crowdfunding is possibly the only area where women founders have a fundraising edge - research suggests women are 29% more successful at reaching their targets. It is rightly often pointed out that without a proper structure in place, and a platform that provides support post-fundraising, the administrative burden of managing a crowd of investors can be a drain on time and resource for companies - but there are plenty of tools that can ease this (and having lots of angel investors is a similar headache). So do your homework first and understand that the work doesn't stop when the money comes in - it is just the beginning. But, unlike many other kinds of fundraising, crowdfunding done right has the major upside of selling product and building a loyal supporter network of customers as you go, which is seriously worth considering for the right types of business.
Convertible loan - this is a hybrid, usually quick, debt to equity vehicle. I've done several of these and mostly rather like them, though they are more common in the US than the UK. This is a good explainer and worth checking out if you are planning an equity raise in the future, but would benefit from a cash injection now to get traction ahead of fixing a valuation/terms for that equity round. But as always, the devil is in the detail and if you are taking this route, get legal advice and beware that it is not eligible for SEIS or EIS tax relief, so you can count the UK angel investors out.
PayPal Working Capital - this cash advance service is based on your PayPal sales volumes, account history, and any prior usage of PayPal Working Capital and, if you're approved, you'll get your funds in minutes. The maximum cash advance amount offered could be up to 25% of your annual PayPal sales, with a maximum of £100,000. Repayments are automatically deducted from your PayPal account when you have sales, based on the repayment percentage you choose when you apply. For periods when you don't have sales, you don’t make any repayments. However, regardless of sales volume, you’re required to repay at least 10% of your total cash advance (including the fixed fee) every 90 days. PayPal is leveraging its huge cash rich, impressive cash conversion cycle - it wouldn't surprise me to see other cash conversion masters like AirBnB and Amazon come up with similar services.
Few of these alternative funding methods (convertibles excepted) are currently eligible to be used alongside match funding from state partners like Scottish Investment Bank or London Co-investment Fund, which are very much geared towards the types of high growth businesses already seeking equity funding. But for the businesses that don't check those boxes, whose the options are already more limited, these options are worth better understanding - and not just by entrepreneurs, but also their advisors.
In conclusion Cashflow, cash conversion cycle and access to working capital will always be the primary challenges, even for successful and profitable businesses - especially at key growth inflexion points. I do believe that this is an area where advice is lagging behind the needs of young companies - and the funding options available to them.
Next week Part 3 of How to Startup - networks, advisors and boards