Finance for Startups

Finance for startups presentation cover by Luego

Finance is a love-hate topic for startups founders. It sucks until you get the fundamentals right.

As founders ourselves, we know how it feels. We never planned to launch a fintech company until we realized that finance could be made simple by design.

We sat down with 274 startup founders over 12 months to ask about their experiences with finance. We learned so much, we believed it could be helpful to share their insights, using simple words, so that the rest of us can learn from their experience.

In this article, you will learn:

  • The mistakes founders make in the early and later stage
  • How to avoid them?

You will see, finance is simpler than you think ๐Ÿ˜‰

What you need to remember from this article

We gathered 6 common pitfalls startup founders fall into. They are categorized into 2 groups: early stage and late stage.

Early Stage pitfalls

  • Ignoring what numbers to look at
  • Monitoring at the wrong frequency
  • Underestimating expenses

Later Stage pitfalls

  • Outsourcing responsibility
  • Hiring too quickly
  • Fundraising when the runway is low

Let's explore those 6 pitfalls one by one!

1. Ignoring what numbers to look at

There is 3 main information you must have access to:

  • โœ… Bank balance โ€” the reserve of cash on your bank account
  • โœ… Revenue โ€” the amount of cash that gets in
  • โœ… Expenses โ€” the amount of cash that gets out

From those 3 primitive, you can calculate the 4 following metrics:

  • โœ๏ธ Burn
  • โœ๏ธ Runway
  • โœ๏ธ Growth rate
  • โœ๏ธ Default alive

Let's dive into each metric with a simple definition and examples.

โœ๏ธ Burn

The burn is the cash you lose every month to run your startup.

It is calculated as follow: Burn = Expenses - Revenue

For example, in February 2022:

  • Expenses = 25Kโ‚ฌ
  • Revenue = 10Kโ‚ฌ
  • Burn = 15Kโ‚ฌ

โœ๏ธ Runway

The runway is the number of months before you run out of money.

It is calculated as follow: Runway = Bank balance / Burn

For example, in February 2022:

  • Bank balance = 150Kโ‚ฌ
  • Burn = 15Kโ‚ฌ
  • Runway = 10 months

โœ๏ธ Growth rate

The growth rate is the monthly rate at which your revenue grows.

It is calculated as follow: Growth Rate = ( Revenue (M2) - Revenue (M1) ) / Revenue (M1)

For example:

  • Revenue in February 2022 = 10Kโ‚ฌ
  • Revenue in January 2022 = 8Kโ‚ฌ
  • Growth Rate = 25%

โœ๏ธ Default alive

Assuming your expenses stay equal, and revenue grows, your company is either:

  • Default alive = you can fuel your own path to profitability
  • Default dead = you will die before you reach profitability

In the early stages, most companies before Product-Market-Fit (PMF) are default dead. This is why raising funds make sense in some cases, because it extends your runway, and gives your more time to iterate to find PMF.

default-alive-calculator.png

If you want to know if you are default alive or default dead, here is a great tool to calculate how much funding your startup needs.

2. Monitoring at the wrong frequency

The frequency at which you monitor these metrics matters. We recommend entrepreneurs monitor them every day.

Not every quarter.

Not every month.

Not every week.

You should know them every day.

Financial metrics matter as much as product metrics. Not knowing them is a bad signal for potential investors.

As a reminder, here are the 7 metrics you should always know:

  • ๐Ÿ‘‰ Bank balance
  • ๐Ÿ‘‰ Revenue
  • ๐Ÿ‘‰ Expenses
  • ๐Ÿ‘‰ Burn
  • ๐Ÿ‘‰ Runway
  • ๐Ÿ‘‰ Growth rate
  • ๐Ÿ‘‰ Default alive or default dead

3. Underestimating expenses

Truth is that expenses grow over time. Assuming expenses will remain constant is a mistakes founders often make.

When calculating your expenses, be aware that:

1) As founders, we tend to undervalue our own time

In the early stages, we often overwork and underpay ourselves. As a consequence, we tend to underestimate the cost of other people's time. Also, remember that not paying yourself is not a sustainable path in the long run. So don't forget to include your own cost in the equation.

2) Hiring employees doesn't cost just their salary

When hiring a new employee, you must take into account the cost that goes beyond their salaries. You must include the following costs in your calculation:

  • Charges and insurances you will pay as an employer
  • Software licenses and furniture you will provide your employee
  • Salaries will only increase with the seniority of your employee
  • Training a new employee will also cost other people's time at the beginning

๐Ÿ‘‰ As a rule of thumb, we recommend entrepreneurs calculate the cost of an employee by a measure of ~2x the brut salary.

For exemple:

  • New employee's brut salary = 50Kโ‚ฌ
  • Realistic employee cost estimate (~1.7x) = 85Kโ‚ฌ
  • Conservative employee cost estimate (~2x) = 100Kโ‚ฌ

3) Paid acquisition gets more expensive over time

As your paid acquisition strategy (and your competitors) saturates the niche of early adopters, you will need to expand your audience and target more difficult-to-convince potential customers. As a consequence, it is fair to assume that the Customer Acquisition Cost (CAC) you have today is bound to increase over time.

Be honest with the numbers

Don't undermine your expenses to make your runway look better. If you evaluate your expenses realistically, or with conservative hypotheses, you are doing yourself a favor for the future.

4. Outsourcing responsibility

In the beginning, the founders are usually accountable for gathering data and monitoring numbers. As the company grows, more people will be involved in the finances, such as the CFO, the accountant, the bookkeeper, maybe an office manager, etc.

Although we recommend involving your team and external experts in your finances, it should not dilute ownership: Everyone is responsible for the numbers.

They should be always accurate and up-to-date. So make sure you have tools and processes that allow cross-collaboration between all financial stakeholders in real-time.

We built Luego to enable fast collaboration on finance for growing startups. But tools like Google Sheet are also a great fit for earliest-stage founders.

5. Scaling too quickly

Before scaling your company, it's important to evaluate if you are before or after Product-Market-Fit (PMF). The reasoning might be different depending on your company's stage.

Here are the differences:

Before Product-Market-Fit

At this stage, you must be very cautious with hiring. Be aware that:

  • Hiring is the fastest way to burn your cash
  • More employees will not help you reach PMF

๐Ÿ‘‰ As a rule of thumb, you should avoid hiring before PMF.

After Product-Market-Fit

Reaching PMF means that you have built a product that the market is willing to pay for. At this stage, the goal is to figure out distribution to take over market shares.

If you have cash, hiring new employees will be tempting. Be aware that:

  • Every hire is an investment for the future of the company.
  • You should measure the Return-On-Investment (ROI) on every new talent you hire.
  • Speed and velocity do not grow linearly as you hire new people. Too many hires can slow the company down.

๐Ÿ‘‰ As a rule of thumb, you should monitor Revenue-per-employee instead of the number of employees.

The best startups do more with less

Whether you are before or after Product-Market-Fit (PMF), remember that the goal of your company is to create value for customers. The best companies are value-creation-machine with outrageous revenue-per-employees ratios.

To achieve high leverage, you will need to focus on hiring exceptional talents, use the right productivity tools and implement lean processes.

For example:

  • Instagram was a team of 13 employees when they got acquired by Facebook for $1 billion in 2012.
  • Notion was a team of 27 employees when they reach 1 million users in 2019.

6. Fundraising when the runway is too low

Fundraising is a major topic in the startup ecosystem because it allows startups to buy time by leveraging human capital and distribution.

Here are 2 thoughts on the relation between fundraising and runway:

The purpose of raising funds vary across the stages of your company:

  • Before PMF, money helps you sustain until finding Product-Market-Fit.
  • After PMF, money helps you sustain your growth.

๐Ÿ‘‰ As a rule of thumb, you should always assume you will never raise money again. Have a plan to become profitable as soon as possible.

Runway gives you leverage over investors

Counter-intuitively, the best moment to raise money is when you do not need money. When startup founders wait until they have a few months of runway left to start the fundraising process, two major downsides can happen:

  1. they conclude a last-minute deal, but gives away a much larger portion of ownership than the industry-standard practices
  2. they don't manage to raise on time, go bankrupt, and shut the company down.

To avoid this situation, you should anticipate your money needs months or years in advance.

As a startup founder, you get the most negotiation power over investors when the runway is the highest, because:

  • Startups look more attractive to investors when they are financially healthy
  • It increases competition and the time pressure on the side of investors because they might miss the deal if they wait.
  • And being default alive at this stage gives you even more power because your company doesn't depend on their money to survive.

However, as the runway decreases over time, the negotiation power of startup founders decreases, and investors get more power, because:

  • Startups now depend on their money to survive
  • It decreases competition on the side of investors and increases time pressure on the startup founder's end.

negociation-power-startup-founder-investor-luego.png

๐Ÿ‘‰ As a rule of thumb, you should always anticipate your money needs as much in advance as possible.

Conclusion

In this article, we have covered the 6 common financial pitfalls we have seen founders fall into. Those recommendations are based on the 274 founders we interviewed over 12 months. Here is what to remember from this article:

There are 6 common pitfalls startup founders fall into

  • Ignoring what numbers to look at
  • Monitoring at the wrong frequency
  • Underestimating expenses
  • Outsourcing responsibility
  • Hiring too quickly
  • Fundraising when the runway low

There exist 4 simple techniques to avoid running out of cash

  • โœ… Know your cash balance and runway at all times
  • โœ… Understand how your expenses will increase over time and keep them low
  • โœ… Understand that revenue-per-employee is a better metric than the number of employees
  • โœ… Assume youโ€™ll never raise money again, so have a plan for reaching profitability as soon as possible

You are now all set to avoid common financial pitfalls and give your company the best chances to succeed!

We hope you enjoyed this article as much as we took pleasure in writing it for you. We are Luego, a team of entrepreneurs building the future of financial tooling for startups. Our vision is to provide founders with the first productivity tool to manage finances super fast.

If you want to be part of the project, you can apply to join the beta and share this article on your favorite startup community. Thank you ๐Ÿ™

team.jpg

Here is a gift for you ๐Ÿ’

If you scrolled down here, we hope you learned something. We created a shareable presentation that summarizes the main takeaways of this article.

๐Ÿ‘‡ Slide the presentation down below ๐Ÿ‘‡

Feel free to reach out at hola@luego.eu to share your thoughts and feedback. We appreciate sharing with and learning from the community.

Stay safe and healthy.

Cheers โœŒ๏ธ

Ilyass & Andrรฉas

Co-founders of Luego.eu

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