As a banker, I’ve spent far too much time in the weeds of Excel financial models for startup companies. Startup finance is not always the most fascinating work, and many founder CEOs are technologists who have no interest or experience with the “numbers” side of a startup. Yet, there are some very basic “Startup Finance” concepts that I think are imperative for entrepreneurial execs to grasp as they grow their businesses. Don’t worry, I’m not suggesting you understand all the inner workings of QuickBooks or GAAP revenue recognition – here are two key areas that will be crucial in growing your venture.
It’s All About the Cash
There are 3 basic financial statements for any company, which in their most basic forms, can be summarized like this:
- Income statement (or P&L): a view of revenue and expense performance over a period of time (monthly, quarterly or annually).
- Balance sheet: a snapshot of the assets and liabilities of the company at a given point in time.
- Cash flow statement: the view of how cash enters and leaves the company. While the income statement can be influenced by accounting treatments, the cash flow statement shows the most true view of how real money flows.
It is often said that “cash is king,” and for an early stage entrepreneur, truer words have never been spoken. Regardless of the stage of your company, it is imperative that you have an understanding of your cash position at all times. And while you may not have the resources or needs to have a full- or part-time CFO, it is important that you know how much cash you burn in a given month, so you’ll also know how much runway your startup has before needing additional cash. Every other financial statement and report is secondary to knowing your cash position, cash usage, and cash runway. Without cash, there is simply no fuel to run a company.
Every early stage company that is not yet profitable should have a running cash forecast that shows monthly burn, months of cash runway remaining, and expected cash low point before additional financing is needed. This should be as “real time” as possible – most entrepreneurs look at this weekly or every few weeks at a minimum.
Understand Funding Sources and Dilution
Many startups that are still burning cash will find that they need to raise outside financing of some sort. The vast majority of the time, this comes in the form of equity (or convertible debt which will convert to equity at a later date). If you’ve never raised a round of funding, you will soon find that there is a litany of terms and variables involved in a round. First, you must learn the vocabulary and understand the implications that are involved with selling a piece of your business. In today’s world there are many free resources to educate entrepreneurs, such as the Term Sheet series, Brad Feld’s Venture Deals and sites like Venture Hacks. In addition, finding a smart startup attorney who has lots of deal experience is a must have.
Once you are up to speed on the terminology, I’d recommend playing around with some modeling tools to help you understand the effects of raising different amounts of money. By spending a little time becoming an expert in this area, you will be able to craft an optimal strategy and deal with an investor, and avoid scrambling to understand how the terms in a term sheet will affect your ownership.
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