right arrow
Back to all posts
'Build don't blitz' is the new mantra from Silicon Valley.
Business

Why Financial Fundamentals are Critical for Today's Tech Startups

right arrow
Back to all posts
Why Financial Fundamentals are Critical for Today's Tech Startups
Business

Why Financial Fundamentals are Critical for Today's Tech Startups

right arrow
Back to all posts
Why Financial Fundamentals are Critical for Today's Tech Startups
Business

Why Financial Fundamentals are Critical for Today's Tech Startups

Runaway inflation, recession worries, and a faltering stock market have turned the world on its head — and the startup space is no exception.

For the past decade, well-funded startups have been coached to 'blitz-scale.' Cash flow and profit be damned! Well, that's all changed. 'Build don't blitz' is the new mantra from Silicon Valley.

Suddenly, startups need to:

●      Track cash like a hawk

●      Build a plan for profitability

●      Weather the storm for at least 24 months 

Why now?

So, why has cash flow and sound financial modeling suddenly become so important? Simply put, the market has changed.

High inflation makes the future revenues of growth businesses look less attractive to investors. To compound matters, the Fed has upped interest rates to cool down inflation and, in the process, ended a decade of cheap money.

The slowdown started last fall, but it hit hardest in Q1 2022. Valuations have suffered massive declines and have dropped from as high as 35x down to 5x!

Challenges to Fundraising

The current economic climate presents many challenges for fundraising. Startups with high valuations can expect to see many down rounds.

Analysis suggests that a startup will now need about 24-30 months of runway before closing the next round. Businesses without good financial modeling and cash flow will struggle to survive until then.

Venture capital investors have become cautious. Many of them aren't even answering the phone to startups looking for investment. There is still money floating around the investment space, but the record highs of 2021 seem like a distant memory.

Profit suddenly matters again

We're emerging from an era where "blitz-scale" was the strategy that many — if not most —venture capital investors required. This growth at all costs, high burn rate approach saw profit as something that could happen much later.

Now, venture capital investors have fallen in love with cash flow and a more cautious approach to risk analysis. "Build don't blitz" is the new mantra.

Why it always mattered

While investor sentiment may have changed recently, sound fundamentals have always been important for a successful startup.

Some of the main reasons why are:

Runway

Any company that's burning cash needs to know its runway. Generalized runway calculations can be inaccurate and can be affected by several factors, like:

●      Large, irregular bills

●      Unpaid invoices

●      Failed credit card transactions

●      Up-front payments included in MRR

Unpredictable Fundraising

Even outside the current financial bear market, no startup could 100% rely on fundraising.

Lots of problems could happen along the way, like timelines that are longer than predicted or changes in investor "taste."

Your runway is one thing you have some degree of control over.

Leverage

A long runway gives you leverage in negotiations. But you'll have even more power if you're at break-even or profitable. Being able to burn discretionary funds can give you the best of both worlds.

What Matters Most? 

Cash flow

Revenue growth is critical, but revenue, ARR, and MRR won't matter if you run out of cash. So make sure your cash flow is solid and you're tracking it accurately.

If you invoice customers and depend on getting those funds later, staying on top of your cash flow is especially important.

Similarly, you need to keep an eye on credit card payments, especially for renewing subscriptions.

Finally, get investor funds into the bank as quickly as possible, even though it can be tricky.

Sales projections

Startup growth rarely goes in a straight line. Setting sales goals is a vital first step in making accurate projections. Any goals you establish should have a clear path to profit.

Make plans, but remember that nothing ever goes exactly as you expect. Use the past to inform your worst-case scenario and prepare for it. But also get ready for the best-case scenario too.

Track your progress and how close you've been to your goals. Build from the BOTTOM UP! Never build from a goal that is unsupported by your funnel.

Profit

Nothing will help a founder sleep better at night than being in a profitable position. But not solely relying on runway means you must balance short-term profitability with playing the long game. Profit gives you leverage, but only if paired with fast growth and other fundamentals.  

Investors have even coined a new term for if your startup is on track to reach profitability before running out of cash: "Default Alive." It's break-even - but new! Investors want to see a clear path to profit, even if it's a long way off.

Today's Startup KPIs

There are countless key performance indicators (KPIs) for startups, but we're seeing a shift toward specific financial fundamental KPIs. These KPIs are about smart growth and building a business alongside systems and processes that move the needle.

Growth rate: Investors that were obsessed with growth previously wanted to see at least 3-4x annual growth. Now, they're happy with 2x paired with solid fundamentals.Growth is still essential, but not at the detriment of everything else. 

Customer acquisition cost: CAC has always been tracked, but it's growing in importance. However, the specific costs aren’t what's important; it's how long it takes to pay it back.

CAC payback period: How soon does it take for a customer to be profitable? Your startup should aim for 12 months. To ensure your CAC is covered, you should seek longer contracts.

Burn Multiple: Burn multiple is a relatively new metric gaining traction. It gets to the heart of startup growth by asking, “how well are you managing your burn?” And is that burn actually turning into revenue?

Taking Action: Building a Forecast

Step 1: The recurring budget

Your recurring budget is the foundation of your operating finances. Basically, it details how much it costs for you to stay in business each month. It's a living document that you can adjust on the fly as things change in your startup.

Step 2: Round Out the Expense Budget with a Full View Forward

In addition to your regular, recurring expenses and fixed costs, you'll have variable costs that will affect your budget and cash position. They are often larger bills that are paid at a later date, like:

●      Insurance bills

●      Annual licenses

●      Partnership fees

●      Inventory purchases

●      Contractor bills

●      and more

 

You’re in for a nasty surprise if you’re not tracking and predicting when significant expenses arrive. Going by memory is a terrible plan; waiting for the bill to come is even worse.

If you have annual payments, get them in your forecast immediately and put them on auto-repeat. Amortizing fees every month can help you get a handle on your costs and prepare for larger bills, BUT It can give you a false sense of security if you are not holding back money to pay those bills.

Step 3: Revenue Projections

Now that you have a handle on your costs, it's time to look at your revenue.

Runway

Adding your current revenue levels into your forecast will give you your runway. If your business is subscription-based, you may already have a good idea of your revenue.

However, If your sales are larger, one-off deals, revenue projections can be more challenging. A CRM (Customer Relationship Management) system can be essential in these cases to keep track of deals and predict sales.

Scenario modeling

Don't just build out a single scenario; build out the best, worst, and likely scenarios. Manage to the worst case, or at least have an emergency plan in place.

Bottom Up

Simply put – how are you going to achieve those sales? Avoid 'we only need to grow by x% every month to reach our goals’ type thinking. Or even worse, 'we only have to sell to 1% of the market to get to X.’

Look at your sales funnel and build from the bottom up. For example, we get 100 leads into the funnel weekly, book 20 meetings, 15 show up at the meetings, ten progress to the next step, and we finish with three purchases.

Not only are bottom-up numbers often more accurate, but they will help you identify spots in the funnel that you can refine.

Step 4: Managing Cash Flow

Cash flow is the lifeblood of your startup. Your runway shortens when you don't get paid. It's especially tough on businesses that send out invoices and await payment, But even subscription businesses, paid via credit card, can struggle with tracking cash flow.

For example, your MRR tracking may not show failed payments until much later. You may not see churn right away. Up-front payments are terrific! But your MRR may amortize the revenue and mislead you on the cash flow side. You may think more money is coming in monthly when you've already received some of it.

Wrap Up

Years of “cheap money” encouraged startups to burn through their runway to achieve market share. However, these days are over.Now, startups need to be cautious with their spending and concentrate on profits.

Businesses need to focus on cash flow, profits, and metrics like CAC payback period and growth rate. With valuations shrinking and down rounds on the rise, conserving capital has become essential for survival.

Until market situations change, it’s back to fundamentals and well-run businesses, which isn’t necessarily a bad thing.

Are you looking for a way to model your future while keeping an eye on the now? Dryrun might be a fit for you.

Clear, actionable forecasts in a fraction of the time you spend in spreadsheets.

Book your discovery call to learn about the Dryrun advantage.

 

See if Dryrun is a fit for you.