When your startup burns more cash than planned
Everybody knows that in order to succeed, you need a good product, a skilled team, and winning technology. That being said, the difference between a company that shuts down and the next unicorn is proper financial planning, effective marketing, and the ability to combine the two. This is where most startups fail. Here's how to do it the right way.
The Israeli high-tech industry has not let two years of COVID-19 get in the way of growth. More so, this growth has left the world in awe. In 2019, just before the worldwide crisis hit, Israeli companies amassed a total of 7.9 billion USD in capital funding. In 2020, with the start of the pandemic, this rose to 10.4 billion USD. 2021 saw another unbelievable leap: investments in Israeli companies went up by 250% and totaled 25.6 billion USD.
Spearheading this phenomenon were startup companies. This translates into highly motivated, talented, and hungry entrepreneurs, with a creative idea, aimed at success. But not everyone succeeds. Actually, only 8% of startups make it past their first year.
This troublesome fact is caused by a number of different reasons, such as unsuccessful fundraising, inner conflicts between founders, a problematic business model, or a product that isn't ready or just isn't good enough. Sadly, one of the main and most significant reasons for this failure is plain and simple: they run out of money.
Why does this happen? The main reason may be due to the inexperience of the entrepreneurs in running a business. Proper financial conduct is a matter of experience, and so is developing an effective marketing plan. Most entrepreneurs have no idea how to synchronize between these two areas, and the result is inevitable.
Planning the revenue model
The most accurate term for describing this problem is "burn rate." The burn rate is typically used to describe the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations. Startup companies start operating, soon to find out that they are running out of money faster than expected. This leads to changes in their plans to penetrate new markets, impossible challenges in meeting goals in the face of a much smaller budget than planned, and eventually, it can lead to shutting down the company.
"In new startups, proper planning can prevent the consumption of excess cash," says Aviad Sorek, the founder and CEO of The Founders, a company that provides external CMO and CFO services for startups. "Entrepreneurs experienced with exits come to us with a good idea and brilliant technology – and that is what they need to focus on, managing and developing their product. A start up is first and foremost a business and, just like every business, they shouldn’t rely on gut feelings. It is very important to understand that the whole issue of income and expenses has to be based on existing clear models."
Which models, for example?
Sorek: "There are a lot of them of course, let me give you an example. There is a concept called 'Unit Economics.' In order to quantify a startup's ability to succeed, you need to calculate the profit from a single customer over their lifetime. This is called 'Lifetime Value' (LTV). You need to compare this number to the amount that the company has invested in getting them as a customer – 'Customer Acquisition Cost' (CAC). It is a pretty simple calculation: for every Dollar spent on CAC, you need to make more than a Dollar on LTV, and it's better to make at least three. That is unit economics. If the ratio is opposite, you're not doing well."
According to Sorek, most companies operating in the B2C model aspire to convert as many users as they can and are then amazed to discover that each new user increases their losses. This discovery usually comes too late, when most companies are already losing money.
According to Ana Lipnik Levy, a co-founder of The Founders and an expert in global marketing, the marketing aspect is a big part of the equation. "The marketing budget is probably the largest expense for a growing company, and each decision has significant consequences. In order to avoid spending too much money, and to correctly analyze reality, there needs to be deep cooperation between two particular divisions of the company – finance and marketing. Many companies don't do this."
What is the right way to do this?
"This is done in countless ways and everyday situations. But the guideline is open and continuous communication between the marketing and finance professionals. Marketing professionals need to relay their plans forward so that the finance division can manage the budget accordingly, anticipate significant expenditures, and know how to predict when and how the Return On Interest (ROI) will be reflected.
"I have met with dozens of extremely talented startups, and it is very important to have them establish methodical work procedures. Even if marketing is sometimes perceived as a gut feeling, an opportunity that cannot be missed, or as intuition. There is a lot to it, but first and foremost, there needs to be a clear path and strategy, and both long-term and short-term thinking. We are always running a marathon and a sprint at the same time.
"Operating from the gut causes startups to invest up to hundreds of thousands of Dollars that they don’t have, with nonexistent goals, in marketing channels that aren't right for their budget or brand. Often, less money can be spent on this with much better results, but it requires creativity and precision. For example, instead of purchasing media and creating high exposure, you can create a content collaboration and reach specific audiences.
"Already in the initial stages you need to work hand in hand with the finance team: to understand the size of the investment and timeframe, to plan the budgetary limits, and from that, to decide on the marketing budget. This is just a small example that demonstrates marketing as the beating heart of the company."
Planning the revenue model
"We help our clients make sure that their rate of expenditure is consistent with the company's business development, its operational pace, and its next milestone," explains Lipnik Levy. "For example, we teach them to fundraise with the purpose of reaching a specific goal: the revenue size, number of users, and so on. In addition, if we take care of both the finances and the marketing – we know how to effectively synchronize the two. Our end game is to allow the entrepreneurs to focus on what they do best, without worrying about the rest of it.
What is the difference between your company and a consulting firm?
Lipnik Levy: "We are a growth engine for startups at their most critical stage and when their budget is very restrictive. That makes us a services company and not a consulting company. We build the entire strategy and personally lead processes step after step. Of course, during the work process we turn into a type of confidant for the entrepreneurs and find ourselves consulting them in much broader fields, but our focus is on getting things done."
And on the financial side?
Sorek: "Here we are also very hands on. We provide the basis for the finance division in-house – accounting, payroll and more. On top of this, we add a professional layer of budget control, analysis of profit centers, providing tools for cash flow management, and helping to recruit investors. We have many skills all under one roof. Our entire team comes from very senior marketing and finance positions. Our collected experience is tremendous and unprecedented."
Lipnik Levy: "We have an internal dialogue in the company about each client. This gives us several perspectives, experience, and an opportunity for networking. You won't find anything like it anywhere else. Each marketing manager has a tremendous professional platform for brainstorming, consulting, networking, and for dealing with dilemmas. In the world of marketing there is great weight to experience and worldviews, and each move can be taken to so many different places, but with such a strong team, with so many specialties in different fields, we know how to base our decisions very well. Of course, this is where the input of the finance team comes in, to know how it all synchs with the cash flow and the financial predictions. It's a privilege that no other company has."
What do you think is the main difference between outsourcing services and managing activities in-house?
Aviad Sorek: "The in-house model allows for ongoing discourse among the different divisions in the company, and that is definitely a huge advantage. But we are talking here about companies that are just starting out. For these companies, using outsourced services is the best way to stimulate true growth. This is where the additional connection that we offer comes into effect: thanks to the management in the marketing division, we know how to give recommendations that aren't disconnected from the company's financial abilities. As for finance, we provide recommendations that consider the company's long term marketing needs."
Lipnik Levy: "We have a real privilege of working with so many agencies. Each one has specific professional expertise that allow creating a broad range of strategies in a few different verticals: cyber is not conducted in the same way as AI, Fintech, or Medtech. We build our operations with the strongest team for each client, according to the technology, the market, and the company's dynamics."
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