VC Cliche of the Week
The single most important financial metric for any startup company isn’t revenues, margin, headcount, or profits. Those are all important, for sure. But the number that matters most is the cash balance.
Because cash is king.
I know that in some markets cash is trash, but in the venture capital business cash is always king.
Alan Shugart once said, "cash is more important than your mother."
That’s because you can’t pay your employees, your rent, or your suppliers with revenues or profits if there is no cash. And that’s a very possible scenario.
I know a couple guys who have built a very nice business here in NYC. They bootstrapped the whole thing. A very impressive feat. They are making good money on paper. But they are constantly cash strapped because they are growing so fast that they can’t collect their revenues as fast as they are spending to grow.
I didn’t learn much in business school, but I did learn a bit about reading a financial statement.
And financial statement analysis, at least the way they taught it at Wharton, starts with the cash balance. If you want to know how much money a business is making, start with the current cash balance and subtract the cash balance from the start of whatever period you are analyzing.
That’s the cash flow, positive or negative, for that period. That is the crudest way to measure profits there is and in many ways it is all that really matters. Particularly in a startup business.
Because allthough you have to back out changes in every other balance sheet item to tie that number back to net income (the accountant’s true measure of profitability), at the end of the day you gotta have cash to be in business. So it may feel good to see profits on paper, but if they aren’t appearing in the cash balances, you’ve got a problem.
Sometimes that problem is bad or fraudulent accounting. The best way to find fraud is to look for companies that are reporting growing profits but have declining cash balances and are constantly in need of financing. That’s a house of cards ready to come tumbling down.
But back to the startup business. Cash is everything when you aren’t profitable. Most of our companies that produce monthly reporting packages report a "cash out date" which is the day they run out of cash absent another financing. It’s not a problem that they have a cash out day because most of them are doing very well meeting their milestones and will have no problem doing another round of financing.
But the startup game, when played with VC money, is all about making the business significantly more valuable from one financing to another. If you can’t do that, you (the entrepreneur) are going to get seriously diluted. And though many entrepreneurs believe that VCs secretly hope for that scenario, it’s not true, at least with high quality VCs.
All investors benefit from smart financial planning and sound fundraising strategies. The best companies have been built with strategies that have been equity efficient for both the entrpreneur and the VC.
And that means watching your cash carefully, knowing how long it is going to last, and making sure you build significant incremental value before you run out.
Because cash is king and always will be.