Cassandra of all startups = cash, its predictability, and timing

Once-flying technology unicorns are having their wings cut as the era of free money comes to an end.

Layoffs and bankruptcies are regularly occurring in the startup and technology industries during 2023.

Mark Suster, General Partner of Upfront Ventures and one of the best VCs with profound startup experience, believes that 50% of the 5,000 early-stage startups funded in the last four years will fail and shut down. He also claimed that failure rates were low due to simply having too much capital in the past.

For investors concerned with entry and exit points, valuation is critical.

The multiples used to determine startup valuations last year or before were not the same as the multiples used this year.

Founders must exercise extreme caution now that cash is scarce rather than excess.

I won't go into the reasons why money is scarce because there are plenty on the internet.

The biggest VC nonsense is that "when we look at the public markets, we can see that valuations are around half of what they were last year," which has been partially neutralized by the Nasdaq reaching its peak levels in July and August 2023. However, some technology companies are still far from their highest prices. Twilio, Hubspot, and Docusign are a few examples.

The scarcity of venture capital funding and pessimistic stock market valuations have resulted in a severe downturn in high-growth tech startups and stocks, affecting startups raising funds at lower valuations in so-called "down rounds."

Startups that could previously raise capital at higher valuations are now seeing their valuations plunge, limiting their ability to attract new investors.

When you're in survival mode, a down round - or raising money at a lower value - might be your best option. Because you need money to survive.

Down rounds, according to the founders, are preferable to going out of business.

Down-rounds can have serious consequences because they dilute current shareholders' ownership interests and harm investor confidence.

Naturally, it can be painful, particularly in an industry where high values may indicate future promise. Lower values indicate an uncertain future.

However, you may have to retreat in order to grow later.

The truth about down rounds is that shit happened and you were caught off guard.

You are unprepared because you do not have any cash.

And the management team's failure to anticipate this moment of failure is their fault.

Most of the founders of the startups mentioned above by Mark Suster are either overly optimistic or financially ignorant.

That is why they will fail.

Not understanding the value of cash, timing, and type of cash clearly is a problem for founders

Understanding basic finance and accounting, at least to the level of cash flow management, should be one of the top priorities for any founder who wants to improve their chances of success on their journey.

The first thing that founders should keep in mind about money is that there are certain things a business needs to do to operate, survive, and grow, and these cannot be done without cash.

You can’t rent a place. You can’t hire employees to develop or sell your product. You can’t run marketing campaigns to acquire users or customers.

Making revenue by selling/monetizing products or services and obtaining investment money are the two most common ways for businesses to obtain cash. The third and most relatively rare is borrowing through bank credits and loans.

Money is, at its essence, a measure of a company's options.

During the early stages of a company, the founder can learn the value of current or future cash by making and evaluating business plans on multiple fronts, such as hiring, building products or features, marketing and sales, fundraising, and investor relations, as well as asking and answering specific, detailed questions about these topics while keeping the company's financial situation in mind.

The best option is to assess the situation on a regular basis based on the startup's most recent position changes and update these estimates once a week, and once a month is the next best option.

This is called "forecasting," in short.

The answers to questions like these can help predict the resources a company will require in the future.

• Why will there be a need for cash and what will it be used for?

• When exactly is it that the cash will be required?

• Is the incoming or outgoing amount certain?

• Is this a recurring payment? Or one time payment?

• Is there a less expensive way to accomplish this?

• Is it possible to meet the need without spending money?

• What is the expected outcome for the spending? In the event that there is some kind of expectation for a return, what kind of return is to be anticipated and within what kind of a time frame?

While considering all of this with a critical and contemplative eye, the founder should keep in mind that running a business cannot be done if there is no liquid cash (cash in your bank deposit account) at the time of expense payment for those items in the operational list given above.

As a founder, this may be the best vantage point for consolidating the true value of cash.

Value of timing for the value of cash

Founders can get a more accurate picture of a company's finances by taking into account the timing of income and expenses, as well as a few other factors.

When waiting for payments from customers or users, cash flow issues may occur.

Customers in some industries will pay you not on the same day as their purchase, but at a later date.

Invoices and sales contracts that forecast future cash flow are not considered "cash" until they are deposited into a bank account.

Don't try to spend money that hasn't yet arrived in your bank account—because you can't.

You can't pay your bills or invest in your business with money owed to you by customers but not yet received.

You must consider this aspect of timing when forecasting and calculating how much money you'll need and when.

The level of urgency of cash needs will range from "immediate" to "not urgent," and how it needs to be allocated at different departments of business operations will change constantly as new business developments force the company to move between stages and change its short-term and long-term goals.

Even though a company's cash flow statement is the best way to find out about its current cash situation and ability to meet both short-term and long-term obligations, both the balance sheet and the income statement can be used to learn more about the current situation of the business and make projections for the future.

As a result of the revenue method, the company's cash flow can benefit from careful consideration of the timing and collection of incoming amounts.

Revenue models, startups, timing of cash

When a company uses non-traditional ways to make money, like subscriptions, where money comes in on a recurring basis and is spread out over time, it can be hard for the founders to do even the most basic accounting and financial calculations.

Subscription models generate revenue that is more stable and predictable over time than traditional models in which customers pay a one-time fee. This predictability has significant implications for businesses in terms of financial planning and forecasting. However, there are some drawbacks to this model.

In subscription-based businesses, growth compounds over time, but income comes in slowly and is delayed.

The term "retention" refers to a company's or product's ability to keep its existing customers/users, which plays an important role in increasing the value coming from the customer, in other words, not losing them.

Customers become more valuable the longer they use a product or service. Each month or year that a customer remains a subscriber or paying customer, the company earns more money. It is critical to keep customers happy and satisfied in order to make more money.

When using the subscription revenue model, the payback periods for acquisition costs can be spread out over a longer period of time, which can be a problem.

A customer costs the company $100 to acquire through marketing channels, but the company only makes $10 per month from monthly subscription prices. This means that it takes ten months for each customer to pay for itself, and in the eleventh month, the customer starts making profit for the company. This will eventually lead to a cash flow problem.

Financing company operations and a long payback period until customers start bringing in profits while trying to get as many new customers as possible by spending the highest possible amounts for customer acquisition based on the company’s available cash, market conditions, saturation levels, and the costs a business tries to grow requires serious financing for the company.

Startup companies that can grow fast and consistently go through this cycle very often and for a long time. They must pay for growth based on predictions that will be proven in the future if the company uses a subscription revenue model. And then have to pay more to maintain future growth.

When a company's current cash flow or cash reserves aren't enough to fund its operations as desired, it can resort to debt financing, which includes borrowing money or using financial instruments like business loans or business credit cards with instalment payments to generate more available cash. The second option is fundraising by using your company’s equity, in which you trade your company's shares for cash with investors.

Subscription-based business models and those that don't rely on a one-time payment method but instead get money from customers or users in smaller amounts over time (mobile gaming or SaaS companies are a good example of this) have to deal with long payback periods for their acquisition costs, which carries a risk for the business.

When using a subscription revenue model, a customer's decision to cancel their subscription to the service or product earlier than expected can cause the business to stop making money. If the business stops making money, it will no longer be able to get back its acquisition costs, and it will begin losing money, which can have a significant impact on the timing and amount of cash available to operate.

This type of revenue model for businesses carries the risk of losing money because it defines customer acquisition target prices and limits based on historical data focusing on customer retention, including details such as average revenue per user/customer level (arpu/arpc) and payback time periods. Of course, businesses with more traditional revenue models face this risk as well, but they see results faster because all of their revenue occurs in a single transaction after the customer is acquired.

Many mobile gaming companies were damaged by this fallacy in 2021 and 2022, as they set acquisition target prices and limits based on the highest levels of ARPU from earlier time periods when the Covid-19 virus forced people to stay indoors all the time, resulting in unprecedented daily active game play times for a year.

ARPUs fell as the Covid-19 virus and its effects became less effective, resulting in shorter average game play times and lower retention.

However, some mobile game company owners or decision makers (managers, directors, and VPs) at these companies were mistaken in believing that high ARPUs would continue, or even rise, and they continued to spend irresponsibly to acquire users with the highest level user acquisition target prices based on curfew days, despite the fact that people began going outside and socializing instead of playing games at home.

When they realized that previous active user levels and life times were no longer valid, resulting in a 50% or greater decrease in average revenue per user than before, their companies suffered significant losses while aiming for profits and growth in 2022.

I'm sure that they wished they had a Cassandra.

Revenue cycle predictability and cash requirements

The unpredictability of the situation in subscription-based business models makes it much more difficult to get a clear picture of not only the financial tables but also the actual unit economics and financial requirements of the company in the future. Especially in the early stages of a company, when general numbers such as acquisition costs, acquisition payback (return) times, and customer life times are still being determined over time through customer data accumulation.

A quick change in the market, target audience, their needs and preferences, or competition can easily cause a change in customer lifetimes and values where a company pays too much for customer acquisition and receives revenue that is less than their customer acquisition cost anytime.

One could also argue that subscription-based business models are more predictable, and she may have many valid points. But can't refuse risks.

When you know how much it costs your company to acquire a customer and how much money they bring in within a specific and guaranteed time frame, things become much clearer and more predictable. For businesses, guaranteed means proven over a longer period of time and with more data.

This is in contrast to the situation in which you do not know how much it will cost to acquire a customer or if you will be able to acquire them, as well as how much revenue you are going to make from them, where the risk is higher with higher unpredictability.

Cash and its details, such as predictability and timing, are your startup's Cassandra. Because predictability implies the ability to make accurate forecasts (or prophecies) in which risks are managed in a healthy manner. This may help you avoid having to do down rounds by being prepared.

When cash flow problems arise and the company requires funds, knowing the current state of the revenue cycle can assist the founders in determining whether to use debt financing (loans), equity financing (fundraising), or other options such as investing their own money. And the management team's failure to anticipate this moment of failure is their fault.

When things are uncertain or dark, getting investor money with a down round is a good option.

In another article, I'll explain which one may be a better financing option for your startup or small business, as well as reasons that can make a difference between the two, depending on the situation. But the predictability of a profitable revenue cycle is the key.

In some other businesses with traditional revenue models, things can become complicated due to timing, and again, cash turnover can become a problem.

The more products or services the company sells, the more money it needs to operate and produce to grow.

The difficulty for companies with this revenue model may come from having difficulty getting paid right away by their customers, where revenue turns into account receivable or even accrued revenue.

When a company invests money in production, marketing, and sales in order to bring in customers, and when those customers make purchases, the company earns money but does not receive it right away. The "accounts receivable" are a record of these delayed, uncollected revenues.

They have been earned and billed, but the money has not been received.

This makes accounts receivable an asset because it represents money owed, not money held.

The money is not yet in your possession, but you are closer to obtaining it.

Even though this is a problem, the company still has to run and pay for its operations.

After the client pays you the money they owe you, you'll need to change your financial tables and accounting to show that amount has moved from your accounts receivable to your cash balance.

Money is now available in your bank account as liquid cash, ready for use.

Furthermore, if your production requires a large amount of prepayment or immediate payment, you may still encounter problems as customer orders grow and you need to pay for production first but make revenue after sales, even if the customer pays at the time of sale.

Understanding the timing of incoming and outgoing cash in the business by depicting revenue model realities can help founders identify cash needs and bottlenecks more effectively before they occur.

Where they might not require a down round.