Monday, August 17th 2020 (9 months ago)
Particularly for first-time founders, fundraising poses one of the most daunting tasks toward starting a business. Far too often, we see brilliant founders make devastating financial mistakes while preparing for fundraising, particularly in the context of cash planning.
If your financial model is a roadmap, cash planning is the compass. Cash planning drives your fundraising goal, which essentially shapes your startup’s survival strategy. Above all else, cash planning serves as an early indicator of when your startup will run out of cash. However, founders frequently sabotage their own fundraise when they make these three cash planning mistakes.
When you over-forecast revenue, you over-forecast cash.
Many Founders have a tendency to generate overly optimistic revenue forecasts, even for internal cash planning. However, when you inevitably fall short of your revenue forecast, you ultimately fall short on cash. This not only jeopardizes the existence of your startup, but also leaves investors disappointed and dubious about the competency of your team.
If you’re generating revenue, check your growth rates and be realistic about the future of your company. Use your financial model to set realistic expectations based on your growth strategy, and regularly adjust based on monthly goals. For cash planning, founders should have a very high level of confidence in achieving revenue goals.
While we recommend using conservative revenue forecasts for cash planning, feel free to create more aggressive forecasts to showcase to investors. This gives you the ability to communicate upside business potential, while protecting yourself against missing revenue forecasts. To learn more about our insights on showcasing revenue potential, check out this post: Don’t Make These 3 Mistakes in Front of Investors.
Allocate cash toward unexpected expenses.
Some founders try to budget cash down to the penny, then fundraise toward the exact amount they think they need to survive. This next statement may shock you: unexpected expenses tend to come up when running a business. What seems like common sense often fails to translate during cash planning. Founders should always include “buffer expenses” within their fundraising goal to mitigate future risk.
As you plan your fundraise, determine how much cash you need to operate over the next 18-24 months. We recommend you add at least 20% to that number to calculate your final fundraising goal and protect your business against the unknown.
During your fundraise, you need to be able to illustrate your future expenses to investors to prove their money is essential to sustaining and growing the business. To make sure that your bases are covered, we recommend adding a “miscellaneous” expense that equals 2%-5% of total revenue buffer.
Always know when your startup will run out of cash without additional funding.
Otherwise, you are driving business with your eyes closed.
To truly understand the cash timeline, founders require a strong capitalization plan as part of the financial model. Fortunately, Forecastr wrote a blog post dedicated to this topic: Financial Modeling for Operations: Part 3 – Capitalization Plan. Your capitalization plan details the strategy that prevents you from running out of cash using fundraising target dates and specific cash amounts for raising debt and/or equity. If you adhere to a carefully strategized capitalization plan, you will better maintain good financial hygiene and accurately understand your cash flow timeline.
With a strong capitalization plan in place, founders can plan fundraising effectively. Generally, founders need 4-8 months to execute a fundraise. With this in mind, we recommend startups begin the process of fundraising no less than 8 months before they anticipate running out of cash. The longer you wait, the more likely you will undermine long-term growth without short-term cash stimulus. Even more, founders in a cash crunch lack leverage against investors. You should acquire funds from investors through a mutual partnership, not running out of cash with your back up against the wall.
Cash crunch may force you between two fateful scenarios: (1) accept terms far more favorable for investors than for the business, or (2) watch your startup die in the vine, devoid of cash.