Startup Fundraising 101: The Pros and Cons of Different Sources of Funding

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By: Matt Ward

Originally published on medium.com

So you’re raising money for your startup. You have a product and a little traction, and now you need to grow.

Who do you talk to?

How do you get the round closed as quickly as possible without screwing your long-term prospects?

You don’t know what you don’t know. Let this article be your intro guide to fundraising. The right partners make all the difference.

“Diamonds Are Forever”

This is one of the most successful marketing campaigns of all time. De Beers (the evil diamond company from “Blood Diamond”) convinced women and the world that without a diamond, the marriage wouldn’t last — the man wasn’t serious.

You have to put your money where your mouth is, so to speak.

And startups are a bit like a marriage. You’re “stuck” together for life, and it can be awesome or awful — it depends on the partner. And since the average U.S. marriage before divorce is eight years, it equates very nicely to the startup-investor relationship.

I’m not cynical enough to say you should spend as much time dating investors as seeing a significant other before getting hitched, but keep this in mind.

Remember, business partnerships are like a marriage, and they aren’t always fun.

Sources of Funding

Other than bootstrapping your business, money from friends and family, and loans or grants, there are four main sources of fuel for your startup:

  • VCs
  • Angels
  • Angel groups
  • Syndicates

This article will cover everything you need to know about these four options.

The Four Sources of Startup Capital

1. Venture capitalists

Let’s start with the obvious one: venture capital.

Venture capitalists manage large pools of money — think several million to several billion dollars in assets under management (AUM). VCs operate what are called funds, and they typically have approximately 10-year lifespans (plus options for an additional two years).

They fundraise, just like startups, but from bigger, wealthier players. Traditional LPs (limited partners — the people investing in VC firms) include pension funds, university endowments, family offices, and ultra-high net worth individuals (UHNWIs). In some regions, like the Nordics, the Middle East, and China, local governments invest in ventures as well to both drive ROI and boost the country’s economy.

2. Angel investors

Angels, unlike many VCs, start not as investors, but as operators in the industry. Whether as entrepreneurs or employees, angels are individuals that accrue significant wealth. They should have a minimum $1M net worth (excluding their primary residence) or greater than $200k per year in income for at least two years. They then reinvest their capital in upstarts. Some angels shoot for returns, and others just look to give back.

A wealth of angel investors is the mark of a healthy startup ecosystem. The more successful founders exiting and reinvesting into the next wave, the greater the density of talent, innovation, and successful outcomes.

3. Angel groups

As the name suggests, angels often form groups. There is power in numbers, and groups of angels can cut larger checks, get better terms, spread out due diligence, and leverage larger networks to help startups succeed.

Typically, angel groups charge anywhere from $100–$1000 per year in dues. These dues help run the network and manage events.

4. Syndicates

Ever since the JOBS Act in 2012, the world of investing has been very different. This bill created the ability to form special purpose vehicles (SPVs) to invest in companies. Syndicates use this structure to allow groups of up to 99 investors to invest in startups via a single SPV — meaning only one addition to the cap table.

This helps startups keep cap tables clean (a big must for later financing) and reduce legal work. The syndicate cuts a single large check (rather than lots of little ones from angels/angel group) and still provides a sizable investor base of folks with networks and skillsets that are often willing to get their hands dirty.

Carry and Management Fees

One last concept to understand before diving deeper into the pros and cons is the incentivization structure. Knowing investors’ incentives helps startups level the playing field.

You’re probably thinking, “The only thing that matters is massive outcomes, right?”

Wrong.

Because VCs manage money for you, they typically earn the most. Generally, VCs employ a two and 20 model, meaning they get 2% management fees and 20% of carry.

Management fees are based on AUM (assets under management). For small firms with a $10M fund, that equates to $200k per year in fees — to run the fund, source companies, and support investments. Seems reasonable.

It gets more interesting the larger the fund gets. On a $100M fund, it’s $2M per year. For a $1B fund, it’s $20M per year.

That’s the reason VCs are almost always looking to raise larger funds. The bigger the fund, the better the management fees and the bigger their paycheck.

But we can’t forget about carry. Carry is defined as the difference between money in and money out.

Examples work better here. Let’s say a venture firm invests $1M at a $10M pre-money valuation. That means they buy 1/11th of the company (investment divided by pre-money valuation plus cash infusion).

Now, fast forward 10 years. The company is crushing it and is now valued at $1B. And let’s say Facebook buys them because Zuckerberg wants to kill the competition.

Well, that’s 100x return. If we assume the company never raised more money (just to simplify dilution, they probably raised more money), then 100 times $1M is $100M.

The difference between the initial investment and the result is $99M. The carry, typically 20%, is paid off of this.

So the VC firm earns an additional $19.8M in carry. That is the concept of carry.

Of our four groups, only VCs and syndicates usually charge investors carry — both generally at 20%.

And only VCs have management fees. Now that you know the basics, we’re ready to look at this from a startup perspective.

The Pros and Cons of Each Investor Class

For a detailed understanding, we should break down the important criteria startups have when fundraising. Then we can evaluate VCs, angels, syndicates, and angel networks to see how each stack up in terms of founder friendliness.

The 11 criteria to consider:

  1. Decision speed
  2. Investment size
  3. Price
  4. Control requirements
  5. Outside help
  6. Industry experience
  7. Ability to follow-on
  8. Bureaucracy
  9. Liquidation preferences
  10. Common problems
  11. Help with future fundraising

Note: All scores will be generalized across the investment sector. Individual groups, firms, syndicates, and angels are all different. We’ll work off of the average.

1.Decision speed

As a startup, you need money now. Although planning your raise in advance and having six months to prepare and close is ideal, you probably procrastinated. You probably need money, and you need it now.

Your burn rate is tough. There isn’t a ton of cash in the bank and even the ramen is running out. Who do you turn to?

Angels — The fastest investor is almost always the angel. Angels can cut checks after just coffee — it’s their money. They can do what they want with it.

Syndicates — After angels, syndicates come in second. Syndicate leads can quickly decide on deals and share them with their investors. Typically, syndicates will run two to four weeks, but hot deals close fast. But as a founder, as long you know the allocation will be met, an extra two weeks isn’t a huge deal.

VCs — Venture firms are often slow and bureaucratic, but they can move quickly when motivated to do so. For hot startups and fast-moving deals, VCs can push investments through and, pending due diligence, be done nearly as fast as syndicates. Typically, though, they are a bit slower due to processes in place.

Angel Groups — Angel networks are definitely the worst here. While there are some fast-moving ones, many groups only have pitch events every few months or every quarter, meaning entrepreneurs often need to wait. And even if angel groups are a go, convincing enough members to cut checks can slow the process down further.

2.Investment size

While speed is great, you need runway even more. A $25k–$50k check might buy you a few months, but if you get $500k–$1M you’re suddenly set until your Series A. The check size impacts how many investors you need onboard, crowding on the cap table, and the number of meetings you need to schedule to complete your close.

VCs — Venture firms usually cut the biggest checks. They typically have ownership percentage targets they need to make the economics of their fund work. Most VCs want every investment to be able to return the fund. So if that is 50 investments per fund, they need companies that can go 50x. All VCs will vary on check size, but most early-stage firms cut at least $250k checks, with many going north of a few million.

Syndicates and Angel Groups — This one is a toss-up. It depends on the size of the syndicate and angel groups. Some syndicates on AngelList like Gil Penchina’s Flight Ventures have close to $10M in backing. They can cut big checks, but it doesn’t always work that way, though. The same is true for angel groups. Here, the minimum investment size plays a huge role. Many syndicates (ours included) let investors invest just $1k to get in on a deal. This empowers investors to participate, but due to the 99 investors clause, this can prevent massive check sizes. Typical max for a syndicate or angel group will be approximately $1M–$2M, with the average closer to $200k–$300k.

Lone Angels — Unless you’re dealing with UHNWIs, most angels cut relatively small checks — $5k–$100k. It’s possible to get more from a single angel, but it’s pretty rare. With angel investors, don’t forget the legal work required to process checks and update cap tables. Often small investments under $5k–$10k don’t make a ton of sense, especially after the initial Friends and Family round.

3.Price and valuation

Dilution is potentially a big problem for founders. When negotiating, remember a small piece of a big pie is better than a personal pan pizza. Startups are all about outsized returns. For example, 1% of Uber would still be worth $700M today (unless they crater — I think Uber may be in big trouble).

In terms of valuation, though, startups can get screwed. So let’s look at how each class of investor handles valuations.

Lone Angels — Angels are often the least price sensitive. Many are involved not for economic reasons, but to give back, or even for their ego. They want to be able to say, “Yeah, I invested in XYZ startup!” Because of this, startups can often get higher valuations when negotiating with individual angels as opposed to other groups. The investors have less negotiating power and generally less insight into the industry and comparables.

Note: Don’t take advantage of angels. Raising at too high of valuations can hurt downstream financing opportunities. No one wants to have a down round.

Angel Groups — Angel networks are more sophisticated than your average angel and are often able to lead a round. They will be more realistic about valuations than lone angels as they place a larger focus on returns for their members. And as they cut larger checks, they can negotiate for better terms.

Syndicates — Syndicates, even more so than angel groups, have pricing power. Because syndicates invest faster, typically with similar or even larger check sizes, they hold more power than angel groups. Syndicates are very focused on returns, especially upside, as the carry is the incentive that syndicate leads really benefit from.

VCs — Venture capitalists usually are the most valuation sensitive (although some recent firms, like Andreessen Horowitz, frequently overpay to get in on the best deals). VCs need to provide returns to their investors to increase AUM and subsequent management fees. In the past, VC was dirtier and much less founder-friendly. Today, though, the valuations are not that dissimilar from a syndicate.

4.Control requirements

Most founders hate giving up control. Between potential conflicts on direction and being forced into unfavorable terms, it makes sense. And if you look at some of the most successful tech companies of today, many like Zuckerberg and Bezos have maintained their control over their companies. This allows the founders (and not investors or board members) to steer the ship and drive returns.

Note: This is not to say governance is bad. Board members can be incredibly helpful, especially for accountability and future focus.

Lone Angels — Most early angels will not take a board seat or have much in terms of control. They will offer guidance when needed (and occasionally when not needed). But all-in-all, they leave the running of the startup to the founders.

Angel Groups and Syndicates — Both angel networks and syndicates require more terms and control than individual angels, but still typically very little. Some may require board seats and most will push for pro-rata, information rights, and updates. But it’s still much less of a confrontational relationship. Angels groups and syndicates usually get out of the way and leverage networks and experience wherever possible to help.

VCs — Surprise, surprise. Venture capitalists are the pickiest when it comes to terms. They have fiduciary responsibilities to their LPs and partners, and they’ll do whatever it takes to drive outcomes. Most VCs, especially from Series A onwards, will require boards and possibly even board seats. This can work out great. It can also result in founders getting ousted. And pretty much any VC will demand pro-rata, information rights, and other clauses to protect their investment.

5.Outside help

Investors always talk about adding value to founders and being founder-friendly. Sometimes this is the case, but sometimes it isn’t.

VCs — At least on paper, VC firms have the most resources to help founders. With management fees, many firms hire advisors, and technical specialists work with founders on their business. It can be a very hands-on investment and the best VCs (like Social Capital) go to work for their founders. They leverage their network and help with hiring and intros, including future fundraising opportunities. That isn’t always the case, though.

Angel Group — I ranked angel networks slightly ahead of syndicates as their members are typically more engaged. Members invest in fewer deals and are often locally present to work with and help founders. This creates strong regional support networks that can be vital to growth.

Syndicates — Syndicates, like angel groups, have large member bases and skillsets. The best syndicates deploy their members’ networks and skills for the greater good of the portfolio. Unfortunately, many investors don’t meet their investees. The relationship can still be quite good, tapping networks and helping with growth, but it has room for improvement.

Lone Angels — Last and certainly least is the individual investor. They will likely tap their network, help where they can, and be able to meet for coffee — but two heads are better than one. There is only so much a solo practitioner can do for startups.

6.Industry experience

Much like outside help, industry experience is essentially the same. The one difference being that syndicates and angel groups would score the same.

7.Ability to follow-on

You’re probably going to need more money. Investors that follow-on fuel growth and make fundraising much easier.

VCs — Venture capital portfolios are usually predicated on follow-on investments. Funds typically reserve 50%–75% of the fund for follow-on investments (although this varies by firm).

The reason is simple. In a world of power-law returns, doubling down on your winners drives the biggest ROI. And because VCs have the biggest chip stack, they can keep doubling down.

Syndicates — Because syndicates are composed of a large pool of investors, there’s a lot of capital at play. Syndicates will typically at least exercise pro-rata to maintain their equity position. And since every investor only contributes a small percentage of the round, it’s relatively easy to raise some follow-on funding.

Angel Groups — Angel networks are less likely to follow-on than syndicates. Between the time commitment of pitch events and reduced focus on ROI, many groups will pass on pro-rata.

Lone Angels — Individuals investors only have so much cash. And most either do not think through follow-on funding strategies or reserve capital. As such, it can be hard for founders to get early investors to contribute more or float a bridge round.

8.Bureaucracy

Raise your hand if you like politics and drama…

Lone Angels — Solo investors definitely win this category. They have no accountability and can cut checks over coffee. Plus, there are no politics over who gets funding or carry.

Syndicates — Although not as nimble as lone angels, syndicates are pretty straightforward. A syndicate lead finds deals and offers them up to the group. In these instances, the lead’s reputation often plays a big role in how many members invest. The lead also has to encourage their investor base to join, without underselling the risks. This can be tricky, as syndicates only earn carry — meaning that reputation aside, they’re encouraged to do as many deals as possible.

Angel Groups — Between the processes of angel networks, dynamics between members, potential rules/guidelines on investment criteria, location, and etc., angel groups are a bit more complex than syndicates. Often, this complexity corresponds to slower investment decisions — not ideal for founders.

VCs — Most venture firms are great, but there are certainly politics at play between GPs (general partners — i.e. managers of the firm). These vary from firm to firm, from how voting occurs to differences in incentives. An obvious example: if part of a GP’s carry/incentives comes from deals they source themselves, clearly there’s a conflict of interest. That GP is always more likely to vote to fund their own deal flow…

Similar issues can occur with partners having veto power and/or control of a firm. When raising from VCs, expect a minimum of three meetings (and understand how decisions get made). Typically founders won’t get a ‘yes’ before pitching at a full partner meeting.

9.Liquidation preferences

You would think that all parties are aligned here — just build a big business and the rest falls into place. Unfortunately, it isn’t that easy.

There are many classes of stock and terms affecting outcomes. The most important to consider are Preferred and Common classes of stock. In a nutshell, preferred means I get my money out first and usually win (or lose the least) even in bad outcomes.

Note: Founders and early employees have common shares, whereas some investors demand preferred shares (to protect against downside risk).

That can mean founders sell the business and still end up with nothing. For a more detailed explanation on liquidation preferences and share classes, see this post.

Lone Angels — Individual investors are often the least savvy and/or cutthroat when it comes to liquidation preferences and terms.

Syndicates and Angel Groups — Both of these investor networks have more experience and battle scars from past investments. This puts both groups in a good position to both understand risks and leverage capital to receive more favorable terms, and often Preferred Shares. These will be less “preferred” than future Series A Preferred, Series B Preferred, and etc. shares, but they still provide a measure of protection for investors in event that things go south.

VCs — Venture capitalists are the toughest on terms and liquidation preferences. Most will fight the hardest to secure their investments, often with additional icing on the cake in the form of multiples (2x multiple: invest $1M and receive $2M) or participation rights (double dipping — receiving money back, plus an equity percentage of leftover capital). As a rule, avoid participation rights, especially pre-Series A. These terms can cripple startups’ ability to raise and leave founders out to dry.

Note: This isn’t legal advice. Talk to a startup attorney, protect yourself.

10.Common problems

VCs are the only real troublemaker in the group. Angels almost universally write off investments, assuming every check will go to zero.

Unfortunately, as VCs have LPs, many venture firms play hardball. Venture funding is fuel — you either take off or get burned.

Things to look out for:

  • Full ratchet anti-dilution — This stipulates that investors will retain their equity position while founders/team will suffer all dilution. It creates a horrible situation where founders lose equity and motivation to continue.
  • Board seat control — When VCs or external parties control the board, founders find themselves at the mercy of the board/investors. This can cause problems, from firing the CEO to acting in the investors (and not the founders’/company’s) interest.
  • Unsustainable growth focus — VCs need investments to be able to return the fund. This can force startups to try and grow at unsustainable rates and ultimately handicap the businesses.
  • Liquidity requirements — Most VCs operate 10-year funds, with an additional two years of optionality.
  • Too much capital raised — Yes, you read that right. Startups can raise too much money, greatly reducing liquidity options. The more you raise, the more you need to be able to sell or IPO for, or the investors lose.

11.Help with future fundraising

VCs — As full-time professional investors with resources and network of the entire firm behind them, VCs are incredible for future fundraising. Between follow-on checks and warm intros to later-stage firms, a VC’s business is built on connections.

Syndicates and Angel groups— While VCs are typically closer with other VCs, syndicates and angel networks have lots of members, each with their own broad network. And for angels that do this for a living, they focus on building the same connections to later-stage funding.

Lone Angel — You don’t know who you don’t know.

The Results

So, who comes out on top? Adding up the points, here’s how they stack up. The fewer points, the better.

  1. Lone Investor and Syndicate (tie): 23 points
  2. VC: 24 points
  3. Angel group: 25 points

If this seems counterintuitive, it’s because it is. There’s no one best way to define an ideal investor. Each group brings something important to the table.

Arguably, individual investors will be the earliest and VCs will come in last. From a funding perspective (arguably the most important variable), angel groups, syndicates, and VCs are all on par in the earlier rounds (pre-Series A). After that, VC money is a must if you need to continue raising.

Of the two most comparable investor classes, syndicates and angel groups, our analysis would lead us to believe that syndicates are a slightly better funding partner. I would tend to agree. As a syndicate lead myself, I see syndicates as the future of investing. SPVs won’t kill venture, but syndicates will continue to take an increasingly large chunk of early-stage investments.

And as angel groups generally have little-to-no upside but come with increased complexity for investing, one would assume more and more angel networks will go the syndicate route.

Closing Thoughts

Hopefully, this breakdown gave you a better understanding of the venture landscape. Knowing the players, how they work, and what to look out for is critical to startup success.

So, look through our list. Which of the 11 are most important? Certain criteria like decision time, investment size, and control requirements are often make-or-break for founders. The same is true for investors.

Pick apart your priorities, and plan your fundraising accordingly.

Note: Having good investors in different classes of venture is recommended — don’t put all your eggs in one basket.

How to go from Seed to Series A

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By: Pourya Moradi

At Think+, our primary goal is to help our portfolio companies go from Seed to Series A as smoothly and quickly as possible. Every round comes with its own specific set of challenges, but what makes series A particularly challenging is that traction alone is not enough and you need to show predictability, scalability, and repeatability.

We meet countless entrepreneurs who found enough early adopters to get to a million-dollar revenue, which leads them to believe the product is enough and they start chasing more revenue by going after low hanging fruits rather than building a process and an infrastructure to capture broader market opportunity.

Below are just a few points to consider before raising series A.

  1. Develop a winning go to market (GTM)

In my last piece, I wrote about how to achieve product-market fit (PMF), but that is not the only thing you need to build a $100M+ business. You should think about your GTM, and define your channel, and sales strategy.

Take for example Stripe — which is now at a $20B+ private valuation! Back in 2010 they identified that the existing platforms for payment processing absolutely sucked! The process was manual, approval required phone calls, and the code/UI/UX left a bad impression with the users of eCommerce sites. As they went through steps 1–3 (identify, unpack, and analyze a pain point) and followed that up with step 4 (market timing), they realized the best place to go was to go to developers of mobile apps that wanted to do in-app payment processing.

This fundamentally changed the game plan! They didn’t have to hire an enterprise-class sales force and go haggle with walmart.com and hundreds of other enterprise-class websites and waste tens of millions of dollars on a direct sales force. They focused on developer conferences and hackathons and a freemium model that grew through a community.

To do this well, you should:

A) Define your market:

· Which markets have the biggest and most urgent pain?

· Where are there gaps in the market?

· Which markets are most aligned with your product’s core value?

· Which markets can you most easily reach?

B) Define your channel (How you link your offering to your customers):

· How, where and why do your prospects choose to buy?

· What are the most effective ways of connecting with your prospects and generating qualified sales opportunities?

· What is the right distribution model/channel based on your core value proposition?

· How does your offering fit with your target markets and channels?

C) Choose a sales strategy

No one method will work for every product or market, so it’s important to consider the price, complexity, scalability of your offerings. There are generally four go-to-market sales strategies, each one catering to a different product and business model.

I — The Self-Service Model: Customer makes a purchase on their own.

II — The Inside Sales Business Model: Prospect is nurtured by a sales rep to convert into a deal.

III — The Field Sales Business Model: You have a full sales organization that closes large enterprise deals.

IV — The Channel Model: Outside agency or partner sells your product for you.

2. Focus on quality of revenue:

If you’ve built a product with a core value proposition that resonates with your customers, you might get some early revenue, but what’s important to Series A investors is the quality of revenue (i.e. scalability). To make sure this is done well you should:

a. Implement data and analytics early on so you can measure where your revenue is coming from, how many times are users performing the core action on the expected cycle. Set up tools required to understand your customers’ behavior and your unit economics as it will allow you to see how you progress and what’s working or not.

b. Focus on engagement and retention as opposed to “pure acquisition”. People think if you increase acquisition, it’s enough, but engagement, activation, and retention are more important than just pure acquisition. You should build a core value and get people to experience it as frequent and as soon as you can.

c. Invest in infrastructure early on before you start to think about scaling. We often get founders that have noticeable revenue but they have focused on attaining low hanging fruits and that gets us worried whether the model is scalable.

3. Focus on sustainability:

Because of an abundance of capital, especially in the seed stage, many companies focus on “growth at all cost”. They use “hacks” to gain momentum without focusing on the process. You should focus on building a capacity that gets you to $100M+ revenue instead of rinsing and repeating what has worked for someone else to get to a few hundred thousand in revenue. Many might be in a market niche for a service or product that grows without much effort, so it deludes founders to just ride the wave without having a clear plan to manage growth.

That’s why a process and having a playbook is so crucial. It might feel like unnecessary overhead and a counterintuitive of two key competitive features of startups: adaptability and speed, but what makes a successful business is the combination of a unique set of variable that work together that translate into growth. A process will enable you to uncover those unique set of variables and will help you find out what’s working and what’s not working.

To prepare yourself for sustainable growth, you should:

· Find the “right” channels that allow you to scale customer acquisition

· Set the right goals/ metrics — this shouldn’t be too short term and not tool long term and that really depends on your sell cycles

· Prioritize — You can easily get distracted by going after every opportunity you find, you should stay focus on a specific customer segment

· Test and analyze — Understand what’s working and not and adjust accordingly

· Identify a repeatable sales process/playbook

There is no specific/straight path to scale and it is deeply personal to each company’s product, market, and customer behaviors. How you come up with the process is not as important as your mindset and consistency. What I’ve found is that great founders have the ability to evolve as their companies grow and have the right mindset at every stage.

You should also be aware of the following risks before entering the growth stage:

· Underestimating how long it takes to raise Series A and overestimating revenue forecast

· Insufficient cash to handle the costs associated with growth

· Hiring mistakes (you shouldn’t compensate quality for urgency)

As always, I appreciate any feedback and suggestion. My email is pourya@thinkplus.vc.

Thanks to Safa and Nazila for being my beta readers and helping with this.

5 signs you’re about to run out of cash

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Originally published on medium.com

Cash is surprisingly hard to track, and knowing when it’s about to run out is harder if you don’t know the warning signs.

Given how important managing cash is to companies, it’s surprisingly hard to get visibility into one’s cash position,  and also to know when a cash crunch is looming, a treasury consultant said in a webinar on Tuesday.

Particularly for companies with operations in multiple states or countries, just getting a handle on your cash balance isn’t easy because of time and other constraints, Kenneth Fick, director of strategy and transformation for MorganFranklin Consulting, said in the CFO.com webinar.

A surprising number of companies don’t use any kind of treasury management system (TMS) to manage their cash, which means the treasurer or a finance analyst has to manually log into each bank portal, access the accounts, and download a CVS or other type of file to input data into a consolidating master spreadsheet, typically in Excel, to come up with the company’s position, a process that can eat up a lot of time and also introduce manual keying errors.

“Simply knowing what cash you have at the beginning of the day generally can take anywhere from two to six hours, so you’re spending half your day on a Monday, Tuesday or Wednesday just trying to figure out what cash you have,” he said.

One company he’s working with hasn’t been able to get any visibility into the cash it has through a subsidiary in India, creating what he calls a cash “black hole” in its corporate-level accounting. “They know [the accounts] exist,” he said. “What cash is there? Can it be repatriated? Is it just sitting in a non-interest-bearing account? They just can’t access it.”

That company’s black-hole situation is unique. For more everyday situations, Fick recommended using a treasury management system because it gives you a way to consolidate your accounts into a single application. Most of the systems are on SaaS-based platforms.

“What they do is minimize these efficiency challenges and provide connectivity directly to the banks,” he said.

Signs point to problems

Fick walked through five early warning signs your cash flow is in trouble.

1. Not having a quarterly cash forecast

Companies that haven’t created a model for forecasting cash that’s separate from the other modeling your financial planning and analysis (FP&A) team does are setting themselves up for problems, he said.

“A lot of time your FP&A team models your balance sheet, P&L, and financial statement over 12, 18, and 24 months for planning, but they fail to take it the next step in regards to the cash component,” he said. “They don’t see [where cash is] at 13 weeks. There’s nothing magical about that. It’s just one quarter out, but it gives you that visibility in the short- to intermediate-term regarding what will come in and go out based on your assumptions in your model.”

2. Not knowing your cash break-even point

The break-even point is the amount of cash you need on a monthly basis to meet your expenses based on your monthly revenue, and if you don’t have a handle on this, you risk coming up short at crucial times.

“If my revenue is $250,000, I know that, in order to make payroll and other expenses, generally, on average, I need about $150,000 to $180,000 in cash per month,” he said. “So, I know if it goes below that, I have to get it from somewhere: a line of credit, cash on hand, whatever. What if you’re a seasonal business? If you sell Christmas ornaments, you get a gigantic windfall in the fourth quarter and you’re cash-flow negative throughout the rest of the year. So you have to understand where that break-even point is.”

Fick said you should take it as an ominous sign if your company resorts to discounting just to get money in the door to meet your monthly expenses. “ A lot of times I’m seeing, ‘Well, I have all this accounts receivable, but I don’t have enough cash.’ If you’re starting to discount because of the cash impact to get revenue in the door, that’s a big warning sign.”

3. Use of long-term debt

There’s nothing inherently wrong with using long-term debt to cover short-term costs if it’s part of a plan for, say, ramping up operations quickly, but if there’s no strategy behind it, it’s a sign cash has become a problem, he said.

“If you’re seeing a company take out long-term debt just to meet short-term expenses, that’s a warning sign because short-term expenses can become long-term very quickly,” he said. “When you’re in that position, it’s best to cut costs than to borrow.”

4. Tax payment delays

No one likes to pay the IRS, but asking for delays because you don’t have the cash is a sign that you haven’t managed liquidity well, which will cost you more in the long run. “Especially for smaller businesses, the IRS will just beat you to death,” he said.

5. Too-fast growth

Fick also said growing too fast can be a warning sign, because it can point to a misalignment between your accounts receivable and your accounts payable.

“So, you’re selling to Walmart or Target and they require you give them 90-day terms,” he said. “They’re the big players. If they say 90 days, it’s really 100 or 115 by the time they cut the check or run the automated clearing house (ACH) or whatever. What your vendors require of you are 30-day payments, and you have no power over them. So, you have to basically float that difference for 90 days. If you’re having trouble with that collection process, that is another big warning sign.”

Best practices

Fick suggested five best practices for effective management of your cash.

1. Communication

It’s imperative that finance executives communicate their forecasts accurately, because miscommunication can lead to decisions that don’t match what’s happening. The company “might borrow more that it needs to meet conditions that don’t materialize or they can leave funds unnecessarily idle, which I see very often, actually,” he said. “Communication is the best way to avoid a liquidity crisis. You always want to forecast [business] drivers, not the number. Effective communication is a best practice regardless of the [market] environment.”

2. Cash flow vs. revenue

Cash flow and revenue both indicate your company’s financial health, but revenue is about the effectiveness of sales and marketing, while cash flow is a function of liquidity or money management. Fick said cash flow can be negative, but revenue really can’t be unless there’s something very wrong with the company. To measure cash flow, don’t forget to include money that comes in through other channels separate from the sale of your core product or service.

“Companies obtain cash in a variety of ways outside their main business,” he said, including “interest, warranty fees, other fee income — even SaaS has a set-up fee — one-off projects for professional services like fixing things.”

3. Inflows vs. outflows

Fick said you should identify all sources of inflows and outflows and then work to maximize inflows while minimizing outflows, and to a large extent that means focusing on timing.

“If your customers are asking for 90 days and your vendors are asking for 30 and you have no power over your suppliers, that’s an issue,” he said. “You can use things like supply chain financing (SCF) to ask your vendors to give you longer terms. Maximize timing, extend your payment terms, understand your control of them.”

4. Scenario planning

Creating scenarios in the FP&A function is common, but it should be done for cash, too, he said.

“What scenarios do, especially for cash, is they provide a playbook for you. What ifs,” he said. “Having these ifs before they happen helps you think through and build that playbook, so if it does happen, you’re executing and not thinking.”

Tariffs provide a good example. “Tariffs affect the P&L but they also affect cash and future business.”

5. Variance analyses

Fick recommended you set tolerances for what you can accept when actuals come in at a variance from your projections. If you set a tolerance of, say, 5%, you’re prepared to take action once you hit that difference from your projection.

“There might be customers who fail to pay,” he said. “Sales don’t materialize, you see unexpected expenses, you have to understand and analyze those in the short-, mid-, and long- term. Nothing is set in stone.”

Despite its importance, cash can be a challenge to manage. But by knowing some of the warning signs and following best practices, you can help protect your company from that gravest of all ills: not being able to meet your company costs because you’ve run out of money.