It is rare for a startup to be profitable on day 1. More often, entrepreneurs have a big vision and raise capital (or self-fund) to chase their dream. The typical tech startup runs operating losses and negative cash flow while the business scales, and early tech investors have traditionally been willing to invest in growth with the expectation that the business will gain value faster than it consumes capital.
While there are still investors willing to fund losses for scaling companies, in recent years, the pendulum has swung far in the direction of valuing profit and positive cash flow more than growth. The heady days of easy capital as long as the business can demonstrate growth have mostly ended. This shift has left many CEOs in a precarious position. They built large expense bases anticipating future growth, relying upon their perception that investors would be willing to keep the capital flowing. It is a rude awakening when they find themselves in need of capital, and are forced to dive-bomb to cut expenses to reach profitability so they can attract investors before the cash runs out.
One of my favorite, and often quoted lines is “too much money makes you stupid.” In essence, when the bank account is full, companies are more cavalier about spending and investing for future growth. They build up their expense base, operations, and infrastructure in ways that are hard to undo. The best example is signing a long-term lease for an office that is bigger than you need today, but ‘clearly will be necessary in the future when the business grows.’ If the growth does not materialize, the business is saddled with an enormous rent expense that is nearly impossible to eliminate.
The less cash a company has, the more often they count it, and the more they consider every expense and commitment. Less cash forces CEOs and leadership teams to be smarter about how they build up their expense base. They are more likely to be vigilant about scaling revenues faster than they scale expenses, so that they can reach profitability sooner rather than later. The result is they become much more desirable investments, even if the growth rate is more modest. When the business has demonstrated product / market fit and the ability to delight customers, then it is time to step on the gas, and the money will become available. ‘If you build it, they will come’ is an apt description of the availability of funding for businesses that are built in a capital efficient manner. If you build it, investors will come to the business when the time is right.
For CEOs, one of the hardest leadership roles is to reinforce the importance of capital efficiency and profitability. We have all faced the optimism of functional leaders who make well reasoned and passionate pleas for resources, justified by all the great things their teams will do in the future. It is easy to be caught up in the excitement and agree to ‘spend money to make money.’ However, the CEO cannot lose sight of getting to profitability as soon as possible, and never let the business backslide. Becoming sustainably cashflow positive will set you free! When the business is funding its growth instead of relying upon the whims of investors, the business is growing responsibly. Not to say that any investors are truly whimsical in their decision making, but fund dynamics, portfolio biases, and market forces often shift investor enthusiasm, and CEOs find themselves suddenly surprised by skeptical investment committees and constrained capital availability.
There is a saying that it is better to be bought than sold. In this context, a company that is desperate to raise a round of capital or sell itself will never do as well as one that is self-sustaining and able to wait for the right buyer or investor to make a fair offer. The business may not be growing as fast as possible, but at least it will not be facing an existential cash-out event and need to go looking for any port in the storm. Positive cashflow provides the time to be bought, rather than the pressure to sell.
Capital planning is one of the most important responsibilities of the CEO, the leadership team, the board, and investors. However, the obligation to be capital efficient sits squarely with the CEO. I have seen too many situations where the board identifies soft spots in the business and guides the CEO to increase spending on those areas to improve performance, and the CEO dutifully follows the guidance and increases the committed spend level. However, the CEO needs to measure the advice in the context of remaining capital efficient and executing their capital plan. If the business runs out of cash, the CEO is the steward ultimately responsible. Boards usually have great instincts and their advice regarding areas that are underperforming or opportunities to invest to improve performance are generally spot-on, but the CEO needs to balance the advice with awareness of the complete operating budget and financial performance. A responsible approach may be to cut back in other areas to fund increasing investment as directed. These are hard decisions that may impact morale, and are squarely in the leader’s hands.
We often talk about growth stages for businesses, and the adage that the team that led a company to one stage may not be the right team to lead it to the next. For a CEO to continue to grow with the business, they must have intellectual honesty about the staff required for each phase, and the quality of the team they have versus the team they need to make the transition. So, when the board suggests that the go to market function needs an upgrade, and they recommend hiring a CRO, it is up to the CEO to look across the entire business and decide how to reallocate expenses, or reconfigure the business so that hiring that new CRO fits within the overall expense budget and capital plan. Hiring a new expensive CRO will hopefully improve revenue, but it will absolutely increase operating costs. The CEO needs to balance the certain increase in costs with the possible increase in revenue, and remain vigilant about maintaining positive cashflow. In other words, the CEO cannot outsource responsibility for spending decisions to the board. Instead, they need to take the board’s recommendations and manage the changes in light of the overall financial plan.