When appointed by the Board to be interim-President, I had taken the reins over a start-up founded by an IT engineer with a patented storage technology. While seeking a Series B financing, I began to meet a long list of investors. The most common question was, “What kept me up at night?” Interestingly, when the engineer-founder had been asked that question, he replied that he needed to complete the best engineered data storage system. When asked the same question, I replied, “Not having enough sales to cover my quarterly projections.” After a while, even the engineer-founder began with my line when he understood why my reply had better traction. The bottom line for any start-up is simply that: cash flow. Meantime, I see too many start-ups that simply just don’t get it.
Recently, I met the CEO of a Silicon Valley tech start-up, Company X, which had initially been financed for $2 million, now exhausted. It has not covered the salaries of its personnel for the last two months. It has one product near completion, other products with some software development work desperately lacking. In other words, the company has had zero sales. Now it seeks investment valuing the company much more, 2X, than its initial funding. What is wrong with this picture?
Rule #1: Every start-up CEO/President should know the company’s daily burn rate and cash in the bank. If this company has depleted its funds, I immediately blame the CEO/President. He/She should have anticipated the financial drought, and sought financing as if there is no tomorrow. Waiting for the last minute is a sign of mismanagement and increases dramatically the cost of capital, viz., namely any future investor now knows that the company is sitting on a hot tin roof, ready for vulture financing. 2X value now? I doubt it. Now, to what degree should any CEO be concerned when the cash gets near the bottom? I recently requested from another CEO in the med tech space for a casual meeting. His reply: I am too focused raising money. That indicates to me that the CEO has singularly identified that, unless he gets that additional capital, he might not be able to operate in a few months based on his cash situation. That is what keeps him up at night. And that is his admirable quality of this CEO.
Rule#2: Focus quickly on sales/revenues/commercial products on Day 1. Any product being developed should be regarded not as a final one, but one that can be modified or improved so that the marketplace embraces it. It is said that Steve Jobs stated that he believed that the consumer does not know what he wants. But if there is no demand for the product, then the consumer is basically stating that he/she is not interested in purchasing it. The Financial Times (www.ft.com), January 8, 2014, published various analysis about the demand of wearable electronic devices, claiming that the overall demand is not there. What the article suggest that seems to be better angle is to combine the devices to clothing or athletic brands like Burberry that consumers recognize. If the product does not sell at the beginning, modify the product. Focus on revenues, whichever way you can get it. Again, look at the technology and see how can one generate revenues in spite of the resistance. So what keeps these guys up at night? The inability to generate sales in spite of consumer doubts.
Let’s go back to Company X. The CEO and its current lead investor are more concerned about valuation for the next round of financing – not about sales. First, if your company is against the ropes, you need to generate revenues to reduce your cost of capital in order to negotiate better terms. Second, it is better to seek some incremental capital to complete one product for commercial markets and to market the product. And, if your team has not been paid, there is the strong possibility that the team will seek other jobs, hence, losing any momentum for product development. Speed is of the essence now.
Instead, Company X is seeking another multi-million dollar round that will be difficult to raise given its current product sales and financial condition and would take months. After discussing the current products under development, I suggested to the CEO to get a product out the door now, with the least marketing costs, to demonstrate to investors the demand for the product. The initial marketing costs should be close to zero for this one product. And if the marketing works, it should show some traction. Why focus on valuation? Company X should have followed Rule #1 and #2. And now we return to my earlier blog, why does 92% of start-ups fail? – failing to answer the question appropriately on what keeps the CEO/President up at night.