Managing startup finances

Morning, everybody. Thank you for coming in at 09:00. It's an early start. So as Kevin mentioned, my name is Kirsty Nathu, and I'm the CFO here at Y Combinator. So I've actually helped now 2,000 companies almost as they've come through Y Combinator. So seen a lot, seen a lot of successes and seen a lot of failures.

So I'm going to help you just understand some of the big mistakes that we see some of these companies doing based on their cash, based on their money. And so, for every business, whether it's a startup or a mom and pop shop, cash is its lifeblood. And if you run out of cash, then the business dies. There's there's really no going back at that point.

It's actually surprisingly easy to run out of cash. We see many startups not realize that they they have done that until it's too late to actually be able to turn it around and do something about it. So we're gonna talk about these three early stage pitfalls.

So this is probably most relevant to you right now, and then we'll talk through another three that as you start to raise money and are starting to think about hiring, are some other other mistakes that companies make.

So we're going to look at what the numbers you should be looking at, how often you should be looking at them, whether your expenses are realistic, and then thinking a little bit more about hiring and looking at responsibilities. Alright. So let's move on to the first one. So the first mistake is really not knowing what numbers to look at to make sure that the health of your company is is good.

And really, there are three things that you should know. Your bank balance, the money coming in and the money going out. And these are not difficult. You don't need anything fancy to be able to do this. This is all information you can get from your online banking or your bank statements. You don't need bookkeepers, you don't need financial software.

This is super straightforward, but you would be amazed at how many companies don't look at this. And then using these three numbers, you can then calculate some other things. You can look at burn, you can look at your runway, you can look at growth rate, and you can figure out whether the company is default alive. Okay. Let's go through these in order. Your burn is purely money in minus money out.

Again, you can get this from your bank statements, it's effectively just the change in bank balance between two dates. Here's an example, super easy. You have 25 k expenses, you have 10 k of revenue, so your burn is 15 k.

If your expenses are a little bit lumpy, some companies, you know, you might have a one off month where where you, I don't know, paid a legal bill or something that's super high, you can do this, you can look at average expenses as well to figure out your burn. That's often referred to as average burn, so you might look at it over three months to kind of get more of an idea.

So then once you know your burn, then you can start to look at what your runway is, and what this means is how long do you have until you run out of money? And the way that you calculate that is you look at your existing bank balance, divide it by your average burn, and that gives you a number of months. So here, we have a hundred and 50 k in the bank.

We've just calculated our burn rate to be 15 k, and so we have ten months of runway. Again, super straightforward, but you'd be amazed at how many companies or how many founders don't know these numbers for their company. And just a point here that, again, the burn might change over time, but this is a number for you. This is not a number to try to make things look good.

This is for you to not lie to yourself. So looking at the burn and going, well, this month it was 15 k, but let's let's just pretend it was 10 k, so then that makes it look like that we have fifteen months of runway left. All you're doing is lying to yourself. You're still gonna run out of money on the same day. It's just making you feel better right now.

So it's super important to to really be honest with yourself on these. You can also look at your growth rate. And so this is just looking at two periods of time, so your money in in month two minus your money in in month one divided by your money in in month one. So this is looking at the the rate that your revenue is increasing.

So in our example here, we have 10 k of revenue in July, '12 k in August, and so our growth rate is 20%. And just a note for the for the people that weren't the the math whiz, whizzes at school, a constant growth rate is what's going to give you the j curve in growth of revenue. Because if you have 20% growing each month, as your numbers increase each month, that 20% is a is a larger number. Okay.

And then the final one is whether the company is default alive, or the other the other side of it is, is it default dead? So the way you calculate this is if your expenses are constant and your revenue growth that you've just calculated continues, have you got enough cash to reach profitability?

And there's a handy little calculator that Trevor Blackwell, who's one of the founders of Y Combinator, created for you to to do this. And basically, are three things that you can you can play with. So you can look at your monthly expenses, which is the red line.

You can look at your monthly revenue starting point, which is the green point over at the start, and then you can change the gradient of that line to be your growth rate, and it will calculate where you become profitable and how much capital is needed. Now, this example isn't the same numbers as the ones that we've just been working through.

So in this example, this is assuming that you will need a hundred and 50 k of money to get to profitability and it will take you two years.

And so those are really key things to know because if you only have a hundred k of money in your bank account, you know that you've got a problem and you know that you either need to find a way to increase your revenue growth or you need to find a way to cut expenses. Because the whole goal here is to be at the point where you can find a path to profitability because it gives you freedom.

Being profitable gives you freedom because you aren't in a position to need to raise money. And kind of like dating, if you don't need to raise money, you appear less desperate, so you the investors want to give you money more, so it's easier to raise money. So it's actually really important to have that option. It can sometimes, you know, it can be it can be a a switch as well.

You don't have to necessarily be profitable right now, but if you know that you could turn off one specific expense or do one specific thing and be profitable, then that's also a great safety net. There's also a really great essay that talks about this in more detail. This was written by Paul Graham, and you can see the the link here to to where that that gives you more information on this.

And again, it's the kind of thing that when we're doing office hours with founders, it's one of the first questions we ask and you'd be amazed how many people don't know the answer. These numbers, super easy to calculate, super straightforward.

The next problem is that people go along and they say, okay, I've looked at my runway, I've looked at my revenue, I know all my numbers, and then kind of forget about it. But actually, this needs to happen pretty often. You shouldn't be looking at it every quarter or every month, you should be looking at it at least every week.

And if your runway is getting low or things are looking not very constant, consistent, you should be looking at it very often, like sometimes daily. And whenever anyone asks, you should know your numbers. Have a have a think now. How many of you know how much money is in the company bank account if you already have one? Great. How much of you know your runway?

Slightly less numbered, slightly less hands, but that's that's pretty good. I like it. I'm impressed. Okay. The next one is under representing your expenses. So if you think back to that default to live calculator, that assumes that your expenses are going to remain constant. And actually, in reality, that's probably unlikely. Most startups, their expenses will ramp up over time.

And you should you should understand how that's going to happen. You know, what what kind of expenses are going to increase and what are they going to increase to? So some examples of expenses that may change over time is the first one is undervaluing your own time.

Particularly in the early days where you're doing everything and you're either paying yourself minimum wage or some very small amount, which by the way, in California, everybody should be paying themselves minimum wage. And you're also doing things that don't scale in order to acquire users.

And that's totally fine and that's what we recommend that people do, but it can make your customer acquisition costs look lower than really they are. And so you should be aware that over time, as you start to hire people to to look into these, that that those expenses are going to go up. Hiring people is not just their salary.

For every person that you hire, you need to provide them with equipment, you need probably desk space, you need health insurance probably, depending on where you're based, and so all of these things cost extra money on top of the salary. And so depending on location, a good rule of thumb is that an employee will cost about 25 to 50% more than just their salary.

So if they're being paid a hundred k a year, then your fully loaded cost to the company is going to be somewhere between a hundred and 25 k to a hundred and 50 k. And again, that's super easy to forget about. You think, oh, I'm going to hire an engineer. I'm gonna pay them a hundred k. That means, you know, that's all it's gonna cost.

But it's it's amazing how those numbers do add up, so just be aware of those. Finally, assuming paid acquisition costs remain constant is another another mistake that we see people make a lot. Whilst it may not seem like this, oftentimes in the early days, it's actually easiest to find your early users because they're the ones that are totally motivated to use the product.

And actually over time, it gets harder to find and convert users, and so the cost of of doing that goes up. And so again, you know, you should be thinking about that. You should be looking at what your costs are right now and seeing, thinking, are they reasonable? What do we think they might go up to?

Because if you can look at things in the worst case scenario and you have, you know, in the worst case scenario, you calculate that you have eight months of revenue eight months of runway left, but actually then things are better than that and you end up with ten months of revenue, then that's bonus. Right? You've got you've got a bit longer to figure things out. Runway is not a vanity metric.

It's not one of these things that's supposed to make you feel good. It's not one of the things that's supposed to be used to to compare yourself against other companies. It's for you to know the health of your company. And so don't ignore this stuff. Don't lie to yourself.

Don't, you know, try to massage these numbers to feel like it's making yourselves better because all that's gonna happen is you'll run out of money and it'll become a shock. Alright. So these ones now are starting to get a little bit more as you raise money, as you're starting to hire people, so it's good to bear in mind right now, but these are probably less relevant to to a lot of you for now.

Okay. The first one is outsourcing responsibility, and often the CEO will hire a bookkeeper to prepare the finances for a company as they start to get a little bit more complex, and that's a total normal thing to do. We recommend that people do that. It's usually once people raise some money, it's not a good time.

It's not a good use of the CEO's time to be doing the books and the CEO can be doing much more high leverage things. But the thing to bear in mind is that even though the bookkeeper is doing the books and preparing those numbers, the responsibility is still everybody's in the company, particularly the CEO, but all the founders, everybody should know what these numbers are.

An external bookkeeper isn't going to know the business like you know the business. You know, oftentimes, they will the way that they they work is that they will get hold of bank statements, and they'll see money coming in, they'll see money coming out, and they'll do their best guess about what these things are, and they won't always be right.

And you can't really expect them to always be a % right because they're looking at it from a very removed position. And so it's up to the founders and it's up to the team to look at those reports that the bookkeepers send every month and to make sure that you understand them, and to make sure that if anything that comes through that looks strange, you question.

It's not necessarily I think I think a lot of it is that people are concerned that asking questions will make it look like they don't understand their numbers, But usually what happens is if you don't understand what these numbers are looking like, it's usually because there's there's been some misunderstanding in the reporting of the numbers.

And so if you're like, well, I thought my revenue was going to be a bit higher this month, what's going on? Why is why is this, you know, why is this this number? Then you can actually go in and look and query what's what's going into that and, you know, you might find that there has been a mistake made.

And this is this is probably one of the number one things that I get founders coming to me complaining about. They'll come up to me in this total panic and they'll be like, the bookkeeper messed up and they told us all this wrong stuff and now I don't, now I have no runway and I don't know what's going on.

And actually, what happened is the bookkeeper sent them the monthly reports, they were like, tick, done my work. Founders didn't look at the the reports, didn't figure out what was going on, and now there isn't enough time left for them to turn the business around either to get profitable or to raise money to figure things out, and the company dies because it runs out of cash.

So super super important to be on this all the time. Hiring too quickly and scaling the company too quickly is it's really easy to do, to hire too quickly because you're under a lot of pressure to to hire people. It feels like it's a it's a really easy, really measurable piece of information.

You know, you talk to founders and one of the first questions that that they will often ask is, oh, so how many employees are you at right now? And you say, oh, I'm at, you know, I'm at 25, and you're thinking, oh no, I've only got 10 employees, that means they're, you know, way more successful than I am. And actually, that's totally not true.

So we already mentioned that hiring employees cost more than just their salary. But you should also be conscious that every hire is actually an investment into the business, and you should be making sure that you're getting a return on that investment. And now, for some types of employees, that's super easy to measure. So, you know, think about a salesperson.

If they're not bringing in more sales than is costing the business to hire them, then clearly you're not getting a good return on investment. But then think about a community manager or a, you know, as a support manager.

It's it's much harder to measure that and and that's kind of one of the things that as a CEO, you need to be looking at and you need to be figuring out to make sure that that all the people in your company are actually working to make the company more valuable. And sadly, this is the point where, you know, if if people aren't working out, you should be prepared to to fire fast.

You know, if if people aren't pulling their weight, then they need to they need to leave the company. And like I say, it's easy to fall into this trap that the more people you have, the better you're doing, but actually the best companies do more with less. And so actually, the real way that you should measure yourselves is what's my ratio of revenue to employees?

Because the higher that is, the better you're doing. You're doing more with less. And that's the path to being profitable from an early stage, which then takes the pressure off to the worry about whether the company is going to continue.

And it's also easy to feel like you have to kind of compete with with all the flashy start ups that have raised bunches of money, and they're all hiring data scientists right now, and you know, oh, that means I must need a data scientist, so I'd better hire a data scientist. Actually, don't. You know, the the Again, the best companies do more with less.

And if you can if you can build a really great company with less employees, then that's amazing for everybody involved. And bear in mind, you know, you should be treating this money carefully. It's not a case of just, oh, I need to hire this person, I need to hire that person, because what the investors who are giving you this money for, they're asking you to do something basically a miracle.

They're asking you to take their money and turn it into 10 or a hundred times that amount of money to give back to them. And the way you're going to do that is by being careful with your expenses and making sure that your revenue grows. As a follow on to that, scaling before you get product market fit is also another dangerous thing that people fall into quite easily.

At the point where you're still figuring out what your product is and you're trying to find product market fit, you should be spending as little as possible. And then that will give you the runway to have time to figure out what it is that you you should be building. And then, you know, people will be beating down the door to to buy your product.

More employees will not help you get to product market fit. It will not help you get there faster, it will not help you get there more efficiently. And one of the conversations that I have with founders is something along the lines of, oh, my sales are low because I don't really have enough salespeople, so if I hire another couple of salespeople, then my sales will obviously increase.

That doesn't sound like product market fit to me. You know, if it if you have that, then customers are beating a path to your door and, you know, it it it feels like the wheels are trying to wheels are falling off as you're trying to look after all those customers. So just hiring more salespeople isn't necessarily going to be the thing that sets that going.

Also, convincing yourself that you need more developers or you need more people to to get the thing that gives you the the product market fit. Another conversation along this is something like, I need four more developers because then I can build feature x y and zed and then obviously, everybody will buy it.

But again, if you have product market fit, then even your janky v zero that doesn't have all of these fancy things is solving a big enough problem for everybody that they're willing to pay for it and they love you for it anyway, and then you can start building up on the more features, and then you can start hiring to do that. This is this is the one that there's no coming back from.

The other ones, if you make these mistakes, you can you can probably solve this and you can, you know, if you hire too quickly, you can figure that out. If you don't know your spend don't know your numbers, you can learn your numbers. This is the one that is, you know, no going back. So if you let your runway get too low before raising, you're going to have problems raising your money.

So the first thing is you should always assume that you will never raise any more money. Always assume that the previous money that you raised will be your last and that you should be aiming to get to profitability on that money. So again, the conversations that I have with founders where they say, oh, it's fine. My investors are gonna put in another million dollars. It'll be totally fine.

That's kinda scary if you're relying on your investors to do that because they don't always. Sometimes they might, but they don't always. So seed stage money is the money that you'll raise often on just an idea, you know, you'll be able to talk to investors about a an idea for a product, you've got a hypothesis that you you want to be able to check, and they will give you some money.

Once you get to series a and beyond, that becomes much much harder. You know, you need sustained growth, you need to have more of an idea, you need to have product market fit. This is why it's a lot harder to raise money as you go through the life of the company.

And in particular, don't leave it too late because if you're running out of runway, your leverage goes down as you're trying to raise money. So if you have six months of runway, let's say, and you think you're about to go and start raising money, that's pretty scary.

It could take three months more to actually get an investor to agree to put money in, and as your cash balances are decreasing over those three months, you know, you're losing leverage.

You can see from here that probably at six months, maybe you can just about pull it off, but really you want to be thinking, at twelve months runway, that's the point where you're thinking, okay, maybe I need to think about whether I raise money or whether I'm thinking about getting to profitability.

And also, if you get to six months and you're unsuccessful in raising money, you really don't have a lot of time to turn this around to get to profitability for the company to succeed. Again, there's a really great essay on our blog that goes into this in more detail. Link down here. So you can you can read that at your your leisure and hopefully take that on board. Okay.

So in conclusion, most companies die because they run out of money. It's super easy not to run out of money just by looking at a certain number of things.

Knowing your cash balance and your runway, understanding how your expenses are going to increase, understanding that the ratio of revenue to employees is a better metric than just the number of employees, And having a plan to get to profitability because you should assume you're not going to raise any more money. Alright. Thank you very much. Okay. So a few minutes for questions?