How to prevent your start-up from running out of cash
There is no such thing as a clear path to success. This is particularly true for fast-growing tech start-ups that require a lot of upfront financial investment, but also a lot of upkeep. Raising investor capital may be the very first step of growing your business, but it isn’t all smooth sailing from there. How to put your money to work and how long you can operate before raising more cash will have a tremendous impact on your company’s financial health. In fact, according to a 2021 report from CB Insights, running out of cash is the most popular reason why start-ups fail.
Why start-ups run out of cash
Running out of cash is often due to two main reasons: poor money allocation and failure to raise more capital at the right time. Start-ups feel the rush to put their money to work as soon as investor capital reaches their bank accounts. However, they may fail to acknowledge how this money should be spent, especially when there are large sums involved. The average funding for pre-seed and seed stages is £500,000 (RLC Ventures). For first-time entrepreneurs, the use and application of these funds can be a daunting challenge.
Without solid education, direction or experience, start-ups can end up misdirecting their cash and/or burning it too quickly. Tech start-ups in particular may throw all their cash into product – their core competency – whilst neglecting other business areas such as marketing and sales. The lack of both business and financial literacy sabotages the potential of many fast-growing start-ups. Being able to raise a large sum of money is an achievement in itself, but one that requires rigorous planning and tenacity. Short-term financial plans aren’t enough to keep your business growing steadily, and they certainly won’t work for the business in the long-run.
Start-ups also run out of cash because they decide to raise capital when they’re too close to running out of money. Being strapped for cash and having a limited time to raise money puts owners in a vulnerable position because there is a very tight window for negotiability. Firstly, the business’s weak finances won’t look appealing to investors, which makes it more difficult to find investors and to close a deal. Secondly, due to time restraints, owners may have to accept a deal with tough terms, or, at least, poorer terms than they would have originally wanted.
How to avoid running out of cash
- Define your runway
Businesses don’t usually start making profit as soon as they launch. In some cases, particularly with fast-growing businesses, they need significant financial investment before the product even goes to market. Even if your business is already making profit, this doesn’t mean that your cash flow is positive (e.g. when your costs are higher than the profit you’re making).
To start with, it is important to determine how long your business can survive without any cash coming in or, in order words, whilst making a loss. That metric is called your ‘runway’. For instance, if you don’t make any profit for the next six months, can you afford to continue developing your product, paying your employees’ salaries and supporting all your other business costs, such as licenses, subscriptions, and office bills? Your runway will be a crucial figure to keep in mind when you’re running a business that is yet to reach its full potential.
To calculate this, you need to determine your burn rate. Your monthly burn rate corresponds to your monthly expenses minus any monthly profit (if you are already making profit). Dividing your available cash by your monthly burn rate will give you the number of months you have until you burn all of your cash. The general advice is that seed-stage start-ups should aim for a runway of 12 to 18 months, but of course this will depend on your business’s own circumstances.
2. Raise money sooner than later
Start-up owners don’t typically walk into a VC Capital firm and leave with a $10 million investment deal. In fact, it could take months from pitching your business to closing a deal with investors. It isn’t a smart idea to raise money only when you desperately need it. Firstly, because investors may question your money management skills, and, secondly, because you don’t know when exactly you will be able to raise those funds.
That is why it is crucial to continuously leverage relationships with different investors and actively make an effort to grow your network. This tactic will prove valuable when the time comes that you do need that extra cash to grow. Plus, having a solid network of people that can advise you and give you a helping hand throughout your start-up’s journey is always going to be beneficial.
3. Cut expenses
If your runway is short and you haven’t been able to raise more funds yet, you may need to cut back on some non-essential expenses. You can temporarily cut back on PR and marketing efforts or cancel subscriptions that aren’t absolutely necessary to your business’s operations. In addition, you can consider reducing office perks and postpone team get-togethers to a later date, once your finances are back on track.
It is tough to implement pay cuts across the business, and your employees certainly won’t appreciate this decision. However, if you have already reduced your salary and reach a point where pay cuts are needed, make sure you have an honest and open conversation with your team. If you assure them that this is a temporary solution, it is less likely that this will affect their morale and performance. As a last resort, consider laying off some of your employees. This is an even more difficult decision to make and, much like with pay cuts, it will require an open conversation both with the employees that leave and the ones that stay.
How can we help you?
Successful tech start-ups require strong support and expert financial advice from the very beginning. Finerva is your modern accounting and financial advisory partner, giving you all the tools you need to grow your business and thrive. Our services range from Core Accounting to EMI Share Options, Venture CFOs and much more. We shy away from being a traditional accountancy firm, providing you with a tailored and highly responsive service that suits your business needs, along with all the support your business deserves. Get in touch with our team at email@example.com. We would be excited to support you on your incredible growth journey.