I was moderately surprised when Professor Warren McFarlan said at our first Accounting class at the HBS GMP program,”if there is one thing that I would like you to remember from my class, it’s that cash flow is king.” Then he showed us the short clip of Cuba Gooding dancing “Show me the money” in Jerry McGuire.
I remembered watching my dad struggled with his business cashflow when I was young. So I was always mindful of this when running our first business. But the modern day startups don’t seem to care too much about it. When I asked how their AR is doing, some seemed nonchalant about their >1 year old receivables.
Sometime back, I met up with an IoT start up. The founder asked for feedback on his go to market. After we covered that, I asked about his pricing thoughts, and any payment policy he intended to have. (Numbers modified for privacy reasons)
“We need to make it easy for customers to commit, so the pricing can’t be too high. We will do a subscription model, then we will also be seen as a SAAS model, with ready recurring revenue, and command a SAAS multiplier for our valuation.”
“We will have tiered pricing, to cater to different usage requirements. We will have a dashboard for users to monitor usage, so that will be the basis for the subscription pricing. Each system will cost us about $150 to manufacture in bulk via OEM, we need to commit 1000 for our first order.”
“So we will charge entry tier customers $40 monthly subscription, and minimum commitment period of 12 months. We will make back our cost by month 4 per device with a bit of margin.”
“We need to fund raise to get the 80K upfront deposit to the OEM, and need money for salary and overhead. So we need to raise at least half a mil for next 6 month operation.”
“No, we can’t ask for an upfront deposits as it would make it hard for our customers to commit. They have to buy at least 20-30 units to start off. I firmly believe a monthly plan is a good way to bring customers on board fast.”
This is usually how such conversations go. A pure software SAAS play could do with a low subscription pricing model as the cost is spread out and the outlay is mostly for overhead and headcount. Not too crazy. But when you have a bill of materials and got to pay for deposits for molds and materials, it’s very silly to totally bank on VCs to finance your cash needs. Even if you have to, try to shorten it to reduce your reliance. You will be a lot less stressed and a much happier founder when you rely on both customer funding and VC for cash flow.
A few thoughts/ observations to share:
1) subsidizing your customers’ cashflow with VC money (which directly translates into your equity and dilution eventually) – is that really the smartest option for you?
2) It’s perfectly common and understandable to ask for deposits or upfront (partial) payments especially when you need to buy materials. Fact is, you have to pay upfront to your supplier to buy materials right? (Oh, one fella argued that’s cos the manufacturer is a brick and mortar business so they could get away with upfront deposits?? Last I checked, startups are also businesses!
3) At times, when startups tell me the customers refused to pay upfront for hardware plays, I really wondered if they got the right type of customers… is Mr Customer having cash flow problem or plain making use of you? Or maybe it just means your overall value proposition is not strong enough yet?
4) Adopting a pricing model / strategy that’s not exactly ideal for your space/ industry, but for the sake of getting a higher valuation from VC, is that really sound? Again I repeat: the definition of a startup success does not come from getting a high valuation or getting funded. Success comes when you have customers buying your product/services over and over again and you make profits off it.
5) Be practical. For the first few deals, if customers find the product useful and want to “buy” instead of “subscribe” for goodness sake pls say yes! I had met one startup that said no as it violated his long term business intention… well, there is no long term intention if you have no short term survival. That company is gone now from what I know.
6) Not all but quite a handful of founders I have met didn’t count overhead and manpower as “costs”… even for software companies. Investors will not be here to pay salaries and utilities for ever.
Some other cashflow related thoughts:
1) Many startups do not watch their AR as they feel getting the sales done or product deployed are more important. I would like to emphasize managing AR /cashflow is equally important. Without the payment from your customers, you will be forever running business on credit terms.
2) Do not over extend the credits to customers. A customer who cannot pay is not really the type of customer you want, no matter how big the brand.
3) Managing cashflow is not the job for just the finance team. It’s important to balance the sales team and finance team objectives.
4) If you can afford to pay your suppliers on time, please do so. It’s a cascading nightmare when one company doesn’t pay on time. Many companies go into receivership due to cashflow problems even when they have a positive margin.