Best Practices for Start-up Companies for Financial, Operational & Strategic Success

Introduction

Making poor business and operational decisions early on in a start-up company’s life cycle can have long-term repercussions. This article is designed to help the reader gain a better understanding of best practices and critical success factors for start-ups in any sector. The contents are relevant not only start-up companies but also to more mature companies as well. ?I have organized this article into several sub-topics.?Please feel free to read through the sub-topics of interests individually or the entire article to gain a more comprehensive understanding of best practices firm-wide.

The information contained in each sub-topic is designed to guide start-ups to follow what I consider to be best practices and to help them achieve financial, operational and strategic success for the long-term. I have learned from watching too many firms making poor strategic decisions and hope this article will help you avoid some of these pitfalls. ?

1) Sales

In starting a sales team look to hire a group of seasoned and experienced sales professionals with good industry contacts. Do not hire a bunch of young and inexperienced sales people as they will not have the network to help you win big clients?Throwing more bodies at the sales problem will not work in the long-term. Make sure that your sales team fully understands your product and how it works. ?The sales team needs to be very proactive in handling customer issues. Ignoring customer complaints or not dealing with implementation issues can be quite harmful for long-term customer relations.?

2)?Marketing

Hire a marketing team that will work closely with senior management, sales, and the business development team. The marketing department should be separate and independent of the sales team, but still needs to work closely with them. Do not outsource all of the marketing functions as you lose control of the corporate message. Make sure you hire an internal design team so that they can ensure consistency in your marketing message and materials and working closely with senior management. ?Hire a professional video production company to make several videos of senior executives talking about your product or demonstrating it and post it on your company website. The company’s marketing strategy should be well thought out.

3)?Products

Start-ups needs to have a well-defined and clearly identifiable products to sell. Otherwise, they are selling phantom technology or vaper ware that no customer will truly understand nor want to purchase. Don’t offer customers a product that does not exist. Many start-ups have a product but without a true business model or clearly identifiable customers. They have no idea on how to monetize their product and translate it into stable revenue streams. Make sure that the product is well designed and is user-friendly. The product offering needs to be competitively priced with a pricing structure that is quantifiable and explainable. Don’t redesign or rename your product so often that even your employees get confused as to what you are selling or what to call it.

4)?Accounting

Consider outsourcing accounting function for the first 2 to 3 year.?After year 3 accounting should be brought in house with a fully staffed accounting department. ?The first in-house accounting department hire should be a Controller / Director of accounting who is a CPA. ?I highly recommend that all accounting follow US Generally Accepted Accounting Principles (US GAAP). Not following GAAP can have long-term repercussions for the firm. ?

Be strategic in your choice of accounting systems. Early on for the first year or two utilize a simple accounting system like QuickBooks or Xero. As the firm grows around year 3 implement an intermediate level accounting package like Sage Intact of ?Microsoft GP (Great Plains). If your firm is really growing fast skip the intermediate systems, and instead implement a more robust ERP platform like NetSuite, Oracle Fusion or SAP which will save you money long-term by not having to do another implementation. ?

The accounting department should be separate and distinct from the corporate finance & FP&A department and should report directly to the CFO. The accounting department should be responsible for all audit and tax accounting relationships with external vendor and providers. ?The accounting department should not handle the following because they conflict with GAAP best practices:

o??Budgeting and forecasting

o??Banking relationships

o??Treasury functions

Please see my article Best Practices for Setting Up Accounting & Finance Departments at Start-ups & Privately Held Companies.

5)??Corporate Finance & FP&A

All start-ups should hire at least a finance manager or director before building out an internal accounting team. After year 2 or 3 a finance department should be built out and fully staffed, but only after the accounting department has been set-up. The finance department should be separate and independent of the accounting department and should report directly to the CFO. The finance department should be responsible for all corporate budgeting, forecasting & planning. This should not be done by the accounting department as it creates a potential conflict of interest.

All budgeting and forecasting should be done using a bottoms-up approach. Top-down budgeting does not work long-term and it is an especially poor practice to utilize at start-ups. The finance group should develop a robust cash flow model to track operating expenses at a granular level. This is key to making sure that spending does not blow through early funding rounds. Too often senior executives want to spend funds too rapidly and the firm’s monthly burn rate becomes unsustainable.?

The finance department should initially be responsible for all capital fundraising, investor relations, banking relationships, corporate insurance, purchasing and treasury functions. As the firm grows bigger departments such as investor relation, treasury and purchasing functions should be spun out to separate departments reporting to the CFO or Chief Operating Officer.

6)?Strategy & Business Development

A dedicated strategy & business development team is critical to the success of any start-up long-term. Too many start-ups skimp on this because of the large expense of hiring qualified individuals. Hire a small team of 2-3?people that have a proven track record of strategic planning and business development experience at other similar firms. ?

Firm’s need to be proactive when it comes to strategy and not reactive. A failure to pivot away from existing business practices that are not working can cause a start-up to fail.?Also, when a firm pivots if this new strategy is not working then it quickly needs to re-assess and re-focus. ?Senior management needs to actively listen to the strategy team’s ideas and inputs on various action plans and not override it on a regular basis. Some of the biggest and most costly strategic mistakes I have seen have been because senior management did not listen to their internal strategy group, and instead listened to a bunch of investment bankers to the financial detriment of the firm

7)?Strategic Finance

Traditional corporate finance and FP&A professional spend upwards of 90% of their time on a large number of routine functions and tasks. This doesn’t leave much time to properly evaluate important operational and strategic decisions that could better optimize business performance and maximize profitability. To remain competitive these days, companies need a strategic finance group that can guide senior management into making the best business decisions possible. This team is usually made up of 2-3 individuals a deep and thorough understanding of corporate finance, accounting, treasury, legal, operations, strategic planning, sales, marketing, corporate M&A, business development and information technology

Often information from different corporate departments gets siloed in those department or business units and never sees the light of day and companies lose the opportunity to act. A strategic finance group can help to bridge these siloes to solve strategic challenges and drive long-term business growth.

A strategic finance group?provides both CEOs and CFOs with a fair and balanced view of all alternatives and options. A strategic finance team in essence serves as a special project rapid reaction force helping management respond to rapidly changing business environments. ??strategic finance team upends the traditional corporate finance, FP&A and strategic planning & business development functions model by leveraging the latest technology to rapidly evaluate a multitude of corporate decisions and options. ?This team should work with the finance & business development team to develop Strategic Finance Enterprise Model financial models, so senior management can properly evaluate strategic options.

8)?Legal

Initially for the first two years a start-up should be outsource all legal work to a competitively priced law firm. Starting around year 2 or 3 a company should consider bringing some legal work in house by hiring a contract lawyer. This will significantly cutdown outside legal costs. A next step would be to hire a paralegal to assist the contract lawyer. And finally, after years 4 or 5 the firm should think about hiring an in-house general counsel to handle any other remaining outsourced legal work.

During initial corporate set-up, a firm should utilize law firms that specialize in your company’s particular industry niche or who have existing clients in your sector. ?During initial fundraising rounds and follow-up rounds using a well-connected law firm is a great way to attract new investors. ?However, these firms can be quite expensive with senior partners charging well over a $1,000 an hour. So, after the initial fundraising avoid using these high-priced firms on a ?day-to-day basis and hire competent local firms which have lower billable rates in the $150 to $250 per hour range. Do not utilize these expensive law firms to manage your company’s day-to-day corporate records, board minutes or routine corporate filings as this is a complete waste of money.

9)?Human Resources (HR)

The human resources department needs to hire a head of human resources at first and then a HR manager or analyst to work with the head of HR. The human resources department needs to have a dedicated HR or employee management system to manage sensitive employee information. Important and sensitive employee data should not be managed in a bunch of Excel spreadsheets that are insecure and difficult to manage and maintain long-term.

The human resources department should be ultimately responsible for selecting all employee benefits packages. However, the analysis and financial review of the various plan options from different vendors should be done in conjunction with the finance and accounting departments to ensure that the best plans are selected that the company can afford. ?Human resources should outsource all payroll functions to a payroll provider. Payrolls are a very complicated function especially in the USA with 50 different states where employees could be located. Therefore, it is best to outsource it to a firm that specialized in payroll management and has the expertise to keep up to date with changes.

10)?Recruiting

The head of HR should initial handle recruiting for the first year or so. However, ?if the firm is growing rapidly then the firm should hire a director of recruiting as soon as possible. The recruiting department needs to have specialized recruiting candidate management and tracking software such as Jobvite and should not be using ???spreadsheets to manage these processes. The director of recruiting should hire independent contract recruiters that are paid hourly when there are a large number openings that need to be filled. Avoid as much as possible the use of expensive external recruiting firms that often have commissions of 20%-30% of a candidate’s base salary.

11)?Employees

Start-ups need to attract the best and brightest employees with diverse work experience and educational backgrounds. ?Companies should hire department heads first and then let them build out their teams. This helps build more cohesive teams and a better work environment. ?Start-ups need to adequately staff their firm or they risk employee burnout which leads to high turnover rates.

Senior management must be committed to developing and nurturing a firm's talent. Employees should be given work and tasks that match their skillsets and their capabilities. Tasking employees with mission impossible goals or tasks is one of the worst ways to manage people. ?People want to be challenged, and they want to learn. Rotating people onto different projects can be one of the best ways to develop more well-rounded and capable employees. ?Firms should pay for continuing education or technical training classes for employees which will directly help improve their work capabilities. ?

Management should listen to employees and not dictate to employees. If your employee turnover is in excess of 20%-35% annually then senior management may want to reflect internally on why and make changes to get this below 15% ASAP. Often the reason why employees leave is that senior management will not listen to their concerns and just ignores them.

12)?Independent Contractors

Independent contractors are a great well for a start-up to contract out key work when there are not employees to handle the work load. Over time consider hiring the best and brightest independent contractors as full-time employees. This will help you retain the expertise these contractors have developed and you won’t have to spend as much money and time as you would if you had to hire new employees. ?

When hiring overseas independent contractors be sure to understand local labor laws. In some countries, long-term independent contractors are considered to be de-facto employees and your firm may be subject to large financial penalties if they are not made employees. Limit the way that you pay independent contractors to direct Wire Transfer or ACH Payments as this are the most secure. Do not pay contractors via PayPal, TransferWise, other electronic payment platforms or using crypto currencies. Do not compensate independent contractors for currency risk exposure and do all payments in USD when possible.

13)?Senior Executives

Hire senior executives that have a proven track record of success and are qualified for the position they are hired for. Do not hire individuals that you think can do the job, hire those that have done the job. Do not hire family member, high school, college or military friends for senior management positions unless they are 100% qualified. It creates a potentially uncomfortable work environment for lower-level employees. Hire senior executives by group or team consensus. If several employees interview a person for a senior management position and the majority of the employees indicate that the person is not qualified or competent for the position then don’t hire that individual.

Do not hire too many senior executives as you will have a bloated management structure. ?Some start-ups turn into bureaucracies with too many expensive chiefs and not enough worker bees. ?In addition, hiring too many senior executives leads to a large amount of additional overhead in salaries. Senior executives (including the CEO and founders of the firm) need to be held directly accountable for their business decisions and actions. One of the biggest problems with start-ups is a lack of accountability at the top. Senior executives need to delegate responsibilities downwards to middle management employees.

14)?Board of Directors

The board of directors needs to made up equally of investor and non-investor independent directors. This creates balance in the board and help it to remain fair and objective. The board of directors should not have more than one or two current senior executives (usually the CEO or founders) on the board. Otherwise, senior management may have too much sway over the board.

The board of directors should not rubber stamp every single plan or request from senior management or the firms’ founders. The board of directors has a fiduciary responsibility to investors and employees to make sure that the company is operating in an appropriate and professional manner.?In order to maintain credibility, the board of directors needs to hold each and every senior executive including the CEO and founders of the firm directly accountable for their business decisions and actions. A significant problem with many start-ups is a lack of accountability at top levels of management.

The board needs to be clear and transparent in the way that they handle key issues.?The board?needs to keep detailed meeting minutes that are readily available for review upon request by appropriate parties at all times. This helps ensure that the board is accountable and that there is a documentation of all activities and key business decisions.

15)?Technology

Developing new technology is a time consuming and costly process. Try to utilize existing off the shelf technology to keep costs down as much as possible. A good example of this is utilizing?standard programming languages or open-source code. ?If the time required to develop a new technology is too great then consider licensing someone else’s technology in the interim until you have the time and financial resources to develop your own technology. Too many start-ups burn through piles of cash before they successfully develop their technology leading to corporate failure.

16)?Patents & Intellectual Property

Protecting new technology and software is critical to the success of any new start-up. Find a good patent law firm that you can work with and has the in-house expertise to understand your product, engineering and technology. Do not try to patent every single concept and be as selective as possible to patent only those key things that are critical to your underlying technology and strategic success. Patent filings are very time consuming, prohibitively expensive and can be a large financial drain on any start-up so spend your money wisely.

Be wary of utilizing government grants and loans for technology development as they may come with strings attached. There has been a recent trend where various US government agencies and departments have been claiming patents or ownership rights of new technologies or products that were developed with its government grants or financing. ?So, make sure that any government grant or loan contracts have clearly spelled out language as to who owns the intellectual property long-term.

17)?Setting Up New Business Units, Subsidiaries or Legal Entities

Start-ups need to think very carefully before starting up any new business units particularly in new geographic regions. Any new business unit needs to have a business plan with full blown financial projections that should be presented to the board of directors for approval.?A lack of a business plan or financial projections for any new business unit is cause for serious concern. This new business unit could possibly cost more money than expected that will starve other existing business units of much needed capital. If a new business unit cannot start producing revenue within 1-2 years, then it should not be started under any circumstances.

When setting up new legal entities or subsidiaries make sure that you file all of the necessary legal documents and you select the right domicile for the entity. When setting up new legal entities make sure that your lawyers draft a complete set of company by-laws, articles of incorporation and operating agreements. ?Also make sure that these lawyers also draft Intercompany Agreements (ICA). These ICAs should be well thought out and must consider all of the major interactions between parent and subsidiaries such as transfer pricing, revenue recognition, accounting and expense sharing. Too often Intercompany Agreements are set-up after the fact which creates operational headaches and potential tax penalty exposures.

18)?Offices & Leases

Initially working out of shared office spaces like WeWorks or sub-leasing other companies’ office space is a great way to save fund for the first 1-2 years. After year 2 a start-up should consider looking for Class B or C office space that is near public transportation and highways that you can configure in a modest manner within your financial means. The company can either lease this space directly from a landlord at market-based rates or sublease it from another firm usually at below market rates. Leases in prestigious and amenity loaded Class A buildings should not be signed by start-up unless they have enough revenues and can support the additional expense.

It is better to sign short term 2–4-year leases that may be more expensive but give you maximum flexibility. Do not ever sign leases over 5 years as this may be a long-term strategic mistake. ?Abatements early on in a long-term lease look great but you ultimately pay for it in the back end of a lease?A better practice is just to have a fixed monthly lease payment each month so that you know exactly what your overhead is at all times.

It is in your company’s best interest to allow for hybrid or even fully remote working arrangement these days if you wish to attract top talent. Because of Covid-19 people are now much more comfortable and capable of working from home. Consider reconfiguring your office space to utilize more hoteling shared work spaces. This also means you company will need less office space long-term and can reduce it leasing costs.

19)?Benefits

A start-up needs to provide basic benefits and healthcare plans with PPO or HMO ?type options with reasonable in-network and out-of-network fees. Be sure to remember that younger employees and older employees have different benefits needs. The finance group should work with human resources to evaluate the cost of all of various benefits packages from various providers.

I highly recommend to consider getting your benefits through a Professional Employer Organization (PEO). A PEO?is a benefit outsourcing firm that can provide small and medium sized firms healthcare and other benefits at reduced rates. This is possible because the PEO pools many firms together with thousands of employees and negotiates volume discounts with healthcare and benefits providers. Many PEOs also can handle payroll functions which is best left to experts. ?PEOs are also good as they allow you to offer benefits to employees in every state. Traditional healthcare plan may be limited to the state where your company is based or has offices in which may limit your ability to attract new employees working remotely from other states.

20)?401-K Plans

By the end of year 2, a start-up should offer some type of 401-K plan to help attract and retain employees. Make sure that the vendor offers a 401-K plan that has a diverse selection of mutual fund options that include at a minimum several target dated funds. The 401-K?provider should offer both regular 401-K and Roth 401-K (after-tax) plans so that employees can best match their retirement planning strategies. ?The firm should consider some basic matching amount such as up to 2-3%% of salary or a matching cap such as?$1,000 to $2,000 per year for each employee if it can afford to. Another consideration to help retain employees is to require a 2–4-year vesting period until these matching amounts are 100% vested.

21)?Stock Options

Stock options should be granted to employees at all levels to attract the best and brightest. Many companies only issue stock options to senior executives only which is a strategic mistake long-term as not all employees are being incentivized. Many start-ups do not give stock options to mid-level and junior employees which does not help in employee retention.?Stock options if issued should vest over a 2 to 4 year period in equal blocks to help retain talent.

22)?Raising Initial Capital & Financing

Do not raise more funds than you need in your A Round. It is better to have follow on B and C rounds asking for capital as the company needs more funds for different growth phases. ?Avoid down rounds in financing where you raise more money for follow-on rounds. A down round occurs when a company accepts a lower post-money valuation then its previous financing round. This is likely to have unfavorable terms for the company. Generally earlier institutional investor will have anti-dilution clauses which require a start-up to issue new shares to catch them up and keep them whole with the new investor at the lower valuation.

Work with an established bank to open a line of credit, if possible, to get your firm through tight times in-between financing rounds. Try to avoid convertible debt later in a company’s financing life cycle. Convertible debt allows the holder to convert debt to equity and will dilute existing shareholder ownership percentage. Convertible debt is more expensive than regular debt and usually carries a 20% discount which makes it more costly for a company long-term.

23)?Going Public

Start-ups should only consider going public when they truly have their act together internally. Too many start-up companies try to go public before they are ready. Often, they don’t have their product lines fully developed nor a large enough customer base. ?Some firms try to go public when their revenue hits the $100M mark. But the timing of when to go public should not really be based on some arbitrary revenue threshold and more about long-term growth potential.

More recently many start-ups have tried to go public via a Special Purpose Acquisition Company (SPAC) This is a quick and easy way to go public as it doesn’t subject the start-up to as much disclosure or regulatory scrutiny as a traditional Initial Public Offering?(IPO) would. However, going public via an IPO is a better strategy long-term as it forces a company to fix all of its internal process and operational issues so it is healthier long-term.

Conclusion:

This article is designed to help the reader gain a better understanding of best practices and critical success factors for start-ups. The articles contents provided several examples of best practices for different sub-topics. The information contained in each sub-topic are designed to help firms to achieve financial, operational and strategic success. Poor business and operational decisions early on in a company’s growth cycle need to be avoided by using best practices and simple common sense. ?I hope this article will help prevent your firm from making bad operational decisions. Please feel free to reach out to me if you have any questions on anything discussed in this article.?