Make money before you raise money

I will start with a horror story.  A friend recently asked me to meet one of her relatives who is the CEO of an early stage business.  The CEO’s story is extreme but not uncommon.  To protect the innocent (and na?ve), I will not identify any individuals. In his late 20s, the CEO started his business two years ago with an idea that met a product gap in the market. Since then, he has hired a team of 7 and outsourced the development of the product with the product development now costing $250k per quarter.  His CTO keeps on coming up with ever more clever product ideas of why the product is not quite perfect. In essence, his CTO seems to be on an intellectual exercise to build the most sophisticated mousetrap (seeking perfection in isolation from customers is never a good idea). At the same time, his head of Sales & Marketing is saying “we don’t have traction” so shifts to a different market positioning every 180 days.   

Two years on and the company scorecard shows no customers; a product that is still pre-alpha; $2m seed capital gone and the CEO left with no choice but to raise more money at a reduced valuation. Ouch! And the CEO can’t put his finger on ‘what is the problem?’ but was consumed with the need to raise more money, seemingly having learned nothing from the last two years.   The CEO still had 6 months cash so I advised him that he should put his attention into the ‘back to basics’ of business to get his product to Minimum Viable Product (MVP) – create a short-term end-result plan and personally lead the execution with the first priority of attracting customers and thereby revenue streams plus invaluable product feedback; take his team of 7 down to a minimum viable team (and manage the outsource dev plan down to MVP and then bring development in-house under a ‘hands-on’ agile head of Product) to slow the cash bleed. If he took these actions, he could extend his cash runway to beyond 12 months by which time, he should be winning customers and growing with a product that was more than punching its weight.  Only when he can demonstrate momentum and growth should he consider raising money at a forward valuation. In short, his priority and focus as a CEO should be ‘Make money before you raise money’.

If that was a case study in how NOT to go about making money before raising money, what does best practice look like?  What I will cover in this blog will be somewhat generic, but the homilies apply to all growing businesses.  There does come a time in the journey of a business to seek further investment for growth capital but my focus here is the days before Round 1/Series A.  Also, let me note that there is a slight nuance between services-based and consulting businesses compared to product ones. The services model offers the potential to be cash-flow positive from Day One by billing yourself and your early employees from the get-go. But today, I am going to focus on exploring product companies where I see so many CEOs become delusional about what really matters in their business and spend disproportionate amounts of time too early raising money when they should be spending all their time making their big idea come to life by doing only four things: 1) Winning customers; 2) retaining customers; 3) building product and 4) hiring the best people.  Once you have your big idea, then success comes executing the plan with focus, focus, focus and the hard work of delighting customers to create the cornerstones of success.  Time spent raising money is the same time sacrificed from building product or winning customers or hiring rockstar employees.

As a CEO, every day, you need to be ruthless where you invest your time aligned with your plan. Now, I have lots of good VC and Private Equity friends and at some point, you may need to accelerate the investment for growth with VCs.  However, before you engage with VCs, then be aware that the first contact may lead to a ‘sales campaign’ in its own right where you have little control over the VC credit committees, partner approvals or due diligence process.  For the CEO, to the VC, YOU are the company so be aware that a funding round can become a full-time job for you as CEO pitching front and centre. It is worth considering that some VCs will only invest in 1 of 100 businesses from their horizon scanning after doing due-diligence on 12-15 companies.  A salutary tale is a CEO that I met who missed the quarter because she was distracted and spending time with a VC on the due diligence process. She had spent little attention with prospective customers to gain their commitment resulting in missing the quarter. Two steps back for the potential one step forwards.  Remember also, if you raise money too early, then you will face greater dilution; loss of control e.g. warrants; and you will be asked to create a lot more reports on OKRs.  

From a human psychology perspective, it sounds crazy but there is a risk of raising too much money and undermining the culture you have carefully created into the DNA of the company.  When we IPO’d Chordiant in February 2000 and raised $70m, I was shocked when colleagues came to me and said, ‘now we have $70m, can we fly first class?’ when the company policy was from CEO to receptionist, we flew coach/economy (employees could upgrade on miles). Other employees saw the IPO as the ‘end’ of the mission.  At Town Hall meetings and internal communications, I had to remind them of the responsibility now as a public company of shareholder expectations and that the IPO was the very start of the journey for us to prove ourselves and earning the trust of shareholders as another key stakeholder group.  The adage of ‘under promise, over deliver’ on the quarterly, accelerating treadmill was the new reality. It taught me that when you hit the jackpot and raise the next round, the whole ethos of ‘treating the company’s money as if it is your own’ and the beauty of bootstrapping can be lost and the carefully nurtured culture threatened.   It is so important after the ‘event’ of raising money, that your business hits all the plans for the following quarters; trust can be damaged if you raise money and miss the plan. I have seen many CEOs who raise money, or the founders take some money ‘off the table’, and the Exec team visibly relaxes to the point where the previously high-growth business becomes a lifestyle business and loses value.

So, what’s the best blueprint?

Some CEOs take the ‘hustler’ metaphor in the start-up phase very literally and use their credit cards or a loan with low interest rates to get started.  I would be reticent to recommend using security of your home, but I have seen it all.  For this blog, I will focus on a well-trodden path where I have seen successful CEOs build high value businesses in a systematic way using a robust playbook. Support your compelling vision with an end-result plan including the quickest route to customers with MVP product.  This allows you to focus the company on the product that transforms customer’s lives – focus on sales; customer success; product innovation and hiring the best.  Underpin all this with a culture where colleagues and customers alike love your company and become your biggest advocates.  If your product is not fully baked, then prototype your idea so others can get excited about it and give you feedback to improve towards the milestone of MVP.  It is important that raising money is only a means to the end - a means to grow faster.    Remember easy money creates wasteful companies.  Within your end result plan, model the revenues and expenses and therefore the cash usage – a good rule of thumb would be to raise for an 18-24 month runway based on the cash projection of the plan. Most of the funding will be for growth and hiring – sales, marketing and product.  70-80% of your cost base is likely to be your employee related costs - normally, you don’t consume the cash as quickly as planned because it takes longer to hire than you had projected.  However, if you are growing faster, you may consume the cash quicker – the good news is that there is a wall of cash and investors for businesses that grow fast, sustainably and exceed their plans.  For planning purposes, taking ‘smart’ funding every 18-24 months in a non-invasive manner allows you to focus on maximising the growth and therefore long-term valuation of the business.

It is worth doing all the obvious things to preserve cash and extend the runway. You can engage customers and employees in making cash go further – payment terms a year in advance; sometimes offering 3-year cash payment from customers in return for more value.  With the early Execs who join for the first 2-3 years, many should be willing to take salaries below market rates compensated through additional stock which further preserves the cash.  The DNA of your company should preserve cash and reward ownership – give all early employees stock and ask them to act like owners of the business – they won’t disappoint.

If you focus on growth and making money, then it becomes a self-fulfilling prophecy where with growth, comes greater confidence, and consequential momentum.  You automatically become more attractive to investors at higher valuations and gives you real life customer case studies to share when you are pitching for the next round of investment.  Internally and externally, it is always good to be specific so talk about why you raised money and how it will be used (to invest in greater customer success; sales; expanding to the next country with granular detail etc.) and when you stand up at All Hands meetings, tell your colleagues how the money was invested and the results achieved. 

Certainly, for the early phases, use a ‘friends & family’ round then transition as quickly as possible to Smart capital.  These rounds should be non-invasive of your time in fact, quick if you are clear on your value proposition and on top of your plan. Angel investors can invest after 1-2 meetings with minimum overheads or due diligence distraction.  These angels come with money, expertise, contacts, networks, mentoring. Good angels can even help intros to prospective customers and hiring amazing people.  Typically, it would be clever to target Angels as former ‘street fighter’ Execs who know the domain and have built similar businesses before, so they have walked in your shoes. Their advice and sharing their ‘scars’ will be invaluable, save you time and stop you making the same mistakes.  When you engage in an Angel round, I would suggest you set a minimum investment (I recommend ￡50k) to reduce the shareholder management issues downstream; create a simple shareholder agreement (where shareholder rights are sensible but limited).  

I have been involved in many successful businesses who have raised money every 18-24 months mainly with follow-on angel investors and broadening the investment club where investors have an equal interest in the financial return as well as wanting to support the CEO become the best CEO possible at every stage of the company growth and success.  I would argue that this ‘drip-feed’ approach to investment for growth allows you as CEO to focus almost 100% on execution of the plans putting customers top of the list, hiring great people and innovating out of sight of competitors. Finally, never get greedy and overvalue an investment round – it is better to provide early funders with a discount to reward them for their risk taking. As Warren Buffett said, “Be fearful when others are greedy and greedy when others are fearful”.  As a CEO, always be fearful and humble. Furthermore, as a CEO, you never want to go out with a ‘downround’ when the valuation decreases.  In the UK, if you involve HMRC or an accountant early in the process, the investment will be able to gain EIS/SEIS status which creates a very attractive tax efficient investment proposition. 

Briefly, I will argue against much of the ethos of ‘bootstrapping’ that I promote.  There is one scenario where you may wish to raise 3-4 years of cash runway and that is in times of adversity, external risks to the business or when you want some firepower for bolt-on acquisitions to grow faster.  You could argue for example, at the moment in UK with a sense of heightened anxiety around Brexit, it may be appropriate to raise a bigger cash ‘war chest’.  Looking back, when we IPO’d Chordiant in February 2000, weeks before the dot.com crash and effectively public markets closing, the timing was opportune.

Throughout your business success, as you invest for growth, your business will need access to capital.  There are only two types of businesses – growing businesses and dying businesses. The essence of a vibrant business is growth.  In the next Monday Mentoring, we will look at the sources of growth and your role as CEO to be the main insurgent for customers.