Tuesday January 24, 2017 0 comments
By Peter Adams
Rockies Venture Club
I’ve heard a lot of founders who say “after this round, we’ll be at break-even.” In half of the cases, I’m thinking that this is a great thing and in the others I am quickly losing interest. How could the same claim result in two such opposing positions?
Break even is basically a good thing. This means that you have at least as much cash coming in as you have going out. Don’t mistake this for having a zero net profit where revenues minus expenses is zero, or apparently “even.” Revenues do not equal cash because many sales will be made on Net 30 terms which won’t result in cash for 30-90 days. In the case of rapidly growing companies, the difference between revenues and cash coming in the door can be significant.
Break even is good because your risk of going out of business because you’ve run out of cash is minimized. Since running out of cash is the number one cause of business failure, having certainty of no negative cash flow makes the investment much safer. Break even is often a point that a company passes through quickly on its way to being cash flow positive, but this is not always the case.
Break even or even cash flow positive can be a bad thing. I know – it sounds crazy, but think of it this way: If you’re putting cash to the bottom line and you’re just having it sit in your checking account, then it’s not working for you. It could be better to take those profits and sink them into more rapid growth. Companies with higher growth curves get the highest multiples when they are acquired during an M&A exit (most of the time).
So, imagine that you have an exit potential at 5X revenues. If you have $1 million in your checking account, then the value of that money is $1 million. But if you invested that in sales and you only got a one-to-one ratio of investment to revenues, (i.e. if you spend one dollar on marketing and it results in one dollar of sales) then the exit would be quite different. In that case, your $1 million would have resulted in $1 million in sales and $5 million in increased value because your acquirer is willing to pay you a multiple on your top line revenues.
So, what’s the best strategy for a startup? Risk everything for growth, or grow too slowly and leave millions on the table? The answer is going to differ for every company in its own circumstances, but consider a compromise: If follow-on funding or cash flow positive status are not highly likely for a company, then a good balance would be to build up a revenue base which, if things didn’t go well, could pay for a bare-bones crew of staff and marketing expense. In this scenario, the company continues to grow, but can scale back to survival mode if the situation required it.
Being able to control cash flow to reach break even means that a company is able to control its destiny. If a company is coming up against a brick-wall and running out of cash, it is not in a good position to negotiate a favorable round of funding, if it can even do so at all.
Companies who mistakenly believe that getting to break even is the goal are missing the point of finance strategy. There is a difference between reaching break even and not needing any further funding and reaching break even and then raising more funds to really accelerate growth and build shareholder value while having the opportunity to scale back to safety if follow-on funding is not available.