The Cash Problem

Here is a scenario that is all too familiar for anyone who has orbited the small company and growth stage company management space.

The Scenario

An email hits your inbox at 9am on a Tuesday from a close acquaintance with the subject ‘quick question’. The body of the email starts with pleasantries and proceeds to lay out the always bright but never quite realized opportunities of his company. Finally, after several paragraphs, a small sentence alludes to the need for some “short term capital” as a bridge to get the “opportunities” in the door. With a nervous sigh you realize the company is out of cash and they are scrambling...

Hoping for the best, you reach out with a time that day to talk. The CEO takes your call on your terms at your time. He is obviously ‘wide open,’ and that is not a good sign. On the call you get another dose of the “opportunity”. According to the CEO, the upside is limitless and the downside nonexistent. You are intrigued. You have followed the company for a while and are optimistic about the fundamentals of the business.

You propose some terms and request some information – you know, the basics – debt schedule, asset schedule, AP aging, weekly cash forecast... other such evidences that this ‘bridge’ is sufficiently large to work and sufficiently secured to truly have a mitigated downside. The CEO says ‘not a problem’ and utters something about having his part time CFO pull that together for you. From past experience, you expect that your request represents several days of work if not already prepared and ready to send.

You start laying out the timeline: “Well, okay, send me those files and I will be thinking through the term sheet. Once we have agreement on the terms and I am satisfied on the files, I will have by attorney draw something up for you to review and execute. Let’s meet up at the end of next week to check in on the schedule.”

The CEO says, “That all sounds good but I need the money by tomorrow at 5pm.”

Uh oh... you sigh again. The familiar feeling of compulsion begins to crop up in you to step in and help. Fortunately, you have been through this before and know to set firm and clear expectations with people who are at the precipice of what they feel is almost assured disaster.

After a pregnant pause, you respond: “It is next to impossible to be responsible with a 24 hour timeline for making a risky bridge-funding investment decision. I am sorry you on are in this position, but the best I can do is a three-week timeline and that is only after reviewing the information requested and feeling confident in the security of the opportunity.”

The other end of the line is dead. You can feel the anxiety building...

Principles

Managing a growing business is not easy. Often the CEO and key operating personnel are balancing customer needs with new customer development and cash management falls through the cracks. 

Managing cash is a low role that seems degrading or maybe too ‘easy’. Or maybe it is the perfect blend of providing escapism while protecting the enthusiasm that propels entrepreneurs onward. Either way, cash management is badly overlooked despite being the primary reason of failure for 29% of failed businesses. And when the cash runs out, the business is done... game over.

What should thoughtful CEOs do with this scenario? Hording cash, pulling punches, under estimating revenue all seem counter to the mandate of entrepreneurial leadership and to the entrepreneurial psyche.

They shouldn’t change their operating prerogative, but rather put in place a process to ensure they are funding-ready at any moment. Revenue slips, hidden costs pop up, legal bills come in, key customers slow pay, AR goes bad... the reasons for a cash scramble are endless. Prepare your business to get funded by having a compelling story prepared and a data room ready.

The Data Room – A Startup’s Survival Insurance

All startups and most small businesses should have a data room with all the relevant information an investor would need to make a decision as well as a pre-drafted and very generous debt instrument, funding document, and security interest (deed of trust) ready to go at a moment’s notice. And even then, the timeline to get funds is weeks, not days.

‘Just in case’ Data Room Checklist:

1. Closed financials for the most recent month including YTD; preferably monthly Notes for any anomalies an investor might notice in your financials

2. Two years of tax returns

3. Six months of bank statements

4. Asset schedule for all fixed assets and description of intangibles

5. Debt schedule for all debts

6. AP aging

7. AR aging

8. Your most recent pitch book

9. Draft of the investment instrument (already legal approved)

10. Draft of security interest documents and a printout of the UCC Lien Position from the Secretary of State

11. A list of representations and warranties on absence of undisclosed liabilities, up to date tax reporting and filing, and completeness of the financials

12. A weekly cash flow forecast that matches your ‘downside’ scenario and shows the ability for these funds to matter

Update this data room monthly along with your monthly close process. In fact, it is often a good idea to format your closing folder on your Box account or other share drive in this format and date the folder. This shows consistency to the investors that is impressive and builds trust. While in discussion with investors, the data room should be updated weekly and should have a word document included that explains dates of changes and substance of the changes.

Anything less than this - an overwhelming amount of preparation and professionalism - is an affront to the people you most depend upon when things are not going your way. 

The Timeline

Even with the most prepared and comprehensive data room, bringing an investor up to speed on the business and in a position to fund a note takes weeks. The following schedule is a minimum workflow and timeline for a $200K bridge with a key investor leading a group of three to five other investors. Ideally, you want one investor to take the round, but when you need money, you aren’t the one driving the deal...

If your data room is solid and up to date and if you have a key investor who is already familiar with your business and could fund your entire need, then the goal of week 1 is to establish a timeline and a pace of urgency with the key investor. 

Put yourself in the investor’s shoes. They will have a network of friends who could invest alongside them. The main insecurity they face in deciding whether to syndicate your deal is whether they become responsible for their friend losing money. This is a huge insecurity. Everything you do must be designed to ensure them that this will not happen.

Your role in this process is to get the key investor ramped up on your need and on the deal. This means ensuring he has all the information he needs to know where this deal rests on the risk/ return spectrum. It is prudent to establish with him early on whether he has ready cash to fund this deal and whether, if he is satisfied that it is a good opportunity and secure, he could fund fast.

Giving plenty of ‘outs’ to the key investor early on is key to ensuring you aren’t suffering from happy ears because the investor you are talking with doesn’t like confrontation... That can kill your business and it wont be the investor’s fault. Diligence of investor interest is your responsibility.

In our experience, the timeline above can be edited/augmented by the following adjustments:

• Add one (1) week for every $100K needed more than $300K
• Add two (2) weeks if your business has debt and no more EBITDA coverage (yes, credit cards and AP both matter) – assume 2x coverage of debt payment is required
• Add two (2) weeks if the key investor wants to use a different note structure than what you have already prepared
• Add three (3) weeks if you do not have a key investor who could do the entire deal on their own
• Add two (2) weeks if you have tax liens or ongoing litigation
• Add four (4) weeks if the funding repayment is mostly contingent (i.e. hire sales people to get the revenue secured to then pay back the note)
• Add one (1) week for any renegotiation of the investor’s terms (even the interest rate)

As you can see, this timeline can quickly become 2 months or more. And while that seems ridiculous, you have to keep in mind that no one sees your business like you do. It takes time to get comfortable with the security of the investment and, most importantly, to build trust with you. Once they establish a baseline of trust which could be inferred based upon the key investor’s involvement, the investors are scrutinizing whether you have fooled yourself. They believe that you believe what you are saying, but they know all too well the mind’s potential to blind itself to risk when facing existential threats. Be patient with this; it takes time.

The Cash Flow Forecast – A Startup’s Coalmine Canary

How far out do you know your cash? Most startups manage a forecast that is chronically over optimistic. Part of this comes from lack of experience, but the majority comes from the DNA of a startup. If startups were run by risk observant auditors, they would never launch. Your cash flow forecast is NOT your model. Don’t try to do the two in the same document. Your cash model is built on the following key elements: 

1. Cash in the bank right now (yes, today)

2. Variable cash expenses to deliver revenue in the period (weekly is best)

3. Fixed cash expenses that cannot be delayed through AP: (i.e. payroll, rent, payroll tax, health insurance, etc)

4. Customer cash from AR (this should be based on the most pessimistic expectation)

5. Vendor cash payments to AP (this is a plug from available cash)

Get the model here:

This cash flow forecast should be accurate enough to predict minimum cash at least 3 months out. In our experience, if your model hits your minimum number (which should be more than $0) 3 months out under pessimistic expectations, you should start the process of getting funds. Your cash flow forecast is the canary in your coal mine; when it drops dead, take note and run fast.

There are a lot of reasons that it can be wrong even as near as 3 months out. Pay particular attention to your expectations of customer payment terms, new customer onboarding and ‘go- live’, vendor terms, and make sure to leave room for a pretty big ‘whoops’ factor. Things come up like licenses you didn’t know you needed or a wildly inaccurate sales trip budgets all of which consume cash now. And of course there is always the inevitable delay on that pending new contract...