This Week in Startups - Five things you need to nail to scale with Scott Orn | Kruze Consulting Startup Finance Basics

Episode Date: February 5, 2021

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Welcome back, everybody. It's this week in startups, and it's our Startup Basic series. What is Startup Basics? Well, I could ask a lot of questions over and over and over and over again. And it's exhausting because I have to repeat the same answer. And let's face it, I have an expertise in startups and investing in them, but there are people in specific verticals like legal or finance, recruiting, you know, you get the idea, who have a much deeper, and more updated set of knowledge that I don't have. And so we do the startup basic series every couple of years. We refresh them. We talk to some experts in our circle, the people who we work with. And we do this in partnership with them to try to have files and videos and podcasts where we can point people to this and say, watch this for 20 minutes, watch this for 30 minutes, and then let us know what questions you have. What specific questions you have after that? And then once we have those, startups tend to avoid major costly, unnecessary, self-inflicted wounds, which I can tell you, in legal and finance can be very acute and they are very avoidable. So Scott Orne is with us again

to do our finance basics, right? And you may have seen the first episode where we did basically acing your due diligence, super important. And then we did in the second episode of startup finance basics, we did a deep dive onto taxes, super important. Always get your taxes right. Always have your diligence right. And today, Scott and I, and Scott's with Cruise Consulting, and you can go to Cruise, K-R-U-Z-E-C consulting.com slash twist, to see all of their content. And they've got 20-minute videos on things.

We'll spend one minute on here, right, when we're giving our overview. So you can really do some deep dives over at cruis consulting.com slash twist. But today, Scott, we're going to do the five things you need to nail in order to scale. It rhymes and it's important, right? I love it. And this, I feel just like you, where I say, the same stuff over and over a lot of times. So I'm super excited to have this recorded on video with you

so that you and I can do other things, but people can still get the benefit of all our knowledge. Yeah, absolutely. So all of this knowledge is, again, on their website. And in the show notes, you will find all these bullet points and links to places to go to get more information. The first one I would say, well, just a quick overview, you're going to need, after you take money from someone like Jason, you're going to need to start producing financial statements. And so you're going to need to start actually having reporting. And with financial statements comes the necessity of also having other systems that we'll talk about here in a second.

But I think just quickly, the three statements you're going to need to start producing for your financials are an income statement, a balance sheet, and a cash flow statement. And, you know, you can do that to yourself or you can work with an accounting firm, someone like us or someone else. But you're going to need those three statements. The income statement is probably, I don't want to say one's more important. the other, but income state is going to show what you're bringing in revenue and what your expenses and give you kind of a simple burn rate. But of course, all investors and startup founders

know that cash is king. And that's really what's reflected on your balance sheet, along with all the kind of liabilities you have and things like that. And then third, especially for capital intensive businesses, which are, you know, equipment companies, robot companies, biotech, med tech, you are going to want to pay attention to your cash flow statement because you may be investing in big ticket things that don't really show up on your income statement because they're expensed over time. But that big cash outflow does show up on your cash flow statement. So those are the big three. So I just want to kind of orient everyone towards that.

And then I think it's helpful probably if you're okay with it, Jason, just talking about some of the systems that people should set up once they get going. Yeah. Well, the first one is I see here is super obvious. having a fresh, clean bank account as opposed to something that has some legacy, you know, deposits, some money you put in from your previous startup, the wrong tax ID, all this nonsense. You want to start fresh, clean, and have that when you log in, it's only this project, correct? I'm a no brain.

I'm laughing because I talked to two separate twist listeners last week who had kind of, by By the way, nicest people in the world. So, so, you know, just want to get things fixed. But they made this mistake. And untang, like, I think they could kind of see on the Zoom call with them, like my face cringing a little bit because it's actually hard to unwind us a little bit. So the first thing, like when you, when Jason sends you a term sheet and you sign it and you're about to get a wire from, you know, launch, you definitely want to go to Silicon Valley Bank or

First Republic, Mercury wrote a bank that is, you know, that works with startups that's used to working with startups and set up a fresh account. That money should come in there. Do not let it hit your personal bank account. Do not pay personal things out of the company bank account. Keep them separate. It'll save you so much time and energy and fees for your accounting firm to unwind that stuff. And it's good hygiene. So I always would make this mistake. I'd be carrying two credit cards with me or I would forget my corporate card that I put business stuff on my personal card. Or my personal card, everybody's had this experience, your personal card gets declined, you're in an airport, you use your business card for a personal expense. And then you got to go switch that, take it out. And now, oh, my lord, somebody looks at it. And it can be weaponized against you. It could be problematic and just make you look dumb that like, oh, my God, you put your business class, you know, or you bought your vacation airplane tickets by mistake because you had it in your, you know, password or credit card, you know, Chrome extension to just auto pay. Right. So you got to be careful with that.

that stuff because it looks bad. It's bad optics. Totally. And, you know, the thing, like you talked about being weaponized against you. The first, we've had a bunch of, we do taxes. So we have a bunch of companies get audited. The, literally the first thing the IRS asked for when they audit you is all money transactions going back and forth between the founder and the company. And that's because that's the easiest way to avoid payroll taxes for, oh, totally. That's the first thing. Wow. And so, you know, if you keep it separate. They're like detectives. They're like master detectives. They're like master detectives. They know exactly the follow the money. Follow the money.

Totally. And it's a great way to, it also prevents theft. You do not want to have a culture of your, at your company of mixing things. Because sometimes we'll come in at like a series A or series B company. And this doesn't happen all, it's not super often,

but like maybe once a year we'll find the office manager was paying their personal credit card with the company's money. Because there weren't, you know, actual checks and balances and a culture of accountability and separation set up. And so that's theft. And there's nothing more embarrassing

than reporting that to your board. We even had a CEO who we loved, who this is probably four years ago, we love this guy. He's nicest guy in the world. He kind of like he just kind of made this lapse in judgment where he thought of the company's money, even though it's from investors,

as his own money. And so he spent about $10,000 of the company's money on clothes and dinners and things like that. And we found it. And we had to do, like a kind of a delicate conversation with the board and say like, hey, this is not. And you know what? He ended up removing himself from the company.

It cost him a lot. So just please don't do this kind of stuff. It's so dumb because what happens in these situations is people are like, well, I'm being underpaid. So I put some expenses there. And it's like, no, no. Just negotiate your salary directly with the board and increase your salary. So if you feel underpaid, the proper way to do that is go to your board and say, I need

to get 2K more a month in order to stay solvent or be. because I deserve it or whatever the reason is, or no reason at all, rather than taking a third of your apartment and, you know, reimbursing yourself $20,000 at the end of the year for it, or something silly like that. Okay, let's go on to number two. And I used to have this problem all the time, which is when I was young, maybe I couldn't get a credit card. I didn't have great, I didn't have great credit when I was in my 20s. Let's leave it at that. And I was concerned about putting a personal guarantee on the corporate card. What if the company has a problem and I got $20,000 in the card that month. Am I going to be wiped out personally?

So let's talk about credit cards with no personal guarantee. These are possible today, correct? Absolutely. Brex actually changed the market. The reason why Brex has such a big valuation is they figured this out. So prior, SVBE, Amex, Chase, whoever you're using, you had to either do a personal guarantee, which are credits on the line, or you would have to segment a bunch of cash in your bank account, put it into a different bank account that they could pull if your credit card got over or you didn't pay it back. Brex came to market and said like, hey, there's a better way. Let's do audit debits and just underwrite kind of proactively on this. And Jason, I'm sure you've heard some horror stories, but I'll never forget, like,

I was on vacation. We had a company that wasn't going to make it. And I was helping do kind of the wind down. And they had a senior lender. And the senior lender was about to sweep all the cash. And it was all fine. It was all agreed upon and everything. And I just happened to kind of ask the founder, hey, did you pay your credit cards off?

because I remember they had Amex, and she was like, oh my God, we haven't yet. And it turned out to be a $25,000 balance that she would have. So imagine your startup's going down. You've made nothing for very little for two years. And then all of a sudden, you're going to owe another $25,000. So she paid it. But it was just like absentmindedly. I kind of asked that question.

So when Brex came in the market, we really kind of put an emphasis on that. Now, the cool thing is SVB and Amex both have startup focus. offerings now. So they are now doing... So they react. It's Brex being in the market. Totally. It was capitalism. Capitalism is best, right? Yeah, love it. Competition. The next one I get a ton of questions about, which is what accounting software should I use. And there's a lot of new entrance. There's a lot of people trying to get your business. But I have always done quickbooks. And in the old days, we would have to buy DVDs and have multiple licenses for $600 a year. It was very frustrating. But now it's all online. I remember that happening 10 or 15 years ago. It all moved

online and correct me if I'm wrong, that's the standard, right? Absolutely. QuickBooks online. They're one of the few companies that successfully ported from desktop to the cloud. That's really difficult to do. Adobe did it too, right? Adobe did a great job too. Zero is the kind of alternative. They came in the market probably like eight or nine years ago, really scared QuickBooks. So again, capitalism at work here. QuickBooks got on their horse, got ClickBooks online. And now visualize like kind of the sun in the solar system. ClickBooks is the center of the sun. And there's tons of apps that now are plugging in and integrating the QuickBooks.

And it's really important. We've had companies use zero in the past and not to be, I don't want to be smirch anyone, but like I'm never sitting there with Vanessa and I going over a tax turn because Vanessa is our head of tax and she does all the tax turns. And we were hitting refresh on zero. And there was a $100,000 deposit that was moving between December and January. It was terrifying.

And that deposit swung the, company into a loss or gain depending on what it was like happening in real time. And so we did the conservative thing. We filed it as the gain in December. That company, pay the taxes, that company ended up getting audited. They passed their audit. But that was the moment where we swore that we were going to be a QuickBooks online shop only because you just can't mess around with this kind of stuff. And so that's why I mean, listen, it's 26 bucks a month, 35 bucks a month. This stuff is so cheap. Well worth it. Do it right. So now I got my perfect bank account fresh and clean. I got my credit card, fresh and clean. It's sweeping. It's not. I got a personal guarantee

and I got quick books all set up. Now, clean, clean, everything's fresh. No problems. All standardized on the top software and platforms and providers. But this is the one where I think people get bombarded with choices, which is payroll. You got to get your payroll taxes right. There's a bunch of people, Xenafits, Gusto, Rippling. We've had many of them as partners on this podcast and advertising. We've used all of them. In fact, we, I think we use two of them right now. Tell me, what is the standard? Does it matter if you use Gusto, Ripling? They're all in great competition with each other, providing great services, correct? They all have, and I would throw Trina in there and JustWorks as well. But those four, the big four, you're not going to really

go wrong. They all have their strengths. Gusto, I'll still never forget. Vanessa came home about eight or nine years ago. She had just met Josh and the rest of the team at Zen payroll, which became Gusto. They were a four-person company. And she said, A, I should invest in them, which I was too stupid to listen to. And B, she's like, they're going to put payroll in the cloud and automate it. And it was such a game changer for her because instead of charging all her clients an hour to run payroll, it was now being done automatically, huge game changer. Now, Rippling, Trinette, you know, JustWorks all have that functionality.

But I think the big kind of dichotomy now is whether you go PEO, or whether you just run kind of the normal payroll and benefits stack. So Gusto does normal payroll benefits. Ripling does normal payroll benefits, but they've come out with the PEO. And then Trinet and JustWorks are PEO. And the advantage, what's really kind of happened since COVID hit is PEOs have become more popular

because a lot of team members have kind of, for lack of a better word, fled San Francisco and New York. You don't even know where they are. Yeah, they're all over. I can tell you, we see all the state registrations. And we see a lot of the state tax stuff. And so the PEOs are actually helpful in that. They will handle some of the local tax compliance for you, which is really, really nice.

Super important. Yeah. And for people who don't know, a PEO is a personal employer organization. When you have a PEO, you basically have your employee, all of your team members become employees of the PEO. The PEO is a collection of companies, almost like a mutual fund of employees of all these different companies, which means they can qualify for great benefits and get them, you know, benefits based on 10,000 people, even if it's just, you know, a hundred, 100 person companies or,

you know, but at some point, you will come off of a PEO. And I think that number is 100 or 200 employees. You'll eventually flip back to employing them directly, correct? Yep. Yep, exactly. And, you know, the nice thing about, so that's, you're exactly right, the, the bond, collective buying power gets you better deals on the PEO. One of the things we like about rippling, they have a lot kind of, they're more, they're fresher company, kind of more modern tech stack, but they also let you work with independent broker. So like Cruz, we are in like 15, 20 states. We actually use Rippling and we're able to use independent broker who got us some of that savings. We saved about $30,000 last year just by working through an independent broker. So

there's a reason why those independent brokers are out there and they're still, they're still doing well. So that's really helpful. And then, of course, a lot of super early stage companies do start with gusto. It's a great place to start. Very easy, intuitive. And they put a lot of effort into their customer support. So you really can't go wrong with those four. But if I can just make one point, I talked to another twist listener on Monday, and he had done the cardinal sin of he, he was, it was tight. He was, you know, his personal finances were mixed in. And he had done $50,000 of distributions to himself without running it through payroll. We talked about this on the tax episode. you know, the IRS and all kinds of regional authorities, when you pay yourself a distribution,

they're going to say, is that payroll? Did you work for that? Is that a distribution? What tax event can we now do? And you need to be careful. Do not do this draw thing. I mean, if you do it for three months, you might be able to clean it up, but it's just not worth it. You want to do these things right, correct Scott? Because when you do them wrong, it's a red flag. And then the diligence team at whatever venture firm or seed fund or accelerator

goes, okay, what else is wrong? If they got these three things wrong, they're using their, they're mixing personal and professional, they're paying themselves draws, they're not paying taxes, they didn't file, they're not using proper software, they're doing this in a Google sheet for accounting.

Like, you're just going to get yourself in trouble. And all of this work, if we look at it is so easy now. Setting this up is low hundreds of dollars, maybe in total. Absolutely. And the beautiful thing about this is that all scales beyond even 100 employees. Like, you're not going to have to touch anything for a really long time. And like years, especially like when you're getting those first checks in setting this stuff up, you do have a little bit of breathing room right in that moment. You're going to get so busy that it's going to be like this, I call it like accounting debt the same way you have technical debt. Like, you're not.

You're not going to want to address this stuff. It's a pain in the butt. And so just setting up correctly the first time makes it so much easier. All right. Now, tax compliance. This is critically important. So we got through the first five items. Pretty, pretty easy.

Get a clean bank account. Get a great credit card with no personal guarantee. Get the right online accounting software. Set up your payroll properly, either PEO or with one of these firms. All of this is going to be a couple of hours each. I would put each of these items at two hours. for you to master it. So you're looking at one day of work. In the old days, this might be two or three days of work each, getting the software, getting a computer, installing QuickBooks,

you know, going to the bank, filling out a bunch of forms and having to go to the branch and all this nonsense. But the last one, tax compliance. Okay. Tell us about tax compliance here. And we've gone over this topic, so I'll do it quickly, but you're going to need to do your Delaware franchise tax. You're going to need to do 1099s, which we just, completed yesterday. It's the first thing that comes in the year. All your contractors who got paid $600 or more are going to need that. If you're in California, New York, Massachusetts, you're going to have like a franchise tax. And then you've got to do a federal and state income tax. And you want to do an R&D tax credit. We had a twist listener. 100%. Yeah, who missed out on

the R&D tax credit last year, which is our average, it's like $50,000 that you just miss out on. It's like it's money that goes in your bank account and helps you, helps mitigate your burn. those are the big ones. But I think the bigger kind of thing, this is related to tax compliance. We just had a company two weeks ago who closed a close $30 million deal, like a $30 million dollar round. But two days before like hardcore legal and tax diligence, we realized that they had done their tax returns before they came to Cruz on a cash basis, which threw everything out of whack. I had lawyers getting mad at the CEO, getting mad at us. We were getting mad.

It was, we cleaned it up. We got it done. The round closed. Everything was okay. But it was, there's just like this stress level that you don't need when you're about to close a $30 million round. So just making, like making sure all these foundational things are set up.

And like your accounting is done in accrual from day one. And you don't go to like a not good tax firm who's going to do your tax attorney correctly. I mean, don't scamp on taxes. It's sort of like, you don't, I always tell. people like, if you're going to go for sushi, instead of going three times to a cheap place, go once to the right place. You don't want to skimp on raw fish. Get the high quality stuff. Just as a bonus here, we went through the five important items. We now have cap table

management software that really educates and simplifies and really helps the CEO and co-founders understand what their dilution is. Do you have some recommendations on that? Yeah. The kind of de facto is CARTA, which we, We've worked with Carter for many, many years. We used to do their tax compliance, so we know them very well. There's a new software out there called Pully, which a lot of companies are using, which is, which is hot. Yeah, Pooley. And I think they just came out of Y Combinator.

I think it's P-U-L-L-E-Y. So there's an alternative to Carter now. You can also just do the old school spreadsheets for early stage companies. I wouldn't recommend a series A, series B do that, but that's fine. And there's a couple other options. But getting that in a visual format, making sure you're. options are granted correctly. I've got two good stories for you. The first one is we had a client, again, two Fridays ago, get a $10 million term sheet. There's a boom, this is awesome. And guess what?

He had not issued all of the stock options yet. He hadn't signed the term sheet, but he hadn't issued all the stock options yet. And we got a panicked call from him because he had, it was like a riot in the company's offices because people found out about it. All of a sudden, their old, strike price on their options was going to be two or three times higher because they hadn't been issued yet. And you just really do not want to do that. That's, I mean, that's, be careful. Yeah, exactly. You've got sophisticated employees now. They know that that price matters. Their strike price matters. So get it right. Totally. And then we had another client, this is like six months ago, who was managing all the option grants in his email,

which I would not just do not do that. So, Instead of having a visual. Yeah, yeah, exactly, right? The irony is amazing entrepreneur who's built this incredibly scalable transportation technology, but was doing it this way. And we got a hold of it. We cleaned it up for him.

But like that's, again, the stress you do not need. And you're sending a signal to your employees. And they've turned you into an archaeologist. Like, you've got to go on the big dig to find out what's going on here. And now you're Indiana Jones trying to uncover, you know, where is the idol who's, you know, and you could miss stuff. All right. This has been amazing.

Yeah. Everybody knows the five now. Five things. Just get these right. Clean bank account. Boom. Credit card. Boom.

Accounting software. Check. Payroll. PEO. Do your research. That one does take. You're going to take five meetings there. You want to get comfortable with the right partner.

Talk to your startup friends. Talk to your accountant, your attorney. They might have some thoughts on it. But they generally are similar. Tax compliance. You got to just have a great tax. attorney, because it is a moving ball. Cap table, super simple. You can use a Google sheet or Excel with your attorneys to start, but you're eventually going to want to put it in a system so people

can look it up themselves. And finally, you've got to have your projections in order. And this is such a big topic that we're going to talk about it on part four of startup finance basics, budgets, financial models, and managing your cash. So look for that episode coming up next week. If you're listening to this in real time, we're just looking at the archive at this week in startups.com. Thank you, Scott. Everybody go to Cruise Consulting.com slash twist

and we'll see you next time on startup basics.