This Week in Startups - Managing Finances in a Recession: Startup Finance Basics w/ Kruze's Scott Orn | E1622

Episode Date: November 29, 2022

Jason welcomes back Kruze COO Scott Orn for another edition of Startup Finance Basics! Jason and Scott break down the state of the market (0:00), 2023 budget planning (9:21), and how to nail investor comms! (14:58) (0:00) Jason welcomes Kruze COO Scott Orn and they discuss the state of startups and VC (9:21) What a 2023 budget plan should look like at a Seed stage startup (14:58) Bias for action, investor comms

All right, everybody, welcome back to startup basics. This is the show where we talk about the basic stuff. You've got to get right running your startup. Finances, accounting, managing your money is one of the critical pieces. Cruise consulting is one of the best startup accounting firms in the Valley here and in the world. And Scott Orne is their chief operating officer. And we chop it up here on these startup basic episodes and talk about just the fundamentals. How you doing, Scott?

I do. Great. Thanks for having us on again. We are recording this in the fall of 2022 in the middle of what most people consider a double-dip recession. We had two negative cortisol growth, that we had a little blip of life. We got Facebook and Amazon laying off 11,000 and 10,000 people, and the funding environment has gotten really tight.

So I thought we'd start out with just emergency triage. this is a once every 10 to 15 year event. I think we did what, maybe 15 years since the 2008 crisis, right? So 14 years. We had this incredible bull run. And now there's been a pullback. People are belt tightening. And that means maybe some revenue gets pushed out.

And that means startups who typically have 12 months of runway, sometimes 18 in a best case scenario, are going to have a hard time raising money. And maybe they're going to have to cut some costs. So let's talk about what is happening, what you're seeing, because, of course, you call your finance team, you call your accountants and say, hey, how do I make this work? And listen, you guys have tools in your toolkit. Let's talk about those tools. It's obviously no silver bullets here. There is no magic wand, but there are tactics, right?

So let's get into the tactical things. Yeah. Well, one good news is we all had this like dry run for this in 2020 when COVID hits. If you remember, like every startup was being told to cut burn and every venture capital firm was calling the startups. So we've had this like kind of a rough draft version. So I've actually seen, I've been super pleased just because we have 750 clients now. So we have a really good barometer of the startup ecosystem.

And people started cutting like in March. Like it was very, very quick. And I think the other really positive signal is 2021 was a huge year. The valuations were crazy. And I have some data I can share with you on basically venture capital, especially at Series A, let their kind of underwriting thresholds go way down. So they used to kind of look for like two or three million of revenue. Right.

And they started doing like a million dollars revenue, right? Got it. But the good news is when the founders who had raised money started realizing that times are getting tough, they did start cutting a little bit. And more importantly, they did like these top up rounds or inside rounds or extension rounds. to get more cash in the door. And that started in March, like I said. So I remember 2008, Jason, like I worked out of VC fund,

and everyone just got caught completely blind. And it was Armageddon, the Sequoia, RIP presentation. And I think Twist is a part of this. Like, you guys do a great job of educating the ecosystem so that this stuff doesn't, like, if you think about it, like how many people watching YouTube videos and podcasts and educating themselves ahead of time on when. they need to cut or when they need to think about these things. And so overall, the ecosystem has responded, but I think your point about the double

dip, it is taking, there wasn't like this big bounce that people experienced in COVID, right? Remember, like by the reopening? Yeah, everything happened, right? So we are settling into a tougher climate and there are a lot of layoffs, spooking people and things like that. Interestingly, we're just starting to see a little bit of layoffs on the startup ecosystem. Like meta, Amazon, these companies are laying off a lot of people. But a lot of times, like, if you look back a couple years, their employment numbers have

like doubled. So they're kind of like letting off maybe like the 10 or 15 percent of surplus, but they're not doing huge, crazy deep cuts. Right. We're kind of seeing that with the startups too. This is numbers are smaller. Got it. Okay.

So to recap what you just said, people took the advice quicker this time. Yeah. And you're attributing that to two things. One, we had the dry run of COVID. In COVID, what people actually saw in a lot of businesses was an uptick, digital businesses, if you were selling, I don't know, some online educational service. And people were home or if you were Peloton, you actually saw an increase in orders, so revenue in.

And because people weren't going to the office or going on business trips, sometimes you actually saw some expenses go down. You also probably saw some productivity go up as your employees stopped commuting and had nothing to do. So they worked longer hours. These things actually were a catalyst. So you did have people saying make cuts. And then you also had this weird thing where I would say two out of three of our businesses saw maybe half, saw an increase in revenue. So it was kind of a very mixed bag.

But at least people understood and got comfortable with the concept of a RIF, a reduction in force. In other words, staffing appropriately to the opportunity ahead of you and not being blind to it, that was a big debate. Some people like Airbnb made huge riffs, Uber, because they were affected negatively by the pandemic. Then we have this crash occurs in 2022 in the first quarter. Funding environment changes, stock market crashes, crypto crashes. Okay, it's undeniable. And, you know, listen, there are resources out there, whether it's this podcast or

blog posts or tweet storms or the decks from Sequoia and VCs saying, hey, listen, we told you, we've been through this before, here's the playbook. So great job to all the founders who took the advice, took the medicine, and extended their runway. And, you know, some people didn't take the advice. We saw that as well. And now they're out of money and maybe their companies are shutting down. That is part of what we do in startup land, right? You expect, as since Cruz focuses on startups, that not all of your clients are going to make it to year three. Oh, totally. Well, I think also like 2021, the VC climate was so hot that I'm sure you saw this a little bit.

Like entrepreneurs got used to playing VCs off each other and picking the highest valuation. Yep. And now some of those decisions are coming home to roost. I mean, we would always recommend go with the, don't pick the new kid in school out of the VCs. Go with like the top tier funds. They're going to be there when times are tough. They'll support you. And now is that time where you have to be just really nice to your VCs.

I told you off camera, I was talking to a venture capitalist friend of mine seed stage last night. And he was saying they're actually at seed stage allocating way more capital to do follow-ons or bridges because good companies need those. Seed investors, you should just think like, if the company's not strong enough, it'll just die. But now they know they have to support them. And the number one thing you do not want to do is surprise your business.

venture capitalists with an accelerated cash out date. I'm sure you've gotten these emails. Like, hey, Jason, last board of meeting, I thought we had 12 months of cash. Turns out we got three months of cash. Can you write me a check, right? I mean, you know why this is particularly infuriating? Yeah, it's infuriating because you want to help. And now the entrepreneur has put you in a position where you've got to do a capital call, you've got to go to your LPs, and they've also signaled to you, they don't know how to fly the plane. Wait a second. You said we were at 30,000 feet.

There are six airports we can safely land at. Now you're saying we're at 3,000 feet and we're ditching this thing in the ocean, where we've got to land on a highway. Like, come on, you're the pilot. You need to know. You need to know how much fuels in the plane. You need to know your air speed. You need to know your altitude.

If you don't know these things, and these things, roughly speaking, are how much do you burn every month, how much cash do you have? And then if you divide these numbers, you get how many months of runway? This is what pilots do. Okay, I'm going 600 miles per hour. I'm at 30,000 feet. The engines cut out. What is my glide path here? Right. And so this is how you have to think about a startup. And this works really well if you have something called the budget, which when you're starting and you're in the accelerator, you're at launch accelerator, why comedy or Texas?

You don't need to budget all that much. You can kind of just lick your finger, kind of feel where the air is flowing. And you say, okay, we got three people, we take a 5K draw, 15K a month is our expense. At 5K for legal, accounting, whatever.

I have 20K a month, okay, 20 months, 400K, that's what we got in the bank, we got 20 months. You kind of, you spitball it, back of the envelope, no problem, easy, easy. But when you get to nine people, 10 people, you got departments,

you have expense, you know, you really need to make what's called a budget, a plan. And these don't need to be five-year plans. A one-year plan is better than a no-year plan. What should happen in terms of making your plan for, let's say it's 2022 right now, for 2023. When you're talking to a siege stage company, under a million in revenue, under a million in cash, what's their goal there? What do you advise them in terms of making a budget? How long does it take? How many lines are there in the spreadsheet. I'm exactly like you. I try to demystify building a financial model budget because so many founders think they need to be the Goldman Sachs, investment banking analysts, Excel Wizard,

and they really don't. They, 75% of every startup's burn rate or expenses is employee expenses or contractor expenses. So right there, like you said it perfectly, you've got five or 10 people, you know what your average salary is, you add 25% for benefits and taxes and things like that, you're 75% of the way there. And then you've got like your software licenses, you've got things like meals and entertainment, you've got maybe you've got rent or things like that, computers, office expenses. Like that, especially as a seed stage company, you're kind of done. And you don't, as the companies get later, a series A, series B, and they have,

especially with their CAPX intensive, like robots or clean-tube. tech or something like that, you definitely need to have a three statement model, which is income statement balance sheet cash flow. But for those seed stage companies, especially SaaS, consumer, you can get away with it just a glorified income statement with those 10 line items I reeled off. And again, you know 75% of it's going to be personnel expenses. And that should then, the key is after you get that, you said it, do the math. You have your cash balance.

Divide that monthly expense into your cash balance. You know how many months you have. And then the next key is overlay that on your business goals. What you told your venture capitalists you are going to achieve on their money. Because like launch can only write one or two checks for your company, right? So the launch playbook is get in C stage, establish a position, and then you want those companies be ready to raise a Series A from one of the Sand Hill or New York funds. If those milestones are not achieved, those Series A funds will not be able to write

a check either. And so it's super important that, you know, whether it's like 10 paying customers or 500,000 users or a phase one, phase two, whatever it is in your industry, identify those milestones, agree with them, agree with your venture capitalists ahead of time. Because they, like people like you have all the insight. You know what's getting funded. You know what it takes, what those milestones need to be. You might pick a milestone that actually doesn't result in future funding. Yes. Yes. And if you check with your seed fund and you say, hey, what a VC is going expect. I might say to you, okay, you're building out a tech team of 12 people. That's actually not the deliverable. They don't care if you have Android. They care if you have iOS. Because they

have iOS and they know 90% of revenue is made by iOS, just for but one example. And so you're like, oh, well, I'm building an Android and I'm building a Mac desktop team and a Windows desktop team. So my software works on all four platforms. You say, you know what? They actually don't care about that. You don't need 16 developers. You need three kick-ass developers doing an iOS app. You need to show product market fit on iOS. And when people get upset of you about Android, you say that's coming next. We're a startup. And that'll be your two.

The end. And by the way, hey, Mr. or Mrs. Entrepreneur, sprinkle in some revenue there. If you can show that you can monetize a little bit, that gets everyone really excited, right? I mean, nothing speaks like revenue. I mean, that's, yeah. I mean, if you show, and this is a thing for us to just pause here, you understand what the constraints are of your business. You understand what the goals are that are going to trigger the next financing. You have alignment with your VCs.

You build trust with them because you actually have a model and you're trying to hit it. And when you send your update, you say, hey, we would make this much revenue in September. We made this percentage of the revenue. Now your credibility is going up because you have put yourself in the bucket of somebody who makes a plan and delivers against the plan. And if you don't deliver against the plan, you explain what you're going to do to either catch up or change the plan, reduce expense, or at least we know, hey, you said you were going to get to a million and a half in reoccurring revenue. You didn't. Okay, no problem. You got to 100K,

you got to 1.2 million, 100K a month, you got to 1.2 million. Great, we can work with that. But we're not surprised that you're going to run out of money quicker, et cetera. And this is where expenses are super important.

Yeah. There are people have gotten loosey-goosey. VCs, employees, everybody in between. Contractors, founders, VPs, everybody has not looked at costs. They buy software.

They don't use it. They hire consultants. They forget they're on a retainer. I mean, it's just gotten crazy. The bell tightening is here. And you can just go down any company right now, could look at their expenses. I guarantee you minimum percentage they could cut is what?

Oh, gosh, 15% without even opening your, without just sticking your hand in there. This is a couple of things you're touching on. First of all, you articulate this. Budget to actuals. Build that budget, but then also look at your financial results. every month. Your accounting firm should be able to give this to you. And this is how you,

like you mentioned a bunch of things, forgetting retainers, buying too much software, paying contractors, aren't doing anything. If you have a tight budget actual process where you review your financial actual results, you will see that in one month, not six months. You can waste so much money by procrastinating and not looking at those actuals because you see it right away, you take, and then I think you probably see this. I know for me, the best founders take action. They don't dilly, dally around or make excuses. Yes. This is the time. And so, that is just so, so important. And then another thing you talked about was messaging to your venture capitalists and seed investors. I see companies, they're happy to send the message out,

the monthly email when things are going well. And they drop off the face of the earth when things are not going well. And there's no way, like, you do this all day long, but like, how hard is it for you, if you haven't heard from an entrepreneur to get that, you know, once in six months email and then they ask you for help? It's like kind of impossible, right? It really is like being brought in, you know, on the game day and you're like, help me win the game. And it's like the game that's starting in four hours, it's like, we need to start four weeks or four months ago to win that game. You needed to practice your shot. You needed to do more push-ups. We needed to get your upper body strength.

We need to get your sleep right. In four hours, I can only just give you a pep talk. You know, I can tell you like, hey, good luck in the game. I think you're awesome. But there's no real changing. Here's another great thing. When you act against a plan and you have a plan, everybody who works for you feels a little bit safer. Yeah.

They work a little bit harder. They have a little more clarity. And then your management loads goes down, goes down. People aren't as anxious. They're not as confused. They have a sense of purpose. And then what happens is, I've seen this all the time. Hey, we didn't hit our number. We hit 87% of plan. However, we didn't hit our top line. But because we spent 42% less because we didn't find these two

hires, we actually are ahead on our earnings and our cash is actually a little is 100,000 more than we thought it would be this month or this quarter. And you're like, okay, great. It's sort of like somebody saying like, hey, listen, we didn't hit the 30,000 feet of our cruising altitude. We only hit 20,000. But the good news is we didn't burn as much fuel. So we're in good shape here. We'll get to that 30. We just had some headwinds, right? And now you're having a really thoughtful discussion with investors.

They feel more credibility. They look out across their portfolio. They got 10 companies, let's say. Seven of them are, you know, doing just fine. They got plenty of run with. They got three that have challenges. They have enough dry powder, as you talked about before, to save one. Now you're in that, okay, which one deserves to be saved?

The credible one, the thoughtful one, the one who sends updates, the one who has a plan, the one who's taking ownership of their performance against the plan. Now's the time to be an adult, to be a grown-up. There are no more bridge rounds. There are no more plus-plus-plus rounds. There's no more find another new seed fund that's on their first fund, who you can tell a great story to and they give you a 500K and they don't even on an uncapped note. These days are over.

You've got to be focused. You've got to have financial discipline, period, full stop. And the credibility thing, I cannot emphasize that enough. You touched on that multiple times because you're right. Like at the beginning of the podcast, you said, like, hey, some revenue, some customer deals, revenue is slipping a little bit. Yeah. But if you're in the ballpark on revenue and you manage your expenses correctly, because

like people don't realize that you as a venture capitalists are a fiduciary. Like, you've got your investors you have to worry about. You send a quarterly letter to your investors telling them how the portfolio looks and you can't just throw good money after bad. And so you're right. Like people do force rank their portfolio. and you're as a startup founder competing against the other companies in that portfolio for reserves. And you're right.

Out of those three that need help, the one has been communicative, whose manager expenses well, has identified their milestones. Those are the people who are going to get funded. All right, listen, this is a great topic. We're going to do many more of these. In fact, our next startup basics and finance is going to be about monthly update. So we're going to drill down into a lot of finer detail there. you can find all the basic series.

This week in startups.com slash basics. We got legal basics. We got customer basics. And of course, we have these finance basics. All these videos are just available for you as a resource. Really appreciate the hard work you do. Cruise is like number one our list of accounting firms.

We refer people to. You charge a fair price. It's not cheap. It's not expensive. It's the right price. And I hear you guys really work hard for, especially the early stage startups that, you know,

they don't have experience in some cases. So you do a lot of teaching, right? That's a big part of your job is to educate founders on what is a P&L, what's a balance sheet, how to read it, how to make a model. It's all really good stuff. And so I appreciate the work you do with our startups, Scott, really. Thank you, Jason. Appreciate it. And this is the time when you and I are burning the midnight.

Oh, man, a lot of weekend phone calls. I don't know if you're getting them. I can't even imagine how many of those you're getting. It's got to be. But this is the job, right? Well, I was going to say, kudos to you for making time and talking these people. This is where you build your reputation of the venture capital. I mean, you've been through many cycles.

And as a, you know, the service providers in our industry don't get enough credit. You know, like you this is when you also have to have a lot of customers maybe, oh, they're short on cash, they're asking for an extension on their bill, they need extra help. And I agree. This is when you make your reputation. You can check out Cruz, K-R-U-Z-E Consulting.com to reach Scott. He's Scott at Cruise Consulting.com, right? Yep, that's it. And Vanessa at cruis consulting.com is our founder.

You can always reach out to her too. All right. We'll see you all next time. This week in startups.com slash basics.