This Week in Startups - Mastering Early-Stage Board Meetings | Startup Finance Basics w/ Kruze's Scott Orn | E1865

Episode Date: December 14, 2023

Today’s show: Kruze COO, Scott Orn, joins Jason to discuss best practices for early stage startups to prepare for and execute successful board meetings. The two dive into the reasons VCs want governance through board meetings (00:56), what should be in a full board packet (6:51), formal things investors look for (11:10), and much more! Timestamps: (0:00) Kruze COO, Scott Orn, joins Jason (00:56) The reasons VCs seek governance in startups and key tips for developing a standardized board presentation (6:51) Building a startup financial package and the importance of presenting a financial flash page at the start of a board meeting. (11:10) Essential factors investors consider during a board meeting (15:08) The most common question regarding in-depth operational metrics (20:51) Examining R&D and engineering support expenses in the calculation of the cost of goods sold * Check out Kruze: https://kruzeconsulting.com * Follow Scott: https://twitter.com/scottorn * Follow Jason: X: https://twitter.com/jason Instagram: https://www.instagram.com/jason LinkedIn: https://www.linkedin.com/in/jasoncalacanis * Great 2023 interviews: Steve Huffman, Brian Chesky, Aaron Levie, Sophia Amoruso, Reid Hoffman, Frank Slootman, Billy McFarland * Check out Jason’s suite of newsletters: https://substack.com/@calacanis * Follow TWiST: Substack: https://twistartups.substack.com Twitter: https://twitter.com/TWiStartups YouTube: https://www.youtube.com/thisweekin * Subscribe to the Founder University Podcast: https://www.founder.university/podcast

All right, everybody, welcome back to this week in startups. It's time for startup basics with my good friend, Scott from Cruise. Cruz does all the accounting for almost all of my startups. And we do this basic series for very simple reason. I get asked the same gosh darn questions over and over again. And I would like to make it easier for me to not have to answer the same basic questions over and over again. All those basic questions are now listed at this week in startups.com slash basics. Go there, learn the basics.

I'm going to tell you right now, if there's 20 little episodes there for you to watch 20, 30 minute segments, you out of the 20 might know 14, but those other six men, that's going to be gold for you. And today is going to be gold as well, because Scott, today we're going to talk about how to run an early stage board meeting and how to present your metrics in a way that your investors will be more confident, trusting and delighted and just understand your business better. So welcome back to the program, Scott. Thank you for having me, Jason. Let's get into it. What are VCs?

You know, let's say you got a seed round done. You raise $3 million. You got 10 people. Cruising along. You're making, so to speak, $500,000 a year, a million a year. You've got a functioning business here. You've got product market fit.

You're growing. And now the VCs say, you know what? Let's do quarterly board meetings. What is their goal? Why do VCs want this governance and these board meetings? They've got multiple goals. The first goal is they are fiduciaries, right? So venture capitalists, I mean, launch like this takes money from big institutions and you sign up to be a fiduciary and make sure that money is invested correctly and is controlled correctly and has put to good work.

And so the governance part of this is actually very, very important to VCs. They have to be able to represent to their partners, their limited partners, that they're doing their job and paying attention to where the money is going. Second of all, venture capitalists is one of the kind of coolest asset classes, I think, because very few, you know, public market investors, for example, they don't really help improve the company per se. They're not out there building alongside the founders or helping them. But that's what's so cool about venture capital. So VCs who invest in your company, they come with a Rolodex. Oftentimes they have a lot of operating experience like people like you.

And so they're in those board meetings, not just to kind of make sure the money spent well and be a fiduciary, but to actually increase the value of the company through their expertise and through their network. Yeah. And there are some very simple best practices here. You're going to make a deck. You're going to present your financial statements. That's blocking and tackling.

You're going to need to have great financial metrics. You're going to need to have a great deck. Okay. Let's put that on the side for a second. There are some tactical best practices in terms of how do you get this information to people and how do you prepare for a board meeting? So let's say we're a week out. Yep.

What happens a week out? Yeah. A week out, you should be absolutely last, should be the final stretch of finalizing your financials. So the way we like to do things is we distribute your financials to a client every month. And we always schedule a call and actually go over those financials, answer all the questions. Oftentimes the client, the startup founder has to answer questions for us. We redo it, send it back out. That's what you want to be finalizing a week out.

You want to have play. I actually really recommend having like kind of a standardized board deck. so you're not reinventing the wheel every time. And so you're going to have your placeholders for different financial metrics. My favorite, so after you finalize the financials, you also need to be cognizant of getting the board pack out with plenty of time to review the whole board pack, really. So do not be the person who sends it out at 11 p.m. the night before or 8 a.m. day of

the board meeting. Because nobody's going to review it. And then you're, yeah, people reviewing it during the two hour board meeting, Zoom call, and that's not efficient. It also makes you look not thoughtful. Yes, yes. So we want to explain to people as how to be thoughtful. So maybe you're two weeks out, you get your first look at the financials, a week out, you polish them up, you understand them.

That's important. Yes. You know, you may not have, we found that a lot of our founders have never had any kind of financial experience. They don't know a PRL versus cash-based accounting. They don't know a P&L. They don't know a financial statement. something Cruz will train you on other accounting firms will train you on how to speak the lingo.

A lot of these VCs have been looking at these things, public markets, private markets for decades. So they're more than willing to go through it, but you've got to learn how to read a balance sheet and to read your expenses and understand your cost of goods, all that kind of stuff. You'll get there. Then, hey, you send that packet out,

I think three days before it's a pretty good number. You know, a week before probably unnecessary. You probably have things you want to put in there. 24 hours before not enough time. I pick three days. Let's pick 72 hours. Board meetings on Thursday. You get it out Monday.

Board meetings Friday. You get it out Monday, Tuesday. You're all good. People have a couple of days. Nobody can complain, right? Totally agree. And like you said, they're going to have more thoughtful commentary and probably not have to spend as much time on the financial segment in the board meeting.

They're going to be able to focus on more strategic stuff. Fantastic. Now, there's always the issue of. of some clever founders, I just had the call right now, it's board meeting next week, clever founder, schedules the Friday before the next week's board meeting,

we just puts catch up call. 15 minutes, sends me a link, sends me three times. This founder is very savvy. Just says, hey, a couple of things I want to get your feedback on J-Cal

before the board meeting. Now I know, this is not to get my feedback. My feedback's going to come during the board meeting. This is to pre-socialize some issues. This is to, maybe get ahead of some challenges, problems, mistakes, headwinds. Pick your term here.

But this is the ultimate and savviness. I agree. It's very savvy for two reasons. First of all, they're getting your brain working on it a week ahead of time so that you can actually be thoughtful during the board meeting. And second of all, they're building credibility with you and alerting you. Often those are usually bad news phone calls. in my experience.

Sure. Because the good news one goes out like an email. Like we just signed Microsoft to a million dollar license. Yeah, everything's great. We got our new hire. Woohoo. TechCrunch wrote an article about us.

Exactly. We. So they're building credibility and letting you know that they're going to come to you when there's a problem, which is really as an investor, that's the kind of people you want to invest in because you're, again, you're there in this asset class to actually build the company,

help people guide them through their journey. So I actually think that's a real positive. and your description of Savvy is right on. Okay. Let's just go really quick through some of the financial packet. We call it a packet, right? And in the packet, you got your deck. Decks going to tell a story.

It's going to be the guide. Typically 20 pages, later stage company. I've seen like 60 page decks, you know, pre-public companies. And then sometimes you have subcommittees that might have a 20-page deck, the comp committee, the accounting. I was thrown on some accounting committee before a company was about to go public and I'm like, I don't know anything about this.

Like, yeah, that's why we want you there. You just want to backstop. And I'm like, okay, I'll go to the accounting committee to ask the dumb questions, which actually was great for me. I was super qualified to ask the dumb questions in that case. But in a startup, you get the 20-page deck. You're going to have the minutes from the last meeting to approve minutes. We have discussions about that.

with Wilson Sincini This Weekendcerpts.com slash basics. That's just what happened at the last meeting tends to be one page very high level these days. A couple of bullet points.

Then you have any actions you have to take, which typically is giving stock grants. But a big part of the package is the financial package. This is where you get to shine, Scott. What should be,

let's go with our steed stage company again. They raise three million. They're making a million. They got 10 employees. What should be in the financial package? Yeah. And if I may,

I'd like to advocate. for early in the presentation, you have like the financial flash page, which basically shows cash, average burn, length of runway, and any kind of like revenue run rate or lighthouse clients you sold, something like that. Because the reason why I like to put it early is maybe first page, second page, something like that is I find a lot of board members like you are used to going to a board meeting and being surprised by bad news. And so you're kind of sitting there, sometimes, like, waiting for the shoe to drop. And if the founder can get that financial flash page in front of you and kind of quell those fears immediately, like your brain, your brain isn't

negatively processing. Your brain's positively processing. Oh, great. Plenty of cash. Plenty of runway. Or, hey, shoot, this looks like a problem here. Not enough cash, not enough runway. We're going to have to really focus on dealing with that, right? So I like to get it up front. Love the financial snapshot. When somebody does that, I think, this person knows they're reading the minds of the board members we're wondering when are we cash out

when are we cash out and are we going to be able to raise this next round are we spending too much money is this plan credible so you're basically saying like listen hey I always like to use financial data

the dashboard of a plane okay you're the pilot you got a co-pilot and crews got another co-pilot navigator Wilson Sincini you got your crew up there you may have a co-founder in the cockpit okay what's our

altitude, what's our speed, how much fuels in the tanks, can we land this plane? Are we safe here? You know, weather report, other things are going to happen, but just some basic metrics. Cash burn, cash balance divided by burn, by average burn equals months left. We as investors, we do this in our heads all the time. Okay, you're burning 100 a month. You got 18. You get 1.8 million in the bank.

Okay, you got 18 months of runway. Oh, wait, you have 200,000 and pay. Okay, you've got 16 months of runway. Oh, you got a settlement. Oh, you got this. You know, oh, 400,000 of that's a loan from Stripe for some, you know, against receivables. Okay, what do we really got?

Right. And then this is, again, back to bad news. Back to perception that you're not being candid. Just be candid. Yeah. If you have investors, they've seen this movie before. You don't need to tell them that the, you know, second act is going to be chaos. We know that.

There's actually a name for it, the OSHIT board meeting. Every VC knows that board meeting. That's usually right after you invest in the company is the OSHIT board meeting because you get surprised by something that wasn't disclosed indiligence. All right. So we got the financial snapshot. You like putting that up front. Get your cash, get your burn, runway, revenue, lighthouse clients. Yeah, a little snapshot.

What are the more formal things that the investors like to see and why? they like to see all three financial statements. And I would put that towards the back of the presentation because you got to remember, your board is going to be made up with like a diverse set of people. You're usually going to have like one super financially person, financially oriented person. You might have one person who's like super strategic or super salesperson. There's going to be a mix. So put that in the product person.

You might have a culture person. Exactly. Yeah. Exactly. So you want to kind of in your general board packet, you want to speak to all those different people at different times, really. But the financially oriented person is going to know, usually it's going to be in the back and they're going to be looking through the details and making sure everything adds up on the balance sheet and the income statement looks good.

And then the other thing is variance. This is another way of building credibility with your investors. If you show what your plan said you were going to do and what your actuals, another way of saying this is budget versus actuals, especially for the quarter, last year to date, things like that. That's another way of building credibility. Take your medicine if you're above what you said you're going to spend. Get in front of that. Tell them why. Explain it.

Maybe the business is actually kicking butt and you decided to hit the accelerator a little bit. Obviously, they should probably know that. They should have agreed to that. But that's, you really can, they will trust you with their cash and their LPs cash if they see budget versus actuals every month because it's just, or every quarter, it's so powerful to know how the company's actually doing versus what they told you they were going to do. And this is where making a plan separates founders who are winging it versus founders who are thoughtful. You could wing it.

Like you could be a jazz musician, no sheet music, you're a savant, you just play the guitar, you're playing the drums, piano. We just all kind of groove. We have a jam session. Okay, that's great. That's groovy. But when you're going to put the album down, you're going to need the sheet music. You're going to need the track list. You're going to try to do something more formal.

So sometimes in year one, yeah. You're riffing, you're trying to find product market fit, fine. But once you have product market fit to some degree, and you got those first 10 customers, you're hiring a sales team, you're going to say, okay, we want to add this many customers. Okay, to add that many customers, we need to have this many meetings, and we have to have this many meetings convert into second meetings, converting into a sale, and then you build a pipeline, and then you have a plan, and then you staff the plan. And now, okay, the whole credibility in the nature of the startup goes from, we're just, we're taking this boat out on little runs, we're going around the bay, we're just trying to see if the boat is good and how the sales work, you know, get a feel for the boat.

And it's like, okay, now we're taking the boat to the new world. What's the provisions downstairs and who we need to have on here? And do we have lemons? Because I don't want to get scurvy out there. Yes, yes. How much fresh water do we have? Do we have flares? You know, you want to have a real thoughtful plan to get to the new world.

world. If I may, it also sets the example for your, in your analogy, the crew. The rest of the management team is watching how you communicate with the board. Oftentimes, they'll come into the board meeting and present their section, maybe the VP of sales or the VP of product or head of engineering, but them knowing that you are accountable to the board on financial matters will help you make them accountable to you and the rest of the company. There's nothing worse than like a rogue VP who's spending too much money or doing weird stuff. If you set the culture on your journey to the new world and say, like, look, we're going to eat a certain number of lemons every day and we're not going to go above that, that really

actually permeates the culture of the startup. It's very, very healthy. It helps you get to that next spot. Yeah. And, you know, he also keeps somebody from going downstairs, taking all the lemons and making a bucket of lemonade and drinking it on the first day. And you're like, no, no, that's not what the lemons are for. Are we supposed to put like a wedge in every day?

It's supposed to be enough wedges for the 20-person crew. All right. There are in-depth metrics. We know this. SAS has certain metrics. Marketplaces have metrics. Those are the drill down. When you start getting sophisticated,

people are going to want to see that, and they're going to want to see those over time. For SaaS, we know this. Subscribers, churn, customer acquisition costs. That's KAC. You got LTV, lifetime value. In marketplaces, very obvious stuff. You got your GMV.

That's the gross merchandise. value. You got your take rate, what percentage of that that you get. You got unit volume. Basically, how many cars did Uber send to pick people up? How many DoorDashs got completed? How many Airbnb nights and stays got done? All of that is very granular. And you present that to the board. They'll have great questions about it. But what are the questions that are going to come up when you present financials most often? What are the most often questions that people start to get? always, you know, well, there are going to be some scrutiny on, hey, is revenue growing fast enough, is what's in here, what's in this number? Is our gross margin accurate? Hey, why is marketing?

Let's go into that one, gross margin being accurate. Explain what gross margin is and why so many, let's call them salty dogs, you know, they've been out on a lot of voyages. They really care about gross margin. Why do we care about that, your salty dogs? Yeah, gross margin is your revenue, You're minus the cost of delivering the service. And the reason why people care about that is if you're in a high margin business, aka most software companies are high margin. Think Microsoft, Google, something like that. You've got a lot more money in the kitty to play with once you've delivered your service.

You can spend more money on marketing. You can spend more money on research and development. You can have a better operating team, right? So a high gross margin hides a lot of sins. And so investors like that, they also, high gross margin companies tend to trade at higher enterprise value multiples. So as you grow as a company and you start raising money, the VCs know that like, hey, this company's going to trade at a much higher valuation eventually when it gets public. And so everyone's kind of building that into their investing valuations. Which is why investors want high gross margin businesses and why they don't fund traditional businesses,

that are low gross margin. You mentioned software, obviously marketplaces, FinTech, consumer, those can all be high gross margin businesses. On the low gross margin, what are some of the lower gross margin businesses that VCs,

they might be great businesses to own, but VCs might not be interested in them because they don't have big exits. Yeah, well, I mean, you know, the classic manufacturing businesses, things like anything that's like super capital intensive is really hard to do.

One of the trends we see a lot over the year, is a capital intensive business manufacturing business figuring out a way to add a high margin subscription revenue stream on top of whatever they sell, right? It just kind of makes sense. Like, hey, you're going to buy this giant piece of equipment. You're going to buy my Peloton bike. But guess what? You're going to pay 40 bucks a month to subscribe to Peloton, right?

That's, you know, that's the way to get VCs interested in capital intensive businesses to layer on that gross margin subscription and prove that there's a lot of value. here and people are willing to pay for it. You just dramatically change the margin profile of the company when you can do that. When you're selling a one-time object, be it a phone or a sweater, a toothbrush like quip, you know, there's plenty of D to C companies out there. What we found with D to C companies were most of them were a race to the bottom. Somebody comes out with a really unique product in the world.

It gets knocked off, gets knocked off. And then all of a sudden you can buy it on these Chinese e-commerce sites. T-Moo, whatever, Alibaba, Baba, whatever. And you can buy it at such a low price that, hey, the drop cam that was once a $4.99 product is now a $4 product or a $14 product. And so then what is drop cam's business? They eventually became Nest bought by Google.

The NEST cam eventually becomes a subscription business. And you're paying for how much storage you have, et cetera. So you really got to be careful about those businesses, services, businesses, like the one you're in. Yeah, totally. you know, accounting, legal. These are, the professionals in these get compensated quite nicely. It's some nice coin, some of the best gigs you can have, and one of the most stable gigs.

However, they don't get sold, right? Generally speaking. And if I may, there's a cottage industry in people, the gross margin thing is really important, making sure that's fully loaded and accurate because there's a lot of VCs out there who've seen this game where people try to load costs. They kind of move the costs around and they move it down into all. operating expenses, even though it's actually a cost of delivering the service, a cost of it's sold. So all the investors out there are nodding their heads because they've seen the

services business that comes to them saying, no, no, no, we've got this really high gross margin. We're going to be amazing. And they look one line down and the operating expenses are exploding and chewing up tons of cash. And the company can never really be profitable. They've just didn't hide the hide the, hide the, hide the eggshell kind of thing. So just be careful of falling into that trap yourself and play it straight. And if you're coming up with a low margin business, we'll figure out how to make it work besides accounting chicanery. So let me ask a very basic question.

Hey, I'm building software. Okay, we got a sales team that's selling it. We have some marketing expense. We have some developers. And then we have the cost of training. How does somebody make the decision that that is the cost of delivering the services or that falls below those costs, what I guess they call cogs. Yeah.

So how do you make that decision? I've seen people make decisions that R&D is not in there, sales is in there, this marketing's in there, that marketing's not in there. Take me through it. Yeah, I usually don't put R&D in the cost of goods sold, except for engineers that are doing, you know, support or actually keeping the product up. and quality QA can potentially be in there too. So usually research and development is going to be down below in operating expenses.

And venture capitalists are used to that. They're used to seeing a lot of money. That's because those are not direct costs associated with delivering the product. Exactly. They're building the next version of the product, right? Or whatever the improvements are. So delivering the product might be like your Amazon Web Services. You might have some support costs in there.

One thing that I see people kind of innocently mess up, and this is why I bring this up, is sometimes, a lot of times of startups, there'll be someone who's doing support and HR, and they're also handling lunch every day. They're handling five jobs, right? And one of those jobs is support in the early days. Do not load that full person's salary into cost of goods sold. Yes, allocate it. Exactly. Yeah. I see company.

This is the discussion you have to have with the founder. So when you go over their reports every month and they say, hey, I see we added this month, $75,000 in customer support staff. Who is that? And you say, oh, that's Steve. And he's, oh, Steve? I thought Steve was also doing the lunch and managing the office and this, that, and the other thing. Oh, yeah, yeah, no, no. But he does customer support.

I was, okay, well, how often does he do? Oh, 10% of his time? Great. So we'll put 7,500 in there. So you get an accurate picture of what is the cogs, the cost of goods. You could unintentionally scare venture capitalists away by doing that incorrectly and having like a terrible margin. And you said the salty dogs, they know, they're like, wait a second, a SaaS business should be like 60 to 80% gross margin. Like, why is this one so out of whack?

I'm just going to pass, right? And so you don't even get a chance to explain yourself if you mess that up. Yeah. So your hosting fees, obviously, that's part of it. Your software licensing fees. Sometimes you build software. You got to buy some of it. Yes.

By somebody else's software and put it in there. Maybe you have cloud storage. Maybe people are keeping huge data sets up there. You got a big cloud storage belt. That goes in there. If you're maintaining this software, the maintenance of the software could go in there. I've seen that go both ways. Yes.

And clearly any customer support, customer success teams go in there because when you sell it, the customer support team has to go in and implement it on the ground. Whether that's happening in person or not, it could be virtually in the ground. But you get the idea. Yeah. I'm just talking about SaaS right now. If you were doing Uber or DoorDash, if you had insurance for that business. Yeah, because that's it.

I was talking to Dara from Uber. He was lamenting the cost of insuring Uber drivers, a very big part of their expense. Yeah. And that is a classic cogs, you would put that in cogs. Cost of delivering it? Where would you put insurance? This is one I was wondering. You know, for Uber, it might be in cogs because it is part of delivering the

Like, that's a really good question. Yeah. That's actually one for Darra's controller. Look it out. But if you had general liability or director's insurance, that's not COGS. That's operating expenses. That's operating expenses. Obviously, that's for you to operate the business.

Right. So we got that. That's GNA, general and administrative. Yes, exactly. Right. Okay. So now we understand that. This is the back and forth that Scott and I are having.

The reason I'm asking these basic questions is because this is what you need to do as a founder. It's your responsibility to understand this stuff. Once you understand this, you understand it for life. You understand it for life. And so just invest a little bit of your time in professional development, everybody. Watch startup basic series. Anything we miss here

that you think should be included in these board meetings, we really went deep. I just think your point about socializing and getting ahead of bad news or getting ahead of a big decision is really, really good. And you couple that with having the deck done early, sent out early, so people can make informed

decisions. That's how you get the best out of your board. And I don't think there's any entrepreneur who accepts investment from it. And they all want feedback. They all want a guide on their journey. And so help your guide be their best. Help them help you. Why take external funding from people you respect and not get their feedback? Yeah.

Crazy to not get their feedback. They are waiting to give you feedback and use them and say, I wanted to go through this with you. I'm a neophyte when it comes to legal issues. I'm a neophyte when it comes to balance sheet. Is there somebody on your team at Sequoia, at Kleiner, whatever, at craft ventures who would spend an hour with me? And they'd be like, spend an hour.

Come by the office, spend the day. We got a curriculum here to go, like, if you ask Sachs, hey, you know, I'm a first time SaaS founder. I got 20, you know, customers. We're doing cash-based account. I don't know what I'm doing. But I know that people love my product and I understand my customer. Like, that's their perfect situation.

Yes. Yeah. That's their perfect situation. Oh, we can teach you that. That's like you coming in and being like, you know what, I know how to make the perfect omelet. I make a perfect steak. I've never baked.

You're like, you never baked. Okay, well, yeah, come in. We'll show you the baking station. It's just camera. Oh, you don't know how you make salads? Oh, you don't have to play salad? Yeah, we got that. Come in the kitchen.

We'll show you how to plate a salad. But if you know how to make the steak, well, great. You can make a brisket and cook it for 14 hours and people lose their minds over it. That's the hard. That's the heavy lifting. Yeah. That's the product. So, you know, don't underestimate yourself.

Be vulnerable, be honest about where you need help. And the great thing about Silicon Valley about what you and I do, Scott, is we love to help. Scott loves to help. I call Scott, I say, this startup's a disaster. Scott's, oh, great, put me to work, coach. Get me in there, right? It feels good to help. And we love it.

We call it clean it up, you know. Yeah, clean up. Listen. Sometimes you got that. listen, I'm from Brooklyn. I got a number of my phone. It says Verizon and it says, you know, Joe's flower shop. That's the one.

Joe's flower shop. I call Joe's flower shop. I get Big Joe. Big Joe can take care of things. He's got no flower shop. But it's Joe's flower shop. You know, I just leave it at them. There are fixers out there.

He'll fix stuff for you. You know what I'm saying? That could be a problem. You can clean something up. Cruz will help you. We fix the accounting attacks for that. That's just that. If you got other issues.

Yeah, call Big Joe. Yeah. You got to call. Joe's flower shop, he'll take care of the other things. You got to fix a speeding ticket. That's different. Yeah. All right, listen.

If you want to get everything together, uh, very simple. Cruise Consulting.com slash twist, cruise consulting. com slash TWIST. That's Cruz with a K. Talk to Scott. He's my guy. He's going to help you. He's one of the good guys.

We collect them over here at launch and this weekend startups. And, uh, thanks again, Scott. Thank you, Jason. Appreciate it. All right. I'll see in person soon. Let's have a little ramen. and we'll see you all next time on this week in Startups Startup Basics.