This Week in Startups - Year-End Planning for Startup Success | Startup Finance Basics w/ Kruze's Scott Orn

Starting point is 00:00:03 All right, everybody, welcome back to this weekend startups. I do a little thing here on the show called Startup Basic. Why do I do this? And I do it every year. Well, the basic things that startups have to get right are critically important. And if they don't get them right, everything can blow up. It's kind of like not checking your air tire pressure or changing the brakes on your car, changing the oil. You know, somebody gets pulled over to the side of the road, their car blows up. And they're like, what happened? It's like, did you see the engine light was on the whole time? And they're like, yeah, I was wondering what that meant. I'm like, you see the low oil. oil sign. They're like, yeah, I wondered what that meant. It means you have low oil. You had to get

Starting point is 00:00:36 the engine checked. You didn't do it. You blew up the engine. Now the whole startup needs to be repaired, et cetera. And one of the areas in which I find constant frustration, legal, accounting, human resources, human capital, these are probably the top three things that can throw a startup into a tailspin. Well, one of my great pit man, you know, in the pit with me, making sure that the car stays on the track is my guy, Scott Warren. He's from Cruise Consulting. They're a CPA. They're dedicated only to VC-backed startups. They're awesome. They've got a bunch of launch clients, including podcast AI. And welcome back to the program, Scott. You've even had some of our early stage customers, our portfolio companies like Superhuman and Com who eventually graduate

Starting point is 00:01:23 because you like to focus on the early stage like me, yeah? Totally. We call it going off to college, actually. And you know what? It's always a sad day when you drop your kids off of college. I'll find that out in about 10 years. But for the startups, it's pretty exciting. And we're happy to, we're happy to do it. They, companies definitely outgrow us. Yeah. And that's fine. There's different people for different stages. You know what I wanted to talk to you about today is the end of the year. The end of the year, everybody tries to get a lot of things done. You would not believe, actually, you would, the number of people would try to close a deal between December 15th and January 1st, which, by the way, it's a really bad idea. If you're a founding, you got to get that

Starting point is 00:01:56 deal closed in October, early November, or else it's not happening until January 15. But let's talk about year-end planning. Let's go through the things that founders should do at the end of the year to set up 2025 for success. Yeah. Well, to continue your car analogy, the gas, what startups run on is cash, VC cash usually, and ideally revenue from their clients, right? And so we like to encourage our clients at the end of the year to just ask themselves, you know, am I going to be raising money in 2025? And the second question is, am I fundable? Would a VC, who I just got introduced to, would they want to write a check? And that's, you know, depending on the answers to that, it's really going to determine how you operate. But we always find, like, the best place to start is just by asking your existing

Starting point is 00:02:43 venture syndicate, hey, am I fundable? Would you want to invest in me if I was new to you? And I think that's a great way to phrase it. And the following. question is obviously what needs to change in order to be fundable. And this changes every year. What was fundable in peak Zerp era, 2020, 2021? There was just money sloshing around. People were making bets without even doing due diligence. Then we went through 22, 23, and 24 where great companies couldn't raise out their last valuation. Had to take a haircut. And everybody had to do a riff. And then it went from growing top line to showing a path to break even and profitability. Apologies to the startup community and the founders out there that VCs can change, you know, their

Starting point is 00:03:26 methodologies and their goals for funding a company, but it is what it is. Survival in a down market becomes paramount because there's not as much money around. And growth becomes paramount in a thriving market because that's how companies get acquired to raise more money. So I think that's a good one. Yeah. Just are you going to raise money? Yes or no.

Starting point is 00:03:46 And it's either yes or no. A maybe means no. Yep. Exactly. If the answer is no, or maybe, which means no, as you said, then what needs a change of the company? And so that's when you start focusing on like, hey, do we need to get our revenue up? Do we need to sign more logos? Do we need to do some cost cutting? Like potentially we look a little irresponsible because we're spending too much money. And another way I like to kind of phrase that second order question is like, hey, Jason, if we get these things in order or if we're

Starting point is 00:04:14 showing you 200% growth in 2025, would you feel comfortable picking up the bat phone? and calling your three favorite series A investors, because that's really the litmus test. Well, and to answer your question, I would be delighted to introduce you to Sequoia, Chamoth, Sacks, pick the person, rule off, great investors, Brian Singerman at Founders Fund. I'd love to do that if you're doubling or tripling revenue year of year. If revenue is flat or down, we should probably have a discussion of if you want to do that now and prove to them that you're unfundable right now and you haven't figured out how to grow, or should we figure out a way to get you to growth,

Starting point is 00:04:49 break even, and say, hey, you know, we decided to see if we could get the unit economics right, get to break even, now we're ready to grow. In other words, we need to have our story correct. And in addition to a story, you do need to have a timeline. Are you raising money in Q1, Q2? And in your mind, Scott, how much runway should you have in months

Starting point is 00:05:08 when you kick off your fundraising? I would say the absolute least amount of runway would be nine months, Because I think, maybe you go down the six, but I like to start with a lot of cash in the bank. Ideally, you are hitting those metrics, right? But you don't want the VCs to run the clock out on you. If you're getting down to three months of cash, venture capitalists are smart and they're worried about adverse selection.

Starting point is 00:05:33 They don't want to be the one who feels like they didn't discover whatever was a matter with you in diligence, right? And if you're getting down to like three months of cash, you're in real trouble. And really, you may not get money. And if you do get money, you're probably going to get it at a. a pretty unfriendly valuation, which no one really wants. So I would say start your fundraising with 12 months in cash. It's probably going to take you three to four months to actually get it done.

Starting point is 00:05:57 And one of the things we've kind of noticed is the fundraising climate is challenging, but like you were kind of talking about, there's certain sectors that are doing really well. For example, the AI, AI companies, this is their time in the sun right now. So AI companies might be able to raise money over six weeks, something really, really short. Whereas if you're a traditional SaaS company or maybe you're in biotech or consumer, it's going to take you three to six months to raise. So you can't really start too early. Just make sure you have enough cash to give yourself some leverage so that the investors can't dictate terms to you too dramatically. Yeah.

Starting point is 00:06:31 And you've got to set a timeline. It's a sales process. You've got to have your targets. I would have set a minimum of six months. If you only have three months, here's a very simple thing. Stop taking a salary. Cut, you know, two people. and raise your prices and basically show six months of runway.

Starting point is 00:06:49 And you know what? It's amazing how many founders would rather go into a fundraising with 12 weeks than take the medicine. If you take the medicine and you now have six weeks, six months rather, you're going to have a much better time. Okay. What's next on this top 10 list? We've got their number one. Are you going to raise money?

Starting point is 00:07:04 What's the next question? The next thing is just like making sure your financials are completely cleaned up and you are ready to roll. You're ready for prime time. And this, you know, it's kind of like all of us. We do a little bit about housekeeping later in the year. But you want to make sure that like this is a little bit of nitty-gritty accounting, but like all expenses are submitted.

Starting point is 00:07:23 You've actually gone over all your invoices to customers that you've actually collected as much as you can. And there's, by the way, just a little tidbit on one of the things you said a second ago, which was, don't be afraid to raise your prices. I cannot tell you how many companies we've worked with who were kind of dead in the water because they were charging very little. and they kind of had nothing else to lose. And so they jacked up their prices, two or three X.

Starting point is 00:07:45 Their customers didn't complain at all, they were happy to pay it. And all of a sudden, the company has a new lease on life. All of a sudden, their long-term value of the customer divided by the customer-acquisition cost is like amazing. And all of a sudden, VCs want to fund him or they're getting into profitability. So this is like the spring, or I would say the winter cleaning time period where you're cleaning. End of year cleaning. End of year, yes. Thank you.

Starting point is 00:08:07 It's a great thing to do. And I can tell you, the people who understand. the founders who really understand their metrics tightly. They understand their customer acquisition costs. They understand their lifetime value. They know how much cash they have in the bank. They know their burn rate. They know, you know, their cost of goods, their gross margin. This is something an accounting team can walk you through and is great. So that's kind of number two is having all your stuff cleaned up, your financials really tight. Third thing, you want to set goals, right, and have a strategy. I call this planning. And we like to do planning. We

Starting point is 00:08:40 with our founders. And we like to say is hope is not a plan. So if you hope you're going to double revenue, that's great. But let's have a plan and let's have a process for making that plan. Where did you get the first 10 customers? Okay, you want to triple your revenue. That would be a good goal for an early state chart. If you're at a half million, you want to get to 1.5 at least, you got 10 customers paying you 50k a year. Well, where did you get them from? Okay, how do you get the next 20? Okay, how many do you get per month? How many churn? All of this could be in a plan. And if you have good books and you've really been thoughtful, you've done an offsite and you've studied all this stuff, asked the hard questions, you make a plan and then you resource the plan. It may turn out, Scott, that you need, you know, a sales executive and a customer success person, a sales executive for every seven new customers and you need a customer success person for every 15, which when we resource this magical plan to triple means 20 new customers, means three account executives need to be on the ground running and you need two customers.

Starting point is 00:09:39 support people to handle all these great customers and not churn them. So you got to make these milestones, could be product milestones, could be hiring milestones. And it's such a great confidence-building exercise for an organization. Yeah, you're involved in a lot of this. I totally agree. And this is the kind of thing where at the board meeting, you want the board to approve your financial plan for 2025, right? Like, it brings a lot of accountability to you, it brings accountability to them. They're going to ask you those exact questions that Jason was just talking about, like, how many sales is X is going to take? What do we need to invest in marketing? And so being able to show them nuts and bolts in a spreadsheet that they can actually

Starting point is 00:10:14 understand is really, really powerful. A lot of startups I see, they get their first 10 or 20 customers because the founders have amazing relationships or they're selling to their friends or things like that. That doesn't necessarily scale as you're getting bigger and bigger. And so you do have to invest those dollars and having that financial plan, I think you've said it like a bunch of times, Jason, where it's like, it's your map. It's your map on the journey. And being able to share that map with your investors is really, really valuable. And it will lower the anxiety in your organization and make you seem like a better leader. And in fact, you will be a better leader.

Starting point is 00:10:47 Because then the people working for you, you've defined reality. And that's what great leaders do. They define reality. Whether the reality is, hey, we're running out of money and the startup's probably going to crash and burn. So we've got to triple our prices and we've got to cut half the team. That's an example of a founder accepting reality and the harsh reality. And then in terms of growth, you got to just define reality for everybody. Hey, we got those first 10 customers.

Starting point is 00:11:12 Six of them were friends of ours. The other four? Man, it took three months to get each one of those. So let's base our estimates on three months of warming up these leads to get them to, you know, try the product and then eventually become customers. I love number four here. Cost optimization review. Yes. Huge.

Starting point is 00:11:32 Huge, huge, huge. Especially like we were, I think our last episode, we talked about the AI company. and we see them spending so much money on their compute costs. And the dirty little secret is the big cloud companies are not very good at invoicing. You think they would be just right on the ball, but we see companies getting double invoice. We see them, the cloud companies for getting to invoice them for a couple months. It can get really messy.

Starting point is 00:11:56 And those expenditures are so large. I think we have the stat where it's like AI companies are spending 20 percent. They're spending 2x more than the typical SaaS company on infrastructure costs, right? Make sense? So that can blow your entire financial model if you're not on top of this stuff, because you're representing something to the board. And all of a sudden, you didn't get invoices for two months and you're spending double what you thought you were spending.

Starting point is 00:12:17 So just really getting in there. It's all negotiable. Life's a negotiation. And so there are multiple cloud providers. You can get startup credits. You could aggressively negotiate with your primary provider using the quotes you got from other providers. And then, listen, you should turn off, do what I do every year.

Starting point is 00:12:35 turn off your credit cards, use one of these credit cards where you can take it from, you know, $5,000 a month limit down to $50 and you just set that in a web interface. I won't give a shout out to anybody. I don't know whose partners or what we're invested in right now. But, you know, there's plenty of cards you can turn on and off very easily or lower the limit on. When you do that, all of your subscriptions will turn off and then you'll see. Was anybody, you know, reading the Wall Street Journal? Was anybody using this obscure piece of SaaS software? Is that, person left the company and the company's paying a $5,000 bill. Turn off your credit cards, do all that.

Starting point is 00:13:11 And, you know, maybe think about office space, your infrastructure, remote work, all that stuff is part of just being frugal. And when you're frugal, again, confidence in the organization goes up, you set a tone. If you're flying in business class or first class in a startup budget, no one. Then everybody's going to start seeing the CEO and the founders do that. They're going to do it. So have great discipline. If they see you having great discipline, they'll have great discipline. All right, let's talk about creating next year's operating plan. What does it mean to, you know,

Starting point is 00:13:43 create the operating plan? Yeah, I always think of this. And again, I'm a financial person. So I think of it in terms of building that financial model that you're going to present to the board ultimately and also to new investors. And sometimes I see founders get really wrapped around the axle on this because they think, oh my gosh, I've got to be a Goldman Sachs analyst who's a whizbang Excel person. And at seed, pre-seed, even like Series A sometimes, what the investors are really looking for it is the basic signposts, right? They want to see how many customers are expecting to sign what the average selling price is, and then what infrastructure costs are going to make, and then also the head count. And we talked a lot about head count earlier,

Starting point is 00:14:24 but start with spend about 70 to 80 percent of their total spend on people. So your head count, that tab in your financial model is actually going to be one of the most important things. The most important. Yeah. And also, I mean, sorry to interrupt Scott. No. It's critically important that you put timing against this. People say, I need to have 20 new customers in this SaaS company that wants a triple revenue.

Starting point is 00:14:47 Okay, you want 20 new customers. Great. How long does it take to onboard a sales executive? Yes. Okay. It takes six weeks to onboard them. Okay. Of every three salespeople, how many actually perform?

Starting point is 00:15:00 Oh, it turns out. out one quits, one gets fired, and you keep one. So actually, you're going to need to hire nine to get to three in all likelihood, or you should at least have plans to do six or seven. You may want to ask the HR department, why is, why do we, you know, what's wrong with our training or selection process that only one out of three hits? Is that us or is that market? I would tell you, by the way, that's kind of market. You know, not everybody works out and salespeople are good at selling themselves and getting huge base salaries and then not performing once they get into your organization. But you need to know the timing,

Starting point is 00:15:30 of this because if it takes you three months extra to get each salesperson and half of them leave and don't perform and some underperform, okay, well, you're probably only going to get eight new customers instead of 20 and then the whole model breaks. Conversely, if you have somebody who breaks out and you hire better salespeople or you raise the price 50%, you need to get half as many customers. So there's all these levers that you are in control over. So that's what the financial model proves to you is, you know, the timing of this and that you're in control. Yep. And there's one other thing I'd add, Jason, which is sometimes the numbers look really good on the spreadsheet, but your company, I've helped scale crews, right? We're like 180

Starting point is 00:16:13 people now. You can only digest a certain number of new employees at a time. Otherwise, your corporate culture gets all out of whack. You start hiring kind of mercenary people who don't care about the vision and the mission and the goals of the company. And so you have to be really careful. So when I build these models, I actually push back on the clients and say, like, are you sure you can onboard that many people? Why don't we stagger this? And the other benefit of staggering is you get some optionality. If you're not closing a lot of sales, then you're going to push back some of those new operations hires or new support hires, right? And so your runway and your months of cash is really a living thing that you can pull the levers on instead of just hiring all

Starting point is 00:16:55 the people in January, February, and then living or dying with your sales. team, right? You have optionality. Your customer success team could be sitting there for six months that is considerable expense with no success to deliver. That's exactly it. Really important to understand these levers. Again, going to make you a great founder, CEO, and going to reduce stress that you have running your company while inspiring the team around you. Number seven, you need to have tax planning. You need to have compliance planning. This is wonky, but it's important. you need to know when your taxes need to be paid. If you have somebody great like Cruz working with you, you're not going to make a mistake,

Starting point is 00:17:34 but you should still understand how extensions work, et cetera. Maybe you could expand upon that, Scott. Yeah, we have some really handy tax calendars on our website for all the major startup metros. So if you're in Austin or San Francisco, Seattle, D.C., New York, you have a custom tax calendar you can find on our website. And that will spell all the deadlines. the most important things you need to do is always file that annual federal and state tax extension, always take care of your 1099s and always do your Delaware franchise tax. You don't want to lose

Starting point is 00:18:07 your corporate status because you didn't pay that and or pay a bunch of fines. As long as you get that extension in on the federal and state income tax return, you're also eligible to do your R&D tax credit later in the year. You buy yourself time. I meet a lot of founders who are trying to raise money early in the year. They're getting overwhelmed by that process and they kind of just punt on the tax stuff. And if they would just file an extension, it's a one-page thing on the IRS website, you mail it, it's super easy. You preserve your optionality for getting your taxes done on time, and you can get your R&D tax credit done later in the year. Yeah. And these R&D tax credits, those are for startups that have revenue for less than five years, less than

Starting point is 00:18:44 $5 million of revenue. Or a thing, we could do a whole episode on it. You just need to have a qualified partner to explain it to you. But you can, if you're doing some research, could be one out of five developers could be, you know, quite meaningful. And there are some countries that are pretty aggressive about it, depending on where you domicile. Let's go on to team and equity management. This is super important. Not most startups don't do bonuses, but when they get later, there might be bonuses. There's promotions. And then, of course, the big one, grants and your 409A. Let's go with the grants of the 409A, since that's the most complex and important. Yeah, well, especially, you know, not too much in bonuses, that's cash comp, but a lot of the payoff for early stage employees

Starting point is 00:19:29 is those option grants. And so a lot of times, just for folks that don't know, you come into a company, you get your big upfront option grant, usually invests over four years, sometimes five years. And then every couple years, typically companies will kind of reincentivize you by giving you a smaller but still meaningful option grant. And so founders need to think about this and need to think about their key employees at the end of the year. Am I at risk of losing them? might they go somewhere else? Is my company not doing so hot? Do I need to even reprice my options if they're just completely out of whack? There's a lot of topics there, but you want to be thinking about this strategically. There's a lot of great resources out there for Cap Table, like Cap Table

Starting point is 00:20:06 software companies that will actually show you what good benchmarks are for not just cash compensation, but for the option compensation. But this is the time to do this. The board is going to kind of expect it. And so this is another thing you can talk about on the same board meeting that you're getting your financials approved. Okay, finally, cash management. We have, startups who raise money are not expected to be mutual funds or venture capitalists or, you know, day traders. However, in this age of there being three, four, five, six, seven percent interest available in different places, you could, if you raise three million dollars, have six percent coming in, which is $180K, which could be two additional sales executives base pay. So,

Starting point is 00:20:51 talk a little bit about how that's changed since rates went up. Yep. We did a study at Cruz, and our clients right now are managing something like $4 billion. They have $4 billion in their bank accounts. Two billion of that is just sitting in operating accounts doing nothing, getting almost no interest, right? And for those of them know, you typically have an operating account where you're just paying your bills out of and collecting revenue, and then you have a cash management account. It can be the same institution, can be the same bank or same money manager. But that's where you're actively getting the yield that Jason is talking about. I really think there's still a ton of potential for startups out there to shift some of that

Starting point is 00:21:27 money into the cash management account. You can set up automatic transfers every month, just get a big chunk of cash. You never want to miss a payroll. Don't cut it so thin. I don't want people to make the opposite mistake, which is they're cutting it so thin and I don't have enough cash to make a payroll. That's, that's, that's, nothing will hurt morale more than that. It makes you look very unprofessional. But that's two billion dollars, probably at least a billion of that from the cruise client base could be sitting in cash management and earning

Starting point is 00:21:52 that yield you're talking about. Yeah. Yeah. It's so obvious and such a good thing to do right now. That might change over time. All right. There's your nine items, 10th item, plan a great Christmas party, a holiday party with your team. Scott, thank you so much for looking out for founders. I appreciate you. I know I send you. you like a lot of disastrous situations and sometimes you get them early enough to avoid the disasters, but you do a good job cleaning up and avoiding the messes. So cruzconsulting.com slash quiz. Talk to our guy, Scott Orrin over there, Cruz Consulting, K-R-U-Z-E.

Starting point is 00:22:28 All right, well done. And if you want to learn more from startup basics, just go to this week in startups.com slash basics. You'll see all the episodes we've done over the years to help you and your team. just avoid problems and keep that car on the track and performing at a high level. We'll see you all next time. Bye-bye.

This Week in Startups - Year-End Planning for Startup Success | Startup Finance Basics w/ Kruze's Scott Orn

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