Volume II: Conserving what little cash you have

Every hero has a nemesis. Frodo had Gollum. Batman had The Joker, and Harry Potter had Voldemort. In nearly every case, the hero finds himself with his back to a wall, the end of the world is near, and people are going to die.

Well, it may not be quite so dramatic when you’re a startup company treading on your new ground, but you still have a major nemesis to deal with. Several in fact. Today, I’d like to talk about what is arguably the most important one. Cash.

Ah, that most glorious of things, which venture capitalists crave like crack. Like 5 year olds crave sugar. Cash is quite a beneficial thing isn’t it? Well of course. But it’s opposite can be your nemesis. Run out of cash, and you run out of business. It’s a simple concept, one which I really wish the airline companies would take into consideration at some point. Incidentally, two of the top seven this week are filing for bankruptcy. The unfortunate thing about a brand new company is that typically, you don’t have any cash. No money at all. And that’s simply not good business.

Initial Capital:

So now, you’ve incorporated this business with the state, maybe you have a partner or three, and you have a product you’re looking at creating. Here’s the catch 22. You need to sell your product to get money. You need money to build your product. As much fun as it is watching a dog chase its own tail, or watching a cat chase a laser pointer, it’s not nearly as funny when you’re on the receiving end is it?

There are a lot of ways to raise capital for your company. The first, which I have very little experience with, is to get outside investors. These are people who invest in other businesses for a living, giving them money in exchange for ownership of the companies and voting rights on their board of directors. I won’t discuss these. I’ve seen how they work to some extent, but if you want to read about them, start looking somewhere else because I simply don’t know enough about them except to say that I don’t think that’s for me.

So, if you’re putting the ix-nay on outside investment, that means that you only have a couple of options left. Personal loans from friends or family, your own money, or getting a loan. Loans from friends or family can be tricky, because there’s a personal attachment there. If the company doesn’t fare well, was it really a loan? Was it an investment? Either way, it can get ugly fast if you fail.

If it was your own money that you had saved up and you fail, the situation isn’t nearly so bad. However, if you got a loan to fund the business by putting up the equity in your house as collateral, you could be in serious trouble. My advice is to take the path that you feel most comfortable with should the company go under. If I were 23 and fresh out of college with no loans, I’d be comfortable with putting it on the plastic. Unfortunately, I’m not. I’m married with a mortgage, car payments, utility bills, cable bills, etc. The whole nine yards really. So taking another mortgage on my house is not a risk I’m willing to take, and I wouldn’t recommend it to anyone.

The fact is that you absolutely must think in the back of your mind“What’s the worst I’m willing to live with if I fail?”. Once you figure that out, figuring out how to fund your company shouldn’t be terribly difficult.

I think the best thing to do is look for beta customers while you’re developing your product. Yes, I said beta customers, not beta testers. There’s one important difference. For new products, beta testers are usually given a free copy of the software for helping out. Beta customers are those who will get to directly influence the final product and in return, are nearly assured that it is developed to meet their needs. If you can convince them to pay you while it is still under develpment, then congratulations. You’re well on your way to being successful. Be be careful when doing this, because it’s easy to take someone’s money, but if they have a serious problem that you can’t address, they’re going to be very put out because they paid good money for a pseudo-custom application and you’re not delivering on your end.

The way around this is to be very up front with them and make sure they know where your priorities are, and that they can live with the basic functionality. You can also help alleviate this trouble by offering them a below retail discount on the software. It’s still not free, but it puts money in your account, gets you a paying customer, and provides you with some important feedback.

First Months:

The first few months of business will be very difficult, especially if you’ve burned your bridges, quit your job and decided to take a chance on running your business full time. This certainly isn’t for everyone and unless your product is ready to ship and you already have customers beating down your doors, it’s probably not a good idea.

Instead, you should be looking to preserve all of the cash that you have on hand. The best idea is to work on your product until it’s nearly ready to ship to customers. You’ll quickly find out that writing the software is only about half the work. There’s a lot of work to do once the last line of code is written. You need to put up a solid website, revise your marketing plan to fit the product, research competition, price your product, get early adopters, talk to customers to get feedback which will help improve your product, etc.

It’s a long list to get through. Fortunately, most people have partners and can generally split a lot of the workload to get things done faster. There’s a really big impulse to start spending money before you have it. I myself was thoroughly tempted by a new deal that Dell was offering just a few short weeks ago. I could have snagged myself a 64bit dual core 3.0GHz Pentium D machine with 4Gb of RAM. The video card was just sick in this bad boy. I already have a pair of Western Digital Raptor drives, a DVD burner and a 20″ LCD monitor so I was all set there in terms of upgrades I wouldn’t need to pay for.

I could make the purchase, write it all off as a business expense, and have the greatest computer I’d had in a very long time for only about $100/month. There was only one problem. I didn’t have the money quite yet. Now, during the course of developing my first product at Moon River, I had the foresight to seek out potential customers and explain to them what I was doing and if they’d be interested in it. This market research landed me a sale based on custom features that were implemented early on because they were included in the design phase. Had I not been scouting around, these features would certainly not be there now, but they were requirements for purchase, so they’re in the product.

Once Moon River was incorporated, I could receive a PO from this pre-customer, send them a bill, and would have capital to spend on whatever I needed, such as this new computer from Dell. The computer I’m using isn’t exactly terrible, but it’s not as fast as I’d like it. Compiling is a little slow, it’s got only a limited amount of RAM, and it’s just not an efficient development machine. It would be fine for running automated tests and whatnot, but running our product through the debugger is a bit painful at times.

So, a faster computer is something that’s debatably necessary. Without this PO, which I know we will receive at some point, I had other options. I could apply for business credit direct from Dell, I could finance it, I could pay it out of pocket with the expectation I would be repaid, or I could lease the hardware. I could also get a business credit card and charge it. Seems like a lot of choices until you realize that none of them are really viable.

What happens if the PO doesn’t come through? What if funding is cut? What if I need money for something else (which always happens). What if the company goes out of business in 6 months and I’ve leased the hardware? Then I’m stuck with a payment for a computer that is meant for a business that doesn’t exist. Granted I keep the computer, but it’s no longer a choice of buying the computer. You have no other option. It really comes down to the fact that we would be depending on an income that simply isn’t there yet.

After anxiously awaiting for the PO based on the initial demo, I decided that it would be best to simply wait till the money was deposited into the Moon River bank account. And once the money is in the account, I will spend about $100 to upgrade the current development machine I have with an additional 1Gb of RAM. As I said before, the computer isn’t terrible, but it doesn’t have a lot of memory either. Adding RAM is very cost effective, uses comparably little capital, and will produce far better results for the money than a new computer. In addition, we’ll have money for other things that we really need, such as new installer software because Visual Studio’s built in deployment project really isn’t that good.

The bottom line is that you need to keep your expenses in check. If you can’t pay for something out of pocket and still leave the business with a reasonable amount of cash in the bank, then perhaps you should think twice about making the purchase. Note, that this is really related to capital expenditures, rather than salaries. Office space, network connections, and other utility costs typically can be avoided only so much. See if you can make do with sub-par hardware, or see if you can get a decent deal off of Ebay if you really think you need it.

You can work out of your basement for a while to help save money. High speed connections are almost a must, so if you need to spend money, here is the place. I would never choose anything other than broadband internet access. It would drive me absolutely insane. To some people, this wouldn’t seem like a big deal. But everyone has their pet peeves and slow internet connections are one of mine.

As your income grows, so can your expenditures. Just remember that on the balance sheet, if the cash on hand ever hits zero, you’ve got some serious problems. On the other hand, if your revenue stays at just above zero for a while before it moves at all, that’s not so bad. You’re bound to incur some corporate expenses before you start making any money. This is to be expected, but be careful not to get in over your head. Debt is a slippery slope for anyone, and it’s so very very tempting to spend money that you don’t have because you think you’re going to get it. It may not happen.

Tempt yourself with this thought instead. Is this purchase absolutely necessary, or can it wait until you have thousands of dollars in the bank? There will be times you must deviate a bit and splurge on a new software package that will really help you out. But in my experience, probably half of the expenditures you want to make in the first 3 months of business, are expenditures that you could safely ignore and will do better as a business because of it.