Magazine Article | August 1, 2019

Cash Rules

Source: Software Executive magazine

By Mike Brody

Serial entrepreneur Mike Brody on maintaining positive cash flow.

If you don’t mind, I’d like to wax poetic about Software-as-a-Service for a moment. I don’t care how old it makes me sound. I remember when the only companies buying application software were really large ones with deep pockets. When I was CEO of CMS (later Transcentive), we used to send clients actual disks with our program on it. It wasn’t until web-based applications came around that all of a sudden anyone with a web browser could use an application without having to purchase rights to it in perpetuity. Small and midsize businesses, not-for-profits, NGOs, and startups could suddenly all subscribe to premium solutions and pay for them in regular installments, dramatically improving their operational efficiency and democratizing application software.

But the subscription model is both a blessing and a curse for us providers. On one hand, our markets have exploded, and the SaaS industry is projected to reach $130 billion in value by 2020. On the other, the software world is notorious for its high startup failure rate, with one of the top reasons for failure being insufficient cash. Companies can run out of cash for any number of reasons — lack of market interest in the product, mismanagement of resources, insufficient funding — but even with all forces working in your favor, managing cash flow is hard. Especially for businesses operating on a subscription model.

Whether venture-backed or bootstrapped, SaaS companies all have to contend with churn and customers delinquent on their payments. It can be difficult to predict how much cash will be coming in each month, but your employees are depending on you to make those estimates, not just for payroll but for the projects they oversee on the company’s behalf. The role of a SaaS CEO is to behave predictably in an unpredictable fiscal environment, and that is no small feat.

At the last couple of investor conferences I attended, VCs kept telling me how impressed they were with Exago’s capital efficiency and positive cash flow. That’s how we were able to reach our current ARR from just $100,000 out-of-pocket startup capital. Achieving that kind of growth means getting good at protecting cash flow. You can’t hire without cash, and you can’t get more cash unless you hire. It’s a delicate balancing act, but there are some rules of thumb that will help keep you on track, especially during those slow quarters.

BUDGET, AND THEN BUDGET SOME MORE

It’s hard to respond to a threat if you can’t see it coming, and a good, realistic budget is about as close to a crystal ball as you’re likely to get as a software executive. Becoming a good manager of cash flow starts with getting good at budgeting. Ironically, everybody hates doing it in the beginning, but it actually makes you feel freer and more independent. It’s just like your personal budget: When you don’t watch what’s happening, all of a sudden your car payment is coming up, and you don’t have the money.

Use budgeting software to create your original budget and track how you’re doing against that budget. It’s especially important to keep the budget updated and not let your enthusiasm overtake reality. Knowing how much cash you have and are likely to have next time you need it means you can make decisions with less risk. Rather than waiting for the worst to happen, you can make estimates based on the data you have: What happens if none of the customers with outstanding balances pay on time this month? What happens if we spend money on a conference, but close no deals from the leads we generate there?

Everyone’s personal style is different, but I like to figure out what the worst-case scenario is. If we can live with that, then I know how safe it is to take chances with the cash we have available. That’s a very conservative approach and probably not for everyone, but it’s also very low-risk. You can make your projections less extreme and still derive a lot of benefit from a good budget.

"It’s hard to respond to a threat if you can’t see it coming, and a good, realistic budget is about as close to a crystal ball as you’re likely to get as a software executive.”

BUILD A TRUSTED FINANCE GROUP

Though budgeting can be tricky, it’s not technically difficult. The challenge is mostly emotional, which is why it’s so important to have someone trustworthy walking you through it. You can work with an accounting firm or hire an experienced accounting manager internally, but whatever you do, make sure you’re working with someone who will tell you what you need to hear, whether or not you want to hear it. Once you have the cash, you can start building an internal finance team, but don’t be reluctant to use an outside financial firm at the start to keep costs low.

When you have your financial advisors in place, learn from them. Think of them as teachers rather than employees or contractors. It’s common for CEOs to just offload financial oversight responsibilities onto accountants, but that’s an urge you want to resist and get rid of as early on as possible. Whether you’re a leader-type CEO or a manager-type CEO, you need intimate knowledge of your company’s finances in order to make realistic judgment calls regarding daily operations. Regardless of the financial responsibilities you entrust to others, you are ultimately responsible for the company’s prosperity and must therefore understand core financial principles. Accept guidance early on so that you are prepared to manage cash flow by the time your finance team is needed for more granular work.

SPEND FRUGALLY, EVEN WHEN YOU’RE FLUSH

When people have cash on hand, whether from careful spending or a round of VC funding, they naturally tend to relax their budgeting habits. It’s important to resist this temptation and remember that it’s possible to be profitable on paper and still have crippling cash flow problems.

Take this example: You’re a SaaS provider, and sales are going well. Your product is in demand, but you’ve got a delinquency problem. A number of your top customers aren’t paying their invoices on time, and it’s starting to impact your ability to meet payroll each period. Somewhere along the line, you hired more people than you could afford to keep, given your delinquency rates, so even though your company is profitable on an accrual basis, it’s in the red on a cash basis. If I’ve got $1M dollars, I calculate my delinquency rates over a given period and then treat that million like $800K to compensate for late payments.

The goal is to get to where you’re making much more money than you need for your annual expenses and can start investing in the future without worrying. So rather than wait until you have the exact right amount of money to hire another developer or another support analyst or another salesperson, you get to the point where you have excess cash and can maintain that.

No matter how much cash you have on hand, you still have to be capital efficient. One of the things I learned from the executive board at my last company was that OPM, other people’s money, can make you stupid. We had raised a considerable amount of money and then spent/wasted a considerable amount of it paying a marketing firm to rename the company. I swore I would never do anything like that again, so I named Exago by going to an online English-Greek dictionary and entering in words “export” and “reporting” and picking a name. The more you can save money doing things like that yourself, the greater your chances of being successful. When you have an influx of cash from an outside investment, spend it like you would spend your own money.

DON’T PLAY BANKER

Even if you’re running on venture capital to start, you ultimately want your customers to become the company’s primary source of income. The more predictable this income, the easier it will be to manage cash flow. To this end, I highly recommend requesting payment up front rather than monthly.

Granted, when you’re building a company, you have to do whatever you can to get business. You might find yourself doing a lot of monthly billings because it’s easier to get a client that way. As you start to grow and have more employees and more fixed expenses, you really want to try to get customers to pay up front. Some software providers even offer a discount if you pay up front because they would rather have a five or 10 percent reduction in price and the money in hand than slightly more money meted out over the course of a year. That’s how critical cash flow is.

Even if you incentivize up-front payment with a discount, some customers will still choose to pay monthly. The ones with more cash on hand will spring for the discount, though, and save you the trouble of chasing after them with invoices each month. Less haranguing and more cash are worth the pain of negotiating a contract with up-front costs.

DITCH THE DRAMA

Positive cash flow gives you more stability, flexibility, and control over your expenses, but it also becomes an important part of your company’s culture. Not many CEOs recognize this — and if they do, they underestimate its value.

Being a consistent and reliable executive fosters a culture of trust that goes a long way toward building your credibility as a workplace and attracting great talent. Your people are your primary assets, and cash not only helps you protect their paychecks, but also makes efficient use of their time and expertise. If you run out of cash and have to pull back on a project — which might look like skipping a conference you were planning to attend, cancelling a software subscription, or (even worse) downsizing a team — your employees will come to distrust your ability to make sound financial decisions. Crises and other dramatic events are really detrimental to the people building the company. It’s painful to work on a project for months only to see the whole thing scrapped due to a shortage of cash and poor executive decision-making. Your most enterprising employees will grow discouraged at having had their time and energy wasted.

Still, and despite your best efforts, there will always be unexpected expenses — and sometimes your cash buffer isn’t enough to cushion the blow. In those instances, make letting people go your absolute last resort. Your people are how you support your customers, and it’s much harder to win a new customer than to keep the ones you already have. High churn is a red flag to investors, and that churn all comes down to your customer care. If you have to restrict (not cut back, but restrict growth), the last thing you should cut is customer care. We achieved a lot of our growth that way and now have a deeply loyal customer base and predictable ARR.

"Even with all forces working in your favor, managing cash flow is hard."

If lack of cash is a leading cause of startup failure, one might imagine that promoting positive cash flow would go a long way toward ensuring a startup’s success. Evidence suggests, however, that how an executive team manages its cash and other assets is the real indicator of success. According to Entrepreneur,

“If you look at both the reasons for failure and the factors for success, it is clear that commitment to a plan is key. This, of course, implies having a plan. This does not mean that you are completely inflexible, but you can stay the course. This is why the most successful companies have one or two pivots. I do not think that every little business adjustment or fine-tuning [qualifies] as a pivot.”

A budget isn’t a business plan, but it is a plan that will help you “stay the course” in the larger context of your company’s mission. Using sound accounting to build that cash buffer will keep your primary assets — your people — well protected when a genuine pivot is needed. Until then, a CEO’s job is to lead the company across a fiscal tightrope, making small, thankless adjustments as it goes, looking down all the while so no one else has to.

MIKE BRODY has led Exago BI as cofounder and CEO through a decade of continual growth to its position as a self-funded and profitable player in the business intelligence software market. Prior to Exago, he pioneered the development of the industry’s first equity compensation application as CEO of CMS/Transcentive. CMS received a VC investment as well as investments by Merrill Lynch and Paine Weber. It was eventually purchased by Computershare. His first entrepreneurial endeavor was as cofounder and COO of Stockholder Systems, Inc., an application software company focused on shareholder administration, which was eventually taken public.