When we think about startup financial issues, we usually refer to funding. However, instead of focusing on funding, which is the outcome, we suggest to focus on the underlying reason which causes a startup to run out of money prematurely. That reason is improper budgeting.
In this article and corresponding video, we discuss three situations that can lead to a startup estimating its capital needs incorrectly.
1.Underestimating certain costs
This typically occurs when things take longer than anticipated: usually around product development or achieving product traction. Underestimating costs is very common in the startup world because there are many unknowns and it may be hard to adequately plan for every possible outcome.
There are two mitigation strategies you can use to deal with this problem.
Strategy #1: Estimate your costs conservatively.
It’s always better to err on the side of caution than to be optimistic and show an unrealistically low budget to investors in the hopes that it will make your company appear as a more attractive investment.
Running out of money before you can hit your milestones because of poor planning will not only make your current investors unhappy, but may also result in your company becoming uninvestable overall.
Strategy #2: Add a contingency
A contingency is your safety cushion that you can use to plan for the unexpected. It is specifically designed to protect you in those situations which are outside of your control.
2. Overlooking certain costs
If you are a startup founder with little to no finance experience, you may not have the knowledge of all the costs you are likely to incur in launching a new venture.
You can address this issue by getting advice from a finance professional or a fellow startup founder. If you don’t have a team member with the required expertise, we suggest you add a finance professional to your Board of Advisors. You can then objectively assess if your budget is complete and thorough.
Unlike the issue of underestimating costs which usually stems from factors outside of your control, senseless spending is usually a result of poor internal controls within a company. It may arise because founders, after having to bootstrap for a long time, lose discipline once they finally get access to capital, especially if they are able to raise more capital than they need (e.g. Initial Coin Offerings).
Examples of unwise spending include going to expensive dinners, taking unnecessary business trips, or making imprudent hiring decisions.
To prevent this problem from happening, we suggest you follow your financial and business plans which you put together before you raised capital and that you do not make any budgetary changes without a clear business case. If you are not qualified to judge whether a change to a business plan is warranted, we recommend getting outside help from an entity, such as your Board of Advisors.
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