What to Do When You Underestimated Startup Costs and Run Out of Funds Before Break-Even
I sat in my office at 3:00 AM, wondering what I could do to pay my employees next week with a bank account with too little money to cover payroll. Even though I had created an excellent product; the true “hidden” costs of scaling had neglected to be calculated into my total cost, and it caught me completely off guard. I was an absolute bundle of nerves… the office itself seemed to be closing in on me… I had underestimated the costs associated with starting a business. I had run out of money much faster than I could ever have imagined! I was in a very frightening place, but I can tell you, you can and will survive this period of time.
The Problem: You used your start-up capital for expenses, but you have not reached your expected revenue, and your runway is being measured in days or short weeks.
The Constraints: You cannot Printed Money! You are up against a time constraint for resolving problems… and you need to maintain calm among your team, as well as your investors, while you are scrambling to figure out a path forward to resolve this issue.
The Solution: You must go into “wartime CEO” mode, drastically reduce ALL non-essential spending, create an open and transparent line of communication to all parties involved, and focus solely on creating cash via cash-generative Activities.
Prerequisites for Survival
The first thing that you need to do is get a good idea of your reality; You will also need: your bank statements, a complete list of any/all reoccurring subscriptions or payments, your current capitalization table, and any basic third-party support (e.g., Google Sheets or Microsoft Excel). You need to be ready to look at the hard numbers without sugarcoating them.
The Reality Check: Assessing Your Financial Runway
Calculating Your Current Burn Rate and Runway Extension Spreadsheet
The most critical piece of information is knowing precisely how long you have left to live. Create a run-way extension spreadsheet as your new best friend, which is a document that tracks your company’s burn rate, or how quickly they are expending liquidity.
The following is a sample layout for a run-way extension spreadsheet:
- Fixed Costs: Rent, insurance, and core software subscriptions.
- Variable Costs: Marketing spend, travel, and freelance contractors.
- Kill Switch Priority: Rank every expense from 1 (Essential for survival) to 5 (Can be cut today).
To determine your burn rate the Corporate Finance Institute provides an excellent resource for determining your cash consumption.
Identifying Non-Essential Expenditures for Immediate Liquidation
Utilizing your Kill Switch List; identify any items that are not directly applicable to generating revenue within 30 days. Cancel the fancy office snacks, pause the expensive PR agency, and stop all non-performing ad campaigns. You aren’t trying to grow right now; you are trying to survive.
What Didn’t Work For Me
My experience shows that it’s much better for me and my colleagues to have a transparent working relationship rather than a fancy office environment. When I admitted I was having trouble leading my team, they all agreed to temporarily decrease their salaries to help; working together through the fire rather than away from the fire.
Strategic Moves When You Have Underestimated Startup Costs and Running Out of Money
Renegotiating Vendor Payment Terms to Preserve Cash Flow
You cannot always pay all of your vendors on a net 30 basis. Be upfront with them, and let them know that you have to re-organize your cash flow and need to offer them a net 60 or net 90 basis instead. Follow-up with them by asking if it would be acceptable to extend your payment terms another 90 days.
Template for Vendor Negotiation:
“Hi [Vendor Name], I’m reaching out to discuss our current payment terms. Due to a temporary shift in our cash flow, we are looking to extend our payment window to 90 days for the next quarter. We value our partnership and want to ensure we can continue working together long-term. Can we move to this schedule?”
Implementing Cost-Cutting Without Harming Growth
Make cuts wherever you can that will have the largest financial impact. For example, cutting customer support = losing customers. Cutting an experimental research and development project with a timeline of more than a year; this will create cash flow savings now with no impact to revenue today. Always put the focus on the things that generate money now.
Securing Capital: Emergency Bridge Financing and Investor Relations
Mastering Investor Communication During Crisis
Make it a point not to wait until you hit $0 before you start to communicate with your investors. The first thing you should do is send an “Investor Update” email to your investors detailing what the issue is, showing them the runway extension spreadsheet and explaining what steps you are taking to resolve it. Investors dislike surprises, but will often appreciate a founder who accepts responsibility for a crisis.
Evaluating Convertible Note Bridge Options
A convertible note bridge is an expedited loan that converts into equity. Generally, they can be executed much faster compared with an entire priced equity round. It is designed to get cash so you have money coming in while working on a longer-term funding solution.
Leveraging Sweat Equity Alternatives to Reduce Payroll Dependency
If paying your team is impossible, you may offer them equity or performance-related bonus incentives rather than cash payments. This aligns incentives very well. Equity aligns interests between a business owner and employee, thus creating a win-win. That, according to the Harvard Business Review, is one of the best methods when cash is scarce.
The “Ghost Asset” Strategy: An Undocumented Workaround for Liquidity
Monetizing Underutilized Intellectual Property or Data Assets
Is there any type of data that you have collected that may be useful to someone else? Or do you have any software applications that were developed for your organization’s internal purposes that could be useful to others? You may have several “ghost assets” that are right in front of you sitting on your shelf. You may sell access to the data or license the internal application software for immediate revenue, which is non-dilutive.
Exploring Revenue-Based Financing (RBF) as a Non-Dilutive Alternative
RBF is not a loan or an equity investment; rather, it’s an agreement whereby you receive cash now in exchange for sharing a portion of future revenue generated by your sales to fund current cash flow needs while building out a scalable business model. The money obtained through revenue based financing will assist you with cash flow issues until your sales have reached a level that allows for sustainable operations.
| Feature | Traditional Equity | Revenue-Based Financing |
|---|---|---|
| Ownership | You give up shares | You keep your shares |
| Repayment | No fixed repayment | Percentage of revenue |
| Speed | Slow (months) | Fast (weeks) |
Operational Pivot: Maintaining Momentum While Lean
Realigning KPIs to Focus on Immediate Cash-Generating Activities
Get rid of any “vanity metrics” that track your social media following, web site traffic, etc. and focus on cash generating metrics. How many phone calls are you making? How many invoices are you sending? How many customers are you upselling? You can connect every action taken to a dollar amount.
Transitioning to a Minimum Viable Product (MVP) Focus to Reduce Overhead
If you are developing a complex feature set, stop! Identify the core function of your offering, which a customer is willing to purchase today, and only develop this core function. Development of your offering with core features will decrease server costs, reduce the time necessary to develop your offering, and reduce the overall complexity of your offering.
Frequently Asked Questions
How do I approach my existing investors for more funding without losing control of my company?
Be honest and transparent with your investors about “why” you require additional funds. If you present them a clear plan for how you will utilize the funds to reach profitability, they are more likely to provide you additional funds. If your investors provide you funds via a convertible note bridge, it will allow your investors to convert their loan into equity in the future without having to establish a valuation that dilutes your equity ownership.
What are the legal risks of delaying vendor payments when cash is critically low?
The biggest risk associated with delaying payments to vendors is that they will sue you for breach of contract or file other claims against you. Always communicate with your vendors prior to missing payment dates. Most vendors will work with you to resolve any payment issues if you honestly communicate with them; however, if you just stop communicating and do not pay them, you will burn bridges with your vendors and face legal issues.
Can I pivot my business model while in the middle of a liquidity crisis?
Yes, but changes to your business model should not be made because you are in a liquidity crisis. Changes to your business model should be data driven and not driven by desperation. If you have sufficient data to prove that you can get revenues from a new market and model, then proceed with changes. Do not change your business model out of desperation; change it because you are trying to solve a specific revenue generating problem that customers are willing to pay for.
