Having spent the past 12 years as a Life Sciences and Technology CFO consulting to venture and private-equity backed companies, I have seen a consistent and recurring dilemma faced by these emerging companies: the struggle between planning for success and conserving cash.
The age-old adage “you have to spend money to make money” may often hold true, but it’s not always that straightforward. Let’s explore this delicate balancing act for startups through the lens of a few examples.
Classic Start-up Dilemmas
Investing in Product Development
Consider the scenario of a tech startup developing a revolutionary mobile app. In the pre-launch phase, the team must decide whether to allocate more resources to develop additional product features, ensuring the product’s excellence, or to launch with a minimum viable product (MVP) to conserve cash. While a feature-rich app might increase the chances of success with the customer base, it will also drain the startup’s financial resources before it even enters the market. The decision boils down to the trade-off between delivering a game-changing product at launch versus conserving enough cash to survive unforeseen challenges.
Another example of a complex product development path is at an early-stage biotech company. Companies like these have a long development path and must incur significant expenses before generating revenue. Imagine a biotech company that has developed a drug candidate with the potential to revolutionize the treatment of certain medical conditions. To move forward and bring this innovation to market, the company needs to fund expensive and time-consuming clinical trials. The company could opt for an aggressive clinical trial strategy, investing heavily in recruiting patients and conducting multiple trials, in the hopes of gaining approval for the maximum number of potential indications. This approach to planning for success aims to demonstrate the drug’s efficacy and safety across multiple indications as quickly as possible. On the other hand, the startup might choose a more conservative approach, focusing on only one clinical indication at first and planning for others sequentially instead of consecutively. This more conservative path conserves cash but will delay the product’s market entry for any follow-on indications.
The Timing of Key Hires
Startups often wrestle with the decision of when to expand their team. Hiring talented individuals is crucial for growth, but it’s also expensive.
Consider a software development startup that’s growing steadily. The company has two choices:
- Option 1: It can hire more engineers, speeding up product development and potentially gaining an edge in a competitive market. This is choosing to use cash to plan for success by investing in their team’s capacity.
- Option 2: It can conserve cash by delaying hires and keeping their cash burn rate low. The risk here is that they miss out on opportunities or fall behind their competitors.
A technology startup must carefully weigh these hiring options. They can’t afford to hire too quickly and run out of cash, but they also can’t afford to miss critical growth opportunities.
When to Invest in Marketing
The same tech startup with the product development decisions also faces tough choices when considering its go to market strategy. To create buzz around its groundbreaking app they could allocate a substantial portion of their budget to an extensive marketing campaign, hoping to gain user traction quickly. This strategy might seem like planning for success, but it carries a significant risk. If the app doesn’t gain the expected traction, the startup could find itself burning through cash with minimal returns.
Another alternative this company has is to choose a more conservative approach, relying on organic growth and word-of-mouth marketing. While this conserves cash, it may hinder the app’s potential for success as it might take much longer to reach the critical mass (sales) needed to reach breakeven and thrive.
When to Fund Growth
Many startups want to scale a company rapidly with the hopes of capturing market share from competitors. This approach represents planning for success, but comes with the heavy costs of the cash burn required to build necessary infrastructure. Alternatively, focusing on fiscal sustainability and long-term profitability may slow down growth but also conserves cash.
For example, a food delivery service might be tempted to expand aggressively into new cities, burning through cash on marketing and promotions to grab more customers. Yet, this rapid expansion might leave them vulnerable when they face a downturn or increased competition. On the flip side, a more conservative approach might limit their growth opportunities.
In my experience as a CFO consulting with early-stage companies, I know that a startup’s journey is full of these difficult choices. The struggle between planning for success and conserving cash is a constant battle.
Here is what I recommend to management teams and boards at emerging companies which face these classic startup dilemmas:
Be clear about your short and long term company goals and objectives.
Developing and articulating specific and agreed-to goals and objectives will enable the startup to define its strategic path. Valuation inflection points must be considered when creating theses because they will help the startup lay out its funding strategy.
Develop a detailed financial forecast.
Translating company goals and objectives into the specific operational and capital resources needed to execute and achieve these will be the basis for a strong financial “base case” forecast. While creating this forecast, the startup will be in the best a position to evaluate their cash runway.
Undertake scenario planning.
It isn’t sufficient as a CFO at a startup to have a single base case financial forecast. Understanding the potential positive and negative implications of various strategic choices and shifts in the business will help a startup team prioritize spending when confronted with tough decisions. This requires multiple forecasts.
If your startup needs help with planning for and understanding the financial and business implications of various strategic choices, our partners at FLG have extensive experience managing through these “plan for success” vs. “conserve case” situations. Thoughtful analysis, discussion, and decision making by both the management and board will enable a startup to make better choices as it navigates between planning for success and conserving cash.