Top 7 financial mistakes startups make
We’re all familiar with the stories of wildly successful startups. The Facebooks, Twitters and WhatsApps of the world are minting young millionaires at a healthy clip, to the envy of many other entrepreneurs. To some, it may look easy to start a company and reap millions after only a few years of development.
It may look easy, but it isn’t. The reality is that many startups make costly financial mistakes and building a successful business requires a broad range of skills. Many of the financial mistakes we often see in young companies could have been avoided. Sometimes financial mistakes are serious enough to cause a company crisis and early death. Other times they lead to a missed opportunity for an acquisition. Below are seven common financial mistakes startups make, with some advice on how they can be avoided.
- Underestimating costs. The most common mistakes startups make is that they underestimate how much cash will be needed to get the business to a point of sustainability or to the next fundraising milestone. Entrepreneurs are inherently optimistic. After months of explaining to prospective investors how they will build their product, trying to demonstrate they’ve thought through all the problems, they persuade themselves it will be easy and fail to allow for the inevitable challenges, wrong turns, and unanticipated problems that can arise. The solution is careful planning and building in buffers every step of the way.
- Raising too little money. This mistake is related to the first: by not fully anticipating all the costs, they don’t raise enough money to get themselves to their next milestone. But this problem is exacerbated by the tendency, once founders are in negotiation with VC s or other investors, to resist dilution and not give away too much of their equity. But cutting back on dilution at an early stage can set the stage for a much worse experience at the time of subsequent fundraisings.
- Acquiring too much debt. Another way to avoid giving away too much equity is to take on debt. Some founders find this attractive. It can increase the founders’ upside. The problem with this approach is that if things are not going well at your company, you can find that one creditor has the power to destroy the company. If you are going to hand someone an atomic bomb, you need to make sure it is someone you can trust to do the right thing even if business is not going well. Such people are not easy to find in our experience.
- Not setting up proper accounting systems. At first making sure you have enough cash to pay your bills is all that matters. But as a company grows and matures, implementing proper accounting systems is crucial. Revenue, costs, capital equipment, and taxes must be properly accounted for. We have seen acquisitions or other exits upset by the discovery that years of revenue accounting were done incorrectly. Sometimes the time involved to go back and correct past mistakes is so great that a potential acquirer simply decides to pass and look elsewhere.
- Skimping on accounting or legal advice. This point is related to the previous point. A small pre-revenue company may not need a full-time CFO; it may not need any full-time accounting staff. But it needs to make sure it is getting accounting and legal advice from people with expertise in those fields and familiarity with their industry. Skimping on these services early on is almost guaranteed to lead to larger costs or missed opportunities later on.
- Hiring too many people too early. It’s true that people are a business’s greatest assets and good people are hard to find. But a great sales person and support engineers before you have anything to sell or support are a luxury you probably cannot afford. Every person you hire increases your costs in many ways beyond their salary.
- Commingling personal and company assets. Founders can find it hard to break habits acquired in the early days before they had investors. But once a company is funded, commingling personal assets with the company’s assets just sets you up for problems and unnecessary distractions down the road. Avoid it.
The good news is that there are services available for startups and other new businesses to help with all these corporate challenges, including accounting, taxes, HR, benefits, and more. You don’t necessarily need to add headcount to establish a proper infrastructure that will let you scale as the company grows.