By Ed McLaughlin and Wyn Lydecker
Why do some startups succeed, while others wind up in a death spiral? A recentBloombergBusiness article, “A Not-So Rosy Path to U.S. Expansion for Flower Delivery Startup BloomThat,” by Ellen Huet, provides an example of one of the most common reasons startups fizzle and fail. A quick summary here of the gutsy steps BloomThat executives took to save their business provides a backdrop and introduction to the three critical steps you should take to launch a profitable, sustainable, and successful startup.
BloomThat’s Wake-Up Call
After graduating from Y Combinator’s incubator program and raising over $7 million in venture capital, BloomThat followed a business strategy that was fairly common for Y Combinator graduates: Grow like mad at all costs. Fortunately, the CEO and co-founder, David Bladow, got a wake-up call when he and his management team reviewed the company’s financials in the summer of 2015. They suddenly learned that they were burning through their cash far too fast. Until that point, the team had not kept close account of up-to-date financials because they had switched accounting firms several times. Bladow’s verbal reaction revealed their predicament “We looked up, and we were like, ‘Holy s–,’ we’ve got a problem.’”
Pivots that Saved the Business
The executives decided to modify their operations with drastic reductions in personnel, a price increase that the market was fortunately able to sustain, and an overhaul of their entire flower delivery system. With these changes, the company’s revenues more than doubled, and their gross margins moved from negative numbers to as high as 30 to 40 percent. Bladow said, “We’ve come through the valley of the shadow of death. I think a lot of companies aren’t going to make it through that.”
The conundrum the BloomThat faced is quite common. They were under pressure from investors to grow as fast as possible with no care about whether they made a profit. The founders knew that operating in markets like Los Angeles and Silicon Valley and promising one-hour delivery with no delivery fee would rack up the losses. But they did it anyway. Once they realized that these practices did not make a viable business model, they started charging for delivery and raised their flower prices.
Investors’ Change of Focus: Profit
It’s not just founders who are beginning to see the light; investors are, too. More and more, venture capitalists want to know when and if a startup will become profitable before making an investment. That makes a lot of sense. According toCB Insight’s distillation of the top 20 reasons startups fail, the second most common reason is because the startup runs out of money.
Three Essential Steps to Startup Profitability
(excerpted from The Purpose Is Profit)
#1 – Plan to Make a Profit from the Get-Go
When you plan to make a profit from the get-go, you will need to have a roadmap that includes steps to generate revenue and to maintain a stranglehold on costs.
To create a revenue model, quantify the following:
(Simple estimates will suffice.)
- How many customers are there?
- How much product will each customer buy?
- How will you price your product (share of value, cost-plus, market pricing)?
- Calculate revenue by estimating monthly sales (customers x units x price)
- Calculate revenue per quarter and revenue per year
To control expenses, understand how much it will cost to run your business:
- How much will it cost to produce your product (manufacturing & distribution)?
- Who will be on your management team, and how much will it cost to compensate them (equity and/or salary)?
- How many employees will you need to start up, and what will it cost to compensate them (salary & medical)?
- Where will you work and how much will it cost (rent per month/year, furniture costs, utilities, & supplies)?
- How will you communicate with your customers and how much will it cost (computers, printers, mobile phones, internet access, website, & hosting)?
- How will you brand the business (business cards, brochures, letterhead, & signage)?
- How much will it cost to sell your product (marketing, travel, & entertainment)?
- How much will it cost for risk management and compliance (legal, accounting, & insurance)?
Then you can perform simple calculations to figure out how much money you’ll be losing or making. Revenue – expenses = profit.
#2. Understand How Much Money You’ll Need to Reach Breakeven
Once you have an understanding of your revenues and expenses, you can make monthly estimates to figure out how much cash you will need to stay afloat until you can generate positive cash flow. You should also estimate any startup costs or capital expenditures you need to make in addition to your day-to-day operating costs.
Adding these estimates together will help you know how much funding you will need before you approach investors or lenders or decide to use your own money to bootstrap your business. Make sure you raise enough capital that you can launch and operate until you reach breakeven. That way, you won’t have to scramble to raise more funding to stay in business when you could be out selling and making more money organically.
#3 – Take Charge of the Money and Control it:
Don’t make the mistake BloomThat made of not paying attention to your money. After launch, don’t hand-off your company’s financial statements until you have achieved breakeven. From day one, develop the discipline to generate and review simple financial reports and budgets on a daily and then on a weekly basis until you achieve ongoing profitability. If you know how much money is flowing in and out on a regular basis, you will know if your business model is working. Your numbers will keep you informed of the health of your business. When you have a clear understanding of the rhythm and flow of your revenues and expenses and their impact on your operating budget, you can hire a qualified financial officer you can trust to help you manage your business.
To put your business on the path to profitability, here are some practices to maintain as you launch and scale your startup:
- Make a realistic budget and operate the business within it.
- Have the person who does your books give you copies of your budget daily.
- If you have variances from the budget, understand why.
- Understand how the timing of revenues and expenses affect cash flow.
To help you stick to your budget, establish rules for yourself and your employees.
- Have an understanding with your team from the beginning that you will keep a stranglehold on salaries and operating expenses until you meet a specified goal or timeframe.
Don’t Hope for Success – Plan for it
Even the best-laid plans cannot include the unforeseeable challenges ahead. But for the most part, the deal-breaking surprises – the ones that make a startup shut down before its time – can be avoided. The last people to be surprised about a startup that is headed into a death spiral should be its founders and investors. If you plan to generate a profit from the beginning, make reasonable financial projections, and stay close to the money, even the unpredictable challenges ahead are likely to be surmountable.
Ed McLaughlin is the author of the upcoming book, The Purpose Is Profit: The Truth about Starting and Building Your Own Business along with co-authors Wyn Lydecker and Paul McLaughlin. The Purpose Is Profit (Greenleaf Book Group) is scheduled for release August 2016.
Connect with Ed on LinkedIn here. His email is Ed@ThePurposeIsProfit.com