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How to Avoid Bankruptcy: A Guide for Startups

By December 3, 2013Article

Startups tend to be rich in enthusiasm and innovation but are often strapped when it comes to capital. Regardless of a company’s funding status, its founders need to stay protective of their human and financial resources. Unfortunately, many entrepreneurs’ personality traits or work styles can lead their businesses right into the red. To avoid financial missteps, startup leaders should be wary of the following seven statements. 

“My job is my life.”

In order to build a business, entrepreneurs have to put in grueling hours and make plenty of personal sacrifices. When it comes to finances, however, founders can’t confuse their work and personal lives. A startup owner might run his individual finances through a simple piece of off-the-shelf software, but downloading QuickBooks doesn’t mean he’s ready to handle the financials of his business. Additionally, entrepreneurs that run their personal expenses through their businesses find themselves in trouble more often than not. Don’t do it. 

“Around here, I wear every hat.” 

The smartest way to take ownership over the financial future of a new company is to hire someone with the skills to do the job well. Founders need to maintain oversight of the process, of course, but only after they’ve found a skilled employee to drive it. This is one — among many — areas in which it pays off to offer competitive compensation and bring in talented people. Finance is half science and half art, and the right professional can ensure that a new company has a handle not only on the numbers but also on the story behind them. 

“All I care about is the bottom line.” 

The bottom line is important, but so are all the steps that lead to it. For this reason, founders need to watch the pennies. A startup leader needs to have a clear view of revenue, expenses, working capital, receivable, payables and financial cycles. Models can be helpful here, especially when it comes to calculating the burn rate. Either the founder or the finance leader needs to make confident projections, measure them and then measure some more. 

“I’m not a details guy.” 

If you’re an entrepreneur, you need to be a details guy. This is true for every facet of the business: market research, product development and finance. A founder needs to make sure he understands pricing norms in the industry. He needs to run two separate financial models — an actual one versus a projected one — and compare and contrast them frequently. And he needs to be meticulous about the paperwork. Corporate documents and capitalization tables take time, and it’s a bad idea to cut corners. 

“We don’t need multiple sources of funding.” 

If you’re an entrepreneur, you’re going to have many sources of funding. On the equity side you have the usual contenders, such as friends, family and others. On a serious note, besides professional investors such as angels, venture capitalists and private equity, there are other sources as well, such as your existing or potential customers and vendors. On the debt side you have accounts receivable financing, lines of credit and Small Business Administration (SBA) loans or mezzanine-level debt financing (hybrid). 

“I don’t know much about my investors.” 

If you seek professional investors, make sure you do the homework and research them. The following is a sample list of discussion items:

  • Know the difference between angels, VCs and private equity firms, even though the lines are getting blurrier.
  • Make sure you know and understand the investment criteria of the group.
  • Does the group have an existing investment in the sector and, if so, are you competing or a complementary to the existing portfolio?
  • Is your company the right fit, right size and at the right stage?
  • Spend time getting to know the investment professionals and do research on the firm. You are getting “married” to the group; make sure you know all of the pros and cons. 
  • Make sure you also cross-examine and interview the group and individual employees by asking them tough questions, such as what happens when deals go bad. 
  • Ask for references from successful and unsuccessful transactions. You will learn a lot more from unsuccessful deals than from big bangs.
  • Negotiate hard, but don’t negotiate yourself out of the deal. 

“I’m not worried about the high cost of capital.” 

We see it all of the time — companies that run into trouble because of the high cost of capital. This is one area where an entrepreneur needs to pay close attention. Cost of capital can simply put you out of business. One of the lowest costs of capital is SBA financing due to the fact it is backed by the government. Thanks to historically low rates, current SBA loans are around five to seven percent. Equipment financing is another source; make sure you are dealing directly with the primary source of capital and not brokers or middlemen, who add their own fee points.  

There is no reliable playbook for building a successful startup. The best a founder can do is learn from experience and from anecdotes, and try not to repeat known mistakes. That is particularly critical when it comes to preserving financial resources and recording the flow of money in and out of the business. Investors want to bet on startup leaders that know how to create great products — and preserve funds for activities that build business. 

Arman Khalili is the chairman of Black Lotus, a provider of DDoS attack protection, and principal at Industry Capital. He is a hands-on executive with an extensive computer technology, sales and business development background, who brings a mix of entrepreneurship and operation management skills to companies. Contact him at  









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