This story is not exactly about one specific Startup. It’s a story that represents an assembly of insights from various Startups and smaller companies I consulted in the past or where I at least discussed with the founders.
This assembly covers 5 things that occur over and over again in various companies, every year. I hope my post will help to avoid already known traps.
What is sudden death
Sudden death typically is a tragedy in real live, but more for the people that stay behind than for the decedent. The situation is no different with a company. The company does not care, it is the owners that suffer.
The root cause for sudden death is lacking liquidity, which leads to bankruptcy. Investopedia tells us, that bankruptcy is “..A legal proceeding involving a person or business that is unable to repay outstanding debts..”.
As sudden means unexpected, a lack of controlling forecast about the balance between spendings and earnings are the most typical triggers for sudden death in smaller companies or Startups.
But why does that happen? I will tell in form of a story:
5 Killer scenarios you might be already in
All what you will read here is shocking. So be prepared to find issues you could find in your company, too. If it feels sometimes like I am looking over your shoulder RIGHT NOW I assure that I don’t. All is written from my memories. No big brother live writing.
Chapter I: When summer kills
Hi, I am Stephen, the CEO of our software company. We have a rainy november at the moment. Our Startup has grown pretty well over the last 4 years and our average earnings exceed our total cost since about 3 years by more than 10%. Our bank account shows a positive balance of an avg. of more than 150 TUSD each month. Even our sales forecast for deals closures is better then ever before.
With our 20 people aboard, we are hardly able to master all the current projects, so we are going to hire 5 more people. As we are already running out of office space today, we plan to move to a bigger office in May. Preparations are already ongoing.
More than 90% of all earnings are based on services we get paid based on our timesheets, the rest is product and license sales, so growth depends on quality headcount.
With our new office we plan to be able to host 40 people. Which means that we need 40 workplaces – and 10 of the existing ones must be replaced. Overall, we need to invest an average of 5 TUSD per workplace incl. notebooks, software, desks etc.
Overall, the relocation will cost us about 200 TUSD and will add additional costs for debt payment and interests of 6.5 TUSD per month over a period of 3 years.
That will not bother us, as we know that each headcount will deliver 10% earnings after cost and with an expected headcount of 35 people in 3 years, we will even be able to pay the loan back earlier. Our loan contract allows that.
Now, at the beginning of February, I can wrap up that we mastered December when our customers became crazy to finish their projects before christmas.
We closed some additional deals in January which will start in March and April, we are on the hire of 2 cool people for the new projects and we discuss with a senior manager that shall start in May to help us master our growth.
In March, we are going to relocate to our cool new office and currently we work hard to prepare the move besides all the current projects. I should probably have a deeper look into some of the bigger projects, but I have to postpone that due to all my other duties.
My business partner and COO is fully overloaded, too. Oh, forgot to introduce him, he is Marvin, a cool nerd with not the least interest in finance, but the best designer and software architect I know. He is already mounting the Kanban-Wall-Boards in the new office.
Wow, we mastered the relocation. And shocking: It is already May.
The whole crowd is happy in the new office and we are ready to take the next step in growth.
But today, I had a strange experience at the cash terminal, it told me that my card can’t be debited. I have to check with the bank later.
Then Marvin called me. He handed over a customer call.
I was surprised about the harsh tone of Mr. Lambsmith, the business owner of one of our important customers. His dissatisfaction with the project progress really hit me on the wrong foot. I was not even aware about any delay.
When he told me, that he would not pay a cent until certain things are fixed, I assured to investigate the case.
Then I called the bank to ask about the cashier problem and they told me that our account balance is below zero and that there is no cashier problem, but a cash problem.
How could that have happened?
After a (not that short) check I found out that due to all these exciting changes, the cool deal closures, new people aboard and the relocation, we had somehow lost track of invoicing.
We had completely forgotten to charge the last two month of delivered services.
But, look, this shouldnt be too much a problem: We have accounts receivables of 180 TUSD open. 120 TUSD overdue. And 280 TUSD not billed yet.
Ok, it might be a problem. According to Mr. Lambsmith, he will not pay the open bills of a value of 140 TUSD until things are fixed. And salary for our employees is almost due. Which will cost another 120 TUSD in 5 days.
To wrap the situation up: Chances to get 120 TUSD overdue payments within the next 5 days are poor. Chances to get the other 60 TUSD of claims are even poorer. The 280 TUSD we have forgotten to bill are impossible to get within the next 5 days.
But damn, we have all these projects in the pipeline, a volume of more than 1.2 Mio USD over the next 6 months! And another 0.9 Mio USD in deals short before closure.
After having talked to the bank, Stephen had to admit that they understand but don’t care. Those guys are interested in cash and securities. Hopes and chances mean nothing to a banker.
That is an important difference between an entrepreneur and a banker you must understand!
Three days later, Marvin and I realized that after a series of calls and discussions, we have to summarize our position as follows:
- Our bank account shows a level of 13 TUSD. Two small customers paid.
- After calls with the overdue customers, we will receive another 99 TUSD until end of May.
- Mr. Lambsmith agreed to pay 80TUSD based on my promise to fix things latest until 7th of June.
- If all payments come in, we sharply bypassed a bankruptcy out of nowhere.
Here, the story of Chapter I ends, but in practice, this is not the end of such stories. Because mastering the first threat has just given Stephen and Marvin another month to survive.
Companies that run into such situations learn that Murphy starts getting enthusiastic:
- You will see customers postpone already started projects due to summer holidays.
- You will see Mr. Lambsmith urge you to invest much more for free.
- You will see your almost closed deals pipeline show up to be hot air.
- You will identify underperformers added to your team.
- You will find out that payments are postponed during summer.
- You will see customers postpone decisions and signatures relevant for payments.
Lesson 1: Don’t plan bigger investments on debt if you can’t pay all frequent cost easily over a period of at least 3 months from your cash.
Don’t move or invest before the summer months. From June to September earnings typically drop drastically and soak up your liquidity like a dry sponge.
Don’t ever forget to invoice. Don’t ever forget to remind customers to pay your invoices in time.
This was the first chapter of a series of 5. If you are interested in avoiding Startup failures, just follow me on Twitter
But so far, I am happy to see you reading the last paragraph of this post and hope you enjoyed the story and found some useful advice that prevents you from blundering.
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