How to be an outstanding Board Member of a Startup (2/4)

This is the second in a series of four articles that explain what it takes to be an outstanding member of the Board of Directors of a Start-up and help it succeed. This training was delivered by the Start-up Board Academy over four half-days.

The trainers were Virgine Verdon and Jean Marc Wismer. This session focused on managing finances at a start-up.

Registration for subsequent sessions here: http://bit.ly/StartupBoD

Key messages on how to manage finances at a start-up

  • Board members coming from the corporate world need to understand that Finance works differently in a start-up
  • Big focus on cash management and spending carefully, otherwise money won’t last long, and the show will stop fast!
  • As Board member, keep an eye on social security charges (even consider paying them in advance, as you will earn interest at higher rates than at any bank!)
  • Board members will have to make the hard decision (i.e. fold) in case the start-up hits the rocks as founder/CEO will try to keep it going as long as possible
  • Board members need to provide the creativity to undertake business pivots or change business model, market, targets or partners before it’s too late

Why Start-ups fail and what should the Board be doing to mitigate that risk

  • 42% of cases: No market need for the product/service (especially in technology)
  • Board needs to talk (a lot) to real clients, not just prospects, and as soon as possible
  • Aim for the followers, not the early adopters (founder will have easily convinced the early adopters already)
  • What matters is whether there is a big enough reservoir of followers and what they have to say about the product / how much they are prepared to pay / how hard will they be to convince…

Key financial metrics for the Board to follow

1) Cash burn rate

  • Understand the cash burn rate and plan for it: i.e. how long you will stay alive until a new round of financing is required
  • New round required minimum 9-12 months ; so if you have less than 12months worth of cash, start thinking of a round and put in place deliverables to show how well you have used the previous round money
  • Best practice for each round: raise 2-year of cash visibility (1 year to work on the product without pressure, 1 year to raise the next round, CEO will work full-time on this)
  • Also look at employee contract terms: to ensure that you still have enough cash to terminate employees within their rights (don’t offer too generous terms!)

2) Sales actual vs planned

  • The key is to understand the delta between actual and planned: is it normal? Can we do something?
  • Board needs to challenge ability to forecast and to deliver said forecast (entrepreneur needs to establish trust) and to help identify reasons for failure/delay in delivering
  • Be careful when it’s not good, but not so bad, reaction is to say “let’s wait a bit” (= “scooping from a sinking boat”) – instead, set a deadline and threshold for things to be turned around, and take definite action if threshold is triggered

Board also needs to understand the business model

  • Key questions to ask:
    • Who is the client?
    • What is the need? Does it work for all stakeholders in the value-chain?
    • Who do you sell to? Is the price accepted?
  • Board needs to go deep into these questions and should test the assumptions and what has and has not been validated
  • Freemium models are good to help validate pricing models, but should be accompanied with early validation of revenue generation potential (the acid test)
  • If using distributors, ensure that there is a right to stop distribution contract if company is sold, otherwise it might compromise chances of finding a potential buyer for an exit (if the distribution contract can not be interrupted)
  • Keep an eye on competitors and consider changes to business model in case market is shifting because of competitors’ move
  • Don’t try to rebuild everything from scratch, leverage providers where it makes sense
  • Be honest on costs and revenues: founders will generally be good at assessing cost, but over-optimistic on revenue generation
  • Manage revenue projection carefully: half the projections, and postpone the revenue flow
  • Perform a regular review of risks, in particular with regards to critical suppliers: keep some stocks and build redundancy
  • Challenge frequently whether the company has access to the right skills at the right time – entrepreneurs have lots of unk-unk, Board needs to help with this and look for support
  • Board should always ask CEO/founder whether they would be prepared to step down if they/you realise that another person is more appropriate for the role

Checklist of financial key concepts

  • Keep in mind: P&L = profit = food for start-up but cash is king, cash is oxygen – you can live without food much longer than without oxygen
  • Balance sheet: intagible asssets (e.g. IP rights) are often too richly evaluated, to avoid art. 725 indebtness
  • Profit and Loss: measure profitability of start-up ; important to check delta between plan and actual and understand the reason(s) of these gap(s)
  • Depreciations are at the discretion of the Board, but always healthy tension between auditors and tax authorities (either too much and Tax authorities are unhappy, either too slow and auditors are unhappy); best approach is to be consistent, never change from year to year ;
    tips: IP rights capitalized at cost from patent attorney, only count furniture if> 5k, don’t capitalize R&D costs
  • Cash management is a must ; be careful at it is not included in any typical accounting software in CH, so use the bank statements and create that cash-flow forecast with monthly views (to catch seasonality) and if possible include scenarios (e.g. to delay revenues in time)
  • Being successful too fast might also bring you into trouble as it will increase the need of working capital – that’s why you need to have cash-flow forecast to make this visible

How to monitor Finances at a start-up?

1) Monitoring system

  • You need a planning tool (even if only excel) with the option to run scenarios/sensitivities
  • Key indicators are different from one start-up to another, so define those that fit your business
  • Board will need to be able to access those numbers, so preference goes to in-house accounting systems, and ability to change reports (best-pick: https://www.banana.ch/en)
  • Reporting needs to be useful, Board needs to define what they want to see and the frequency (balance with the costs of producing the data)
  • Board needs to run sensitivity analysis to see impact on cash flows and financing needs and to see impact on balance sheet (art.725) e.g. run “what if” scenarios on:
    • Revenue: late start, slower growth, lower price, higher distribution margins
    • Cash flows: terms receivable / payable, payments in tranches
    • Expenses, expenditures, capitalization
    • Inventory, batches, timing of spending large cash amounts
    • Financing, valuation, dilution
  • As Board member, the name of the game is: you need to be able to see ahead of time the need to raise additional money or to wind down the start-up

2) Monthly sales

  • Need to understand your customer acquisition costs and how to reduce them to minimum
  • Spend time with the entrepreneur to understand these costs, the sales forecasts and the assumptions
  • If sales done primarily by CEO/Founder, need to understand why still by him if he is not successful and if he is successful, how easy will it be for others to also be successful once the company will grow and CEO has no more time for sales
  • Always be realistic over how long it takes for a new sales person to become successful (i.e. not from day 1, that’s for sure!)

3) Employee costs

  • If you are using contractors, you need to check you are not the only employer and check they are treated as independent by Social Security (as well as have the right to work in CH) – in doubt check directly with authorities
  • You need to cover the costs of healthcare and sickness (daily allowance insurance)
  • Be mindful of how long people work – rules are in place for a reason/don’t break the law (burn-out is a really issue).
    At minimum, there needs to be a signed agreement that staff don’t do extra time, unless with prior approval, which will be documented + extra time won’t be paid and should be taken as holidays in lieu + people must fill-in time sheet + mandatory to take holidays and lunch breaks.
    This is high-risk area, because in case of crisis, conflicts around this will emerge. So it needs to be watertight before problems emerge.
    You need to show that you have been vigilant – can’t not afford situation where employee(s) show(s) s/he has been tracking down hours and you were not. If you were not tracking until now, then ask for waiver and start tracking now.
  • Tax withholding for foreign employees – take it out of salary b/c in case they don’t pay, you are responsible, and you won’t be able to recoup the money once paid

4) Expenses

  • Expenses whenever possible – it’s much simpler
  • Expenses are tax deductible vs capitalizing expenses creates the danger of overstating assets

Overindebtness (Article 725)

1) Article 725.1

  • Where the last annual balance sheet shows that one-half of the share capital and the legal reserves are no longer covered (net loss > ½ Equity + ½ Retained Earnings) the Board of Directors must without delay convene a general meeting and propose financial restructuring measures
  • Consider this as Yellow card
  • If start-up raises capital for two years, after first year it will probably be in 725.1 – you need to take action and raise more capital again
  • Board needs to look at this test once a year, needs to inform the investors if you fail and the Board needs to take action
  • No time limit, you can stay in 725.1 state provided you take action
  • Board can not resign if company in 725.1

2) Article 725.2

  • Where there is good cause to suspect overindebtedness, an interim balance sheet must be drawn up and submitted to a licensed auditor for examination. If the interim balance sheet shows that the claims of the company’s creditors are not covered, whether the assets are appraised at going concern or liquidation values, the board of directors must notify the court unless certain company creditors subordinate their claims to those of all other company creditors to the extent of the capital deficit
  • Consider this a Red card
  • If you prove there is a running business (and no liability to employee i.e. no risk that they are not not going to get paid), you can continue without going to the judge
  • You need to subordinate some loans (easy for shareholders, less easy for banks) ; if things get better later – be careful at how you un-subordinate the loans – need to respect the order of priority of creditors (banks always come first)
  • You need to run two balance sheets, one as going concern and one in liquidation (inc. lower book value for liquidation of assets, payment of salaries and holiday due to employees, year(s) on lease, penalties to contract(s), VAT and any other taxes)
  • Go to the judge with all the information -> more open to help you in this case
  • Board can not resign if company in 725.2

Board liability in financial management

  • Board liability cases do occur almost exclusively in bankruptcies
  • Minutes of Board meetings are critical to ensure that the situation of overindebtness was addressed appropriately

Relations with auditors

  • Auditors are not the enemy
  • They will ask intelligent questions and the Board needs to be involved
  • Auditors will take action if the Board is not
  • So, always advisable to have auditors as they will challenge the Board
  • Proving you are a going concern: they will want to see that you can deliver the plan for next year and that by their measurement, you will be able to cover costs and remain out of article 725 for the next year of operation

Raising financing

  • Try to have the right kind of investors, given the stage in which your start-up is and the plan
  • Don’t go chasing the wrong target as raising financing is draining and you don’t want to waste your time with wrong investors
  • Be worry of too high valuation on 1st round, because if you don’t create value in-between, it will be extremely hard for follow-ups rounds

Risk management: why implementing a risk analysis?

  • The BOD has an inalienable duty regarding the overall management of the company
  • Make sure there is a general discussion about risks every month, rather than doing it once a year
  • Really useful to do that regularly and if possible with external persons
  • Most practical approach: list of risks with impact and likelihood + mitigating actions

 

If you want to read the first article in the series: link to How to be an Outstanding Member of the Board of a Startup 1/4

Advertisements

3 thoughts on “How to be an outstanding Board Member of a Startup (2/4)

  1. Pingback: How to be an outstanding Board Member of a Startup (3/4) | Lionel Guerraz' Blog

  2. Pingback: How to be an outstanding Board Member of a Startup (4/4) | Lionel Guerraz' Blog

  3. Pingback: Entrepreneurs: how to get the most of your start-up Board of Directors? | Lionel Guerraz' Blog

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s