Kirsty Nathoo - Managing Startup Finances

Morning everybody! Thank you for coming in at 9 o'clock. It's an early start. So, as Kevin mentioned, my name is Kirsty Nathu, and I'm the CFO here at Y Combinator.

So, I've actually helped now 2,000 companies, almost, as they've come through Y Combinator. So, I've seen a lot, seen a lot of successes, and seen a lot of failures. I'm going to help you just understand some of the big mistakes that we see some of these companies doing based on their cash, based on their money.

For every business, whether it's a start-up or a mom-and-pop shop, cash is its lifeblood. If you run out of cash, then the business dies. There's really no going back at that point, and it's actually surprisingly easy to run out of cash. We see many startups not realize that they have done that until it's too late to actually be able to turn it around and do something about it.

We're going to talk about these three early-stage pitfalls. This is probably most relevant to you right now. Then we'll talk through another three as you start to raise money and are starting to think about hiring, some other mistakes that companies make.

We're going to look at what the numbers you should be looking at, how often you should be looking at them, whether your expenses are realistic, and then thinking a little bit more about hiring and looking at responsibilities. Alright, so let's move on to the first one.

The first mistake is really not knowing what numbers to look at to make sure that the health of your company is good. There are three things that you should know: your bank balance, the money coming in, and the money going out. These are not difficult. You don't need anything fancy to be able to do this. This is all information you can get from your online banking or your bank statements. You don't need bookkeepers, you don't need financial software; this is super straightforward.

But you would be amazed at how many companies don't look at this. Using these three numbers, you can then calculate some other things: you can look at burn, you can look at your runway, you can look at growth rate, and you can figure out whether the company is default alive.

Okay, let's go through these in order. Your burn is purely money in minus money out. Again, you can get this from your bank statements; it's effectively just the change in bank balance between two dates. Here's an example: super easy, you have 25K expenses, you have 10K of revenue, so your burn is 15K.

If your expenses are a little bit lumpy, some companies—you know, you might have a one-off month where you, I don’t know, paid a legal bill or something that's super high. You can look to average expenses as well to figure out your burn, and that's often referred to as average burn, so you might look at this over three months to kind of get more of an idea.

Once you know your burn, then you can start to look at what your runway is. What this means is how long do you have until you run out of money. The way that you calculate that is you look at your existing bank balance, divide it by your average burn, and that gives you a number of months.

So here we have 150K in the bank; we've just calculated our burn rate to be 15K, and so we have 10 months of runway. Again, super straightforward! But you’d be amazed at how many companies or how many founders don't know these numbers for their company.

Just a point here: again, the burn might change over time, but this is a number for you. This is not a number to try to make things look good. This is for you to not lie to yourself. So, looking at the burn and going, "Well, this month it was 15K, but let's just pretend it was 10K," so then that makes it look like we have 15 months of runway left. All you're doing is lying to yourself; you're still going to run out of money on the same day. It's just making you feel better right now.

So, it's super important to really be honest with yourself on these. You can also look at your growth rate, and so this is just looking at two periods of time: your money in in month two minus your money in in month one divided by your money in in month one. This is looking at the rate that your revenue is increasing.

So, in our example here, we have 10K of revenue in July, 12K in August, and so our growth rate is 20 percent. Just a note for the people that weren't the math whiz at school: a constant growth rate is what's going to give you the J curve in growth of revenue. Because if you have 20% growth each month, as your numbers increase each month, that 20% becomes a larger number.

Okay, and then the final one is whether the company is default alive or, the other side of it, is it default dead. The way you calculate this is if your expenses are constant and your revenue growth that you've just calculated continues, have you got enough cash to reach profitability?

There's a handy little calculator that Trevor Blackwell, who's one of the founders of Y Combinator, created for you to do this. Basically, there are three things that you can play with. You can look at your monthly expenses, which is the red line; you can look at your monthly revenue starting point, which is the green point over at the start; and then you can change the gradient of that line to be your growth rate, and it will calculate where you become profitable and how much capital is needed.

Now, this example isn't the same numbers as the ones that we've just been working through. So, in this example, this is assuming that you will need 150K of money to get to profitability, and it will take you two years. Those are really key things to know. If you only have 100K of money in your bank account, you know that you've got a problem.

You know that you either need to find a way to increase your revenue growth or you need to find a way to cut expenses. The whole goal here is to be at the point where you can find a path to profitability, because it gives you freedom. Being profitable gives you freedom because you aren't in a position to need to raise money and, kind of like dating, if you don't need to raise money, you appear less desperate.

So, the investors want to give you money more, so it's easier to raise money. It's actually really important to have that option. Sometimes it can be a switch as well; you don't have to necessarily be profitable right now, but if you know that you could turn off one specific expense or do one specific thing and be profitable, then that's also a great safety net.

There's also a really great essay that talks about this in more detail. This was written by Paul Graham, and you can see the link here to where that gives you more information on this. Again, it’s the kind of thing that when we're doing office hours with founders, it's one of the first questions we ask, and you'd be amazed how many people don't know the answer.

These numbers are super easy to calculate; super straightforward. The next problem is that people go along and they say, "Okay, I've looked at my runway, I've looked at my revenue, I know all my numbers," and then kind of forget about it.

But actually, this needs to happen pretty often. You shouldn't be looking at it every quarter or every month; you should be looking at it at least every week. If your runway is getting low or if things are looking not very constant or consistent, you should be looking at it very often—sometimes daily.

Whenever anyone asks you, you should know your numbers. Have a think now—how many of you know how much money is in the company bank account? If you already have one, great! How many of you know your runway? Slightly less number, slightly less hands, but that's pretty good; I like it! I'm impressed.

Okay, the next one is under-representing your expenses. If you think back to that "default alive" calculator, that assumes that your expenses are going to remain constant. Actually, in reality, that's probably unlikely. Most startups’ expenses will ramp up over time. You should understand how that's going to happen. What kind of expenses are going to increase and what are they going to increase to?

Some examples of expenses that may change over time: The first one is undervaluing your own time, particularly in the early days where you're doing everything. You're either paying yourself minimum wage or some very small amount, which, by the way, in California, everybody should pay themselves minimum wage.

You're also doing things that don't scale in order to acquire users. That’s totally fine, and that's what we recommend that people do, but it can make your customer acquisition costs look lower than really they are. You should be aware that over time, as you start to hire people to look into these, those expenses are going to go up.

Hiring people is not just their salary. For every person that you hire, you need to provide them with equipment, you need probably desk space, you need health insurance, probably depending on where you're based. All of these things cost extra money on top of the salary. Depending on location, a good rule of thumb is that an employee will cost about 25 to 50 percent more than just their salary.

So, if they're being paid 100K a year, then your fully loaded cost to the company is going to be somewhere between 125K and 250K. Again, that's super easy to forget about. You think, "Oh, I'm going to hire an engineer, I'm going to pay the 100K; that means that's all it's going to cost." But it's amazing how those numbers do add up, so just be aware of those.

Finally, assuming paid acquisition costs remain constant is another mistake that we see people make a lot. Whilst it may not seem like this, oftentimes in the early days it's actually easiest to find your early users because they're the ones that are totally motivated to use the product. Over time, it gets harder to find and convert users, so the cost of doing that goes up.

You should be thinking about that. You should be looking at what your costs are right now and seeing, thinking, are they reasonable? What do we think they might go up to? If you can look at things in the worst-case scenario and you have, you know, in the worst-case scenario you calculate that you have eight months of revenue, eight months of runway left, but actually then things are better than that and you end up with ten months of revenue, then that's a bonus! You've got a bit longer to figure things out.

Runway is not a vanity metric; it's not one of these things that's supposed to make you feel good. It's not one of the things that's supposed to be used to compare yourself against other companies. It's for you to know the health of your company.

So, don't ignore this stuff. Don't lie to yourself; don't try to massage these numbers to feel like it's making yourselves better. Because all that's going to happen is you're running out of money, and it'll become a shock.

These ones now are starting to get a little bit more relevant as you raise money and as you're starting to hire people. It's good to bear in mind right now, but these are probably less relevant to a lot of you for now.

Okay, the first one is outsourcing responsibility. Often, the CEO will hire a bookkeeper to prepare the finances for a company as they start to get a little bit more complex, and that's a totally normal thing to do. We recommend that people do that. It's usually once people raise some money, it's not a good time; it's not a good use of the CEO's time to be doing the books.

The CEO can be doing much more high-leverage things, but the thing to keep in mind is that even though the bookkeeper is doing the books and preparing those numbers, the responsibility is still everybody's in the company, particularly the CEO. But all the founders, everybody should know what these numbers are.

An external bookkeeper isn't going to know the business like you know the business. Oftentimes, the way that they work is that they will get hold of bank statements and they'll see money coming in, they'll see money going out, and they'll do their best guess about what these things are, and they won't always be right.

You can't really expect them to always be 100 percent right because they're looking at it from a very removed position. So, it's up to the founders, and it's up to the team to look at those reports that the bookkeepers send every month to make sure that you understand them.

Make sure that if anything comes through that looks strange, you question it. It's not necessarily that people are concerned that asking questions will make it look like they don't understand their numbers, but usually what happens is if you don't understand what these numbers are looking like, it's usually because there's been some misunderstanding in the reporting of the numbers.

If you're like, "Well, I thought my revenue was going to be a bit higher this month. What's going on? Why is this number?" then you can actually go in and look and query what's going into that. You might find that there has been a mistake made, and this is probably one of the number one things that I get founders coming to me complaining about.

They'll come up to me in this total panic and be like, "The bookkeeper messed up! They told us all this wrong stuff, and now I don’t know, I have no runway and I don’t know what's going on!"

Actually, what happened is the bookkeeper sent them the monthly reports. They were like, "Tick, done my work," and the founders didn't look at them. They didn't figure out what was going on, and now there isn't enough time left for them to turn the business around either to get profitable, or to raise money to figure things out. The company dies because it runs out of cash, so super, super important to be on this all the time.

Hiring too quickly and scaling the company too quickly is really easy to do. It’s really easy to hire too quickly because you're under a lot of pressure to hire people. It feels like it's a really easy, really measurable piece of information. You talk to founders, and one of the first questions that they will often ask is, "So, how many employees are you at right now?"

You say, "Alright, you know, I'm at 25," and you're thinking, "Oh no, I've only got 10 employees; that means that, you know, you're way more successful than I am." Actually, that's totally not true!

We've already mentioned that hiring employees costs more than just their salary, but you should also be conscious that every hire is actually an investment into the business. You should be making sure that you're getting a return on that investment. Now, for some types of employees, that's super easy to measure.

For example, think about a salesperson—they're not bringing in more sales than it's costing the business to hire them, then clearly you're not getting a good return on investment. But then think about a community manager or, you know, a support manager. It is much harder to measure that, and that's kind of one of the things that as a CEO you need to be looking at and you need to be figuring out to make sure that all the people in your company are actually working to make the company more valuable.

Sadly, this is the point where, you know, if people aren't working out, you should be prepared to fire fast. If people aren't pulling their weights, they need to leave the company. Like I say, it's easy to fall into this trap that the more people you have, the better you're doing, but actually, the best companies do more with less.

The real way that you should measure yourselves is what's my ratio of revenue to employees? Because the higher that is, the better you're doing: you're doing more with less, and that's the path to being profitable from an early stage, which then takes the pressure off about whether the company is going to continue.

It's also easy to feel like you have to compete with all the flashy startups that have raised bunches of money, and they're all hiring data scientists right now. You’re thinking, "Oh, that means I must need a data scientist, so I'd better hire a data scientist!" Actually, don’t! The best companies do more with less. If you can build a really great company with fewer employees, that's amazing for everybody involved.

Bear in mind, you should be treating this money carefully. It's not a case of just, "Oh, I need to hire this person; I need to hire that person," because what the investors who are giving you this money are asking you to do is basically a miracle: they're asking you to take their money and turn it into ten or a hundred times that amount of money to give back to them.

The way you're going to do that is by being careful with your expenses and making sure that your revenue grows. As a follow-on to that, scaling before you get product-market fit is also another dangerous thing that people fall into. At the point where you're still figuring out what your product is and you're trying to find product-market fit, you should be spending as little as possible.

That will give you the runway to have time to figure out what it is that you should be building. People will be beating down the door to buy your product. More employees will not help you get to product-market fit. It will not help you get there faster; it will not help you get there more efficiently.

One of the conversations that I have with founders is something along the lines of, "Oh, my sales are low because I don't really have enough salespeople, so if I hire another couple of salespeople, then my sales will obviously increase!" That doesn’t sound like product-market fit to me. If you have that, then customers are beating a path to your door, and it feels like the wheels are falling off as you're trying to look after all those customers.

So, just hiring more salespeople isn't necessarily going to be the thing that sets that going. Also, convincing yourself that you need more developers or you need more people to get the thing that gives you the product-market fit—another conversation along this line is something like, "I need four more developers because then I can build feature X, Y, and Z, and then obviously everybody will buy it."

But again, if you have product-market fit, then even your junk version that doesn’t have all of these fancy things is solving a big enough problem for everybody that they're willing to pay for it, and they love you for it.

You can then start building on more features, and then you can start hiring to do that. This is the one that there's no coming back from. The other ones, if you make these mistakes, you can probably solve this. If you hire too quickly, you can figure that out; if you don't know your expenses, you can learn your numbers.

This is the one that is, you know, no going back. If you let your runway get too low before raising, you're going to have problems raising your money. So, the first thing is you should always assume that you will never raise any more money. Always assume that the previous money that you raised will be your last and that you should be aiming to get to profitability on that money.

Again, the conversations that I have with founders where they say, "Oh, it's fine; my investors are gonna put in another million dollars, it'll be totally fine," that’s kind of scary if you're relying on your investors to do that because they don't always—sometimes they might, but they don't always!

Seed stage money is the money that you'll raise off of an idea. You'll be able to talk to investors about a hypothesis that you want to be able to check, and they will give you some money. Once you get to series A and beyond, that becomes much, much harder. You need sustained growth; you need to have more of an idea; you need to have product-market fit.

This is why it's a lot harder to raise money as you go through the life of the company. In particular, don't leave it too late because if you're running out of runway, your leverage goes down as you're trying to raise money. If you have six months of runway, let’s say, and you think, "I'm about to go and start raising money," that's pretty scary.

It could take three months more to actually get an investor to agree to put money in, and as your cash balances are decreasing over those three months, you’re losing leverage. You can see from here that probably at six months you may be able to pull it off, but really you want to be thinking about 12 months runway. That's the point where you're thinking, "Okay, maybe I need to think about whether to raise money or whether to get to profitability."

Also, if you get to six months and you're unsuccessful in raising money, you really don't have a lot of time to turn this around to get to profitability for the company to succeed. Again, there's a really great essay on our blog that goes into this in more detail. You can read that at your leisure, and hopefully take that on board.

In conclusion, most companies die because they run out of money. It's super easy not to run out of money just by looking at a number of things: knowing your cash balance and your runway, understanding how your expenses are going to increase, understanding that the ratio of revenue to employees is a better metric than just the number of employees, and having a plan to get to profitability because you should assume you're not going to raise any more money.

Alright, thank you very much! Okay, so a few minutes for questions.

So the question is, how do you balance the two sides of you should do things on a shoestring and be profitable as early as possible versus you should just throw money and get market share as fast as possible? I know it depends on the stage of the company as well.

You know, in the early days, then probably being careful with your money and making sure that you have a plan to get to profitability is a good thing. Just having a plan doesn't mean that you necessarily have to actually be doing it.

So, an example might be, maybe you're plowing all of your revenues back into marketing in some description or other, and knowing that you could actually slow—you know, the way to reduce your expenses is to reduce your marketing, which might slow your revenue a little bit. But it would conserve that cash to preserve the runway.

It's just a balancing act, and the other thing you have to bear in mind is that obviously the investors want you to spend money super fast. They want you to come back to them, cap in hand, with, you know, "Please, please give us more money!" So, there are some tensions there, but it's all just being responsible with it and giving yourself enough time and enough runway to be able to figure it out.

I'm just curious: at what stage do you see a founder engage in that company? Do you start with a quiet exit CFO first? Then I can probably see a...

Okay, so the question is when do you bring in a CFO? It's surprisingly late. Actually, even probably post-series A, you probably don't need a full-time CFO at that point. There are a lot of services that do, you know, consulting CFOs and will do strategy or, you know, help you to figure out your numbers, create a deck or whatever for raising money.

A full-time CFO is actually pretty late on. Just to bear in mind that the difference between a CFO and a bookkeeper, at least for the U.S., is that generally the way that this works is the bookkeeper you would have earlier. They're the people who are just going to get your numbers coming through your bank statements into a balance sheet, into an income statement, into the accounting system.

So, they're providing the reports for that, and then separately to that, you would hire a CPA, an accountant who would prepare the tax returns and file those for you each year. So, there are actually two different sets of people. A bookkeeper you would need earlier, a CPA you need annually to do your tax returns, and then a CFO who's going to sort of oversee that and do more of the building our forecasts, building out budgets, and things like that are probably a little bit later on.

Before that, it's really the founders; they should be doing it. So, why can you have any calculator? I mean, there are tools online. Personally, I think it's actually better to build it yourself because I think it makes you think about it in your mind, so usually just doing good old spreadsheets for me works well.

But certainly, there are other ways you can do it, and there are a lot of services and startups trying to help to make it easier to see forecasts and things.

Okay, maybe one more question and then we'll move on. Do you have a product-market fit? Oh, for investors, so are you raising seed stage money?

Yeah, okay. So, at the seed stage, so the question is should you provide forecasts in your deck if you haven't reached product-market fit. The answer is probably no. Certainly, at the seed stage, if you're talking to professional investors or experienced investors, they probably aren't really going to look or ask you for that number.

They'll ask you for things like, "So, how big could this get, and what's the total market size?" and, you know, questions like that. But they're not going to be looking for, "Here's our monthly growth predictions."

Probably, if you're being asked those kinds of questions from investors and you're raising money at the seed stage, it probably means that those investors aren't actually that experienced at investing in early-stage companies, so that's a data point for you to decide whether it's a good person to work with.

Certainly, by the time you get to series A, however, you should have some plans. The point of a Series A is that you've got product-market fit, and that you know; you have more of an idea. I mean, forecasts are always forecasts; you don't know for sure.

But yeah, okay, I think we are up. So, thank you very much! I'm doing an AMA on Friday, so if there are questions that didn't get to, then feel free to drop them in there, and I will answer as many of those as possible. Thank you! [Applause]