“Grow faster (than you have forecast) and burn less cash.” This is my one-liner on the key take-away from every start-up board meeting. The role of the finance leader can be tricky.
Finance leaders have two primary roles:
- Allocate (scarce) capital efficiently. Efficiently is defined as earning a return above the cost of capital.
- Anticipate future potential risks; plan today for ways to mitigate them.
Role #1 is often misunderstood. Many employees believe that any project that generates positive gross profit or earnings is worthy of investment. However, even projects that generate a positive return on capital may not meet the cost of capital for the business. Thus understanding the unit economics of the business in great detail is critical. Armed with that knowledge the finance leader ought to work with functions across the business to drive positive changes to all the inputs into the unit economics model.
The most common risk in start-ups is running out of cash before the business can raise additional funds.
Role #2 requires always being aware of this possibility and figuring out ways to extend the cash runway while still investing in profitable revenue growth (under the constraint of Role #1.) The likelihood of this risk has increased tremendously in the last six to nine months, as the cost of capital has reset at a higher, more normal rate than it was from mid 2020 through end 2021.
As a result, I expect the volume of private company M&A (particularly in-market consolidation) to keep spiking in coming quarters. M&A can be a path to both grow revenues and create cost savings (through synergies and elimination of duplicative functions). I expect most deals to get done without requiring much upfront cash – the deal consideration being mostly equity and the cash component being paid through long-dated earn-outs.
Finance leaders who are skilled at these two roles are naturally somewhat unpopular.
Taking on this senior finance role requires being comfortable voicing a perspective informed by paranoia (bad things could happen) and conservatism (i.e. lower expectations.)
While venture investors don’t say this enough, my experience is that they want the finance leader to play this role and actively push the CEO to be disciplined and re-consider all their different investment efforts. Start-up investors back founders to take risks (i.e. be the visionary creating a new future,) and they are much more comfortable when the leadership team includes a thoughtful finance leader capable of playing the balancing role of the pessimist.