Key Financial Indicators

All three indicators are important, but emphasis shifts depending on stage:

Cash (Early Stage: Pre-Product/Market Fit)

Run Rate (Growth Stage: Post- Product/Market Fit)

Annual Revenue (getting ready to IPO)

Cash

In the beginning, cash is all that matters because it is the lifeblood of the company. It pays the team, rents the apartment you work out of, gets super-fast Internet access and a lot of snacks from Costco. It’s the printout from the ATM that has two commas in it, and you dance around for a few minutes before reality sets in: the timer has started.

Managing the cash balance of the company as the most significant high-level financial indicator makes sense in the early days. You take the total bank balance you have, and divide it by how much you spent this month, and that tells you roughly how many months you have left before you run out of money. Maybe you take it one step further and make a simple forecast showing estimated hires and an estimated monthly rent when you move into a real office, but it’s still very simple.

Cash: Net Burn Rate

As long as revenues are growing, burning $400K a month becomes less and less risky over time. Which brings us to our next phase of money: Run Rate.

Run Rate (ARR vs. ARR)

When we started out we were focused on cash because we didn’t have revenue, but as soon as we had revenue growing it was all that mattered. As a newly minted SaaS CEO I diligently studied SaaS metrics, and I was surprised to discover that run rate has different meanings depending on who you’re talking to, and your business model:

Annualized Run Rate (ARR) — This metric extrapolates future performance of the company based on the latest results. Using this metric, a true statement about your company would be: “our Q1 2015 quarter puts us at $1.57 Million run rate”. How did I get that number? I took the $392K of revenue earned in Q1 and multiplied it by 4 to get an annualized number.

Annually Recurring Revenue (ARR) — With the rise of SaaS, recurring revenue has become more common. Recurring means there’s a subscription in place and the customer is charged on an ongoing basis, rather than a one-time purchase. E-commerce companies rarely have recurring revenue (exceptions: Amazon Prime and Le Tote) though they may be able to model the rate and value of return purchasers. In this case, a true statement about your company would be: “at the end of Q1, our annually recurring revenue was $1.81 Million”. How did you get that number? By taking the annual contract value of all existing subscriptions at a certain date.

So far, these two numbers aren’t that different. Annual recurring revenue is 15% higher than annual run rate, based on Q1 performance. Here’s the problem though: You’ve been giving your investors guidance with a goal to achieve $4.5 Million in annual recurring revenue by the end of the year. You’ve told them you are only slightly (-3.2%) behind target.

So your company is going to generate $4.5M in revenue by the end of the year? No.

Based on your forecast, your company will generate $2.6 Million in revenue for the year, if you hit your goals.

The reason for the difference is important: you need to collect revenue for the entire annual contract up front for about 50% of your customers, but if you make a change and switch to accrual accounting. You can now recognize revenue as it is earned, rather than when it is paid to the company.

That means if you sign up a customer for an annual contract and collect $12,000 from them on December 1st, this year only $1,000 of that money is attributed to that year’s revenue. The rest is unearned for for that year, and will be spread out over the next 11 months into the next year.

To illustrate the point again about why this can get confusing, consider the Annualized Run Rate metric above. Let’s say your forecast calls for $962K of revenue in Q4 of 2018, which would give you an annualized run rate of $3.85 Million ($962K x 4). All these statements are true, but which ones are right? Which ones should be communicated from founders to investors? Which should be used in fundraising to set valuations (i.e. multiplied by public market multiple for your specific sector)?

Revenue

A few years agao, the Wall Street Journal published “Tech Startups Woo Investors With Unconventional Financial Metrics — but Do Numbers Add Up?”, using statements from Hortonworks’ CEO to set the stage in the opening paragraph.

Chief Executive Rob Bearden forecast in March 2014 that the software firm would have a “strong $100 million run rate” by year-end. But the number looked a lot smaller after Hortonworks went public and then reported financial results: just $46 million in revenue last year.

Can you see how this confusion might have happened? As we’ve explored, run rate is not the same thing as revenue.

Deferred Revenue

Earlier in this post we explained your company’s year-end run rate will be $4.5M but your revenues for calendar this year will be $2.6M. Revenue for calendar year will be only 58% of your year-end annual recurring revenue, and that’s great — because it means you are growing! As the previous article goes on to explain:

It turns out that Mr. Bearden wasn’t talking about revenue, though he didn’t say so at the time. The Santa Clara, Calif., company now says the $100 million target was for “billings,” a gauge of future business that isn’t part of generally accepted accounting principles.

Right now maybe you have ~$500K of revenue whose recognition is deferred between next month and next six months. Deferred revenue is great, because it’s cash you can use now. It’s non-dilutive financing for operations. It’s great for startups. But it can be difficult to communicate, as the Hortonworks CEO found out.

Some things you need to watch out for in this article was the suggestion that you’re doing something shady in reporting these numbers and providing this kind of guidance. If anything “billings”, future contract revenue, annual recurring revenue or whatever you want to call it is a valuable aspect of SaaS businesses that should be shared with investors as it helps create a more complete picture for why a company commands the price it does in the public market. These aren’t wishes and hopes, they’re numbers derived from real contracts signed with real customers.

Annual Recurring Revenue of a growing company will always be greater than annual revenue of the current calendar year, and investors who think this is misleading fundamentally do not understand how SaaS revenue works.

Revenue Multiples

Going back to our previous analysis, we had several different numbers we could use to offer guidance for your company revenue this year: $1.57 Million annualized run rate based on Q1 performance, $1.81 Million based on annual recurring revenue at the end of Q1, $4.5 Million projected annual recurring revenue at the end of 2015, $2.6 Million forecasted revenue earned in calendar 2015, $3.85 Million annualized run rate based on forecasted Q4 2015 performance. All true statements, but which are the right metrics.

Choosing the Best Option

How do you figure out what your company is worth at the end of this year? Let’s assume that Brad had a solid valuation model going into our Series A round. Your company was valued at $18.5 Million pre-money at $1.5M annual recurring revenue. That’s 12.3x annual recurring revenue, which lines up with the higher end of the range for SaaS company ARR multiples on exit.

If we assume 12.3x annual recurring revenue multiple holds steady, at the end of 2015 we would multiply $4.5M annually recurring revenue x 12.3 = $55.5M, which is 3x the original valuation on the round… a nice markup for your investor, and a healthy position for the company. However, you need to be careful. In many cases things have changed overtime. If you really want to get the most accurate valuation from an outside source. Take a look here how Five23 can help you find the correct value of your company.

Of course growing slower and other exogenous factors (markets, multiples etc.) could change everything in this projection of the future, but it at least gives you an idea of where you stand.

What About Profit?

You might be wondering why we didn’t include profitability as one of the phases. It is important, and can happen anywhere along the way depending on choices the company makes about how much to spend and when to pursue break even. As companies grow and mature, the distance from negative to cash flow break-even becomes a smaller percentage of revenue, increasing the company’s flexibility to decide to be profitable.

Profitability (or lack thereof) is a choice in many cases. Burn is one of the few things entirely within the company’s control.

Generally, we think controlling expenses is a lot easier than figuring out how to make more money. So when you do find a way to make money, you should leverage it like it’s an unfair advantage that could end at any time. In a market where capital is available to support rapid growth to claim a market, startups are operating a breakneck speed to claim it.

When the Bear Market Comes

A question we see all of the time is: “Right now we are in a bull market. What happens when things reverse / we go into a bear market?”

Our answer: Report on every minute of it with data. Longer contracts. Avoid selling to startups or SMBs, or businesses whose customers are startups or SMBs. Sell a huge library of one-off research reports to customers who can’t get budget for an analyst and/or tools. Cut expenses, hunker down and become profitable so you can control when/how you fund the company and choose your rate of growth into the future.

Being on top of these items will give you the step up as markets change and your company grows. If you have further questions, or would like to know how Five23 can help you. Please feel free to contact us here.

The post 3 Phases of Financial Indicators first appeared on Five23.

1. Make a “value-based” pros & cons list

Imagine that you’re considering a move. Will you relocate to another city? Pull out a piece of paper and write a classic pros and cons list for the move. Now, here’s where science has added a helpful twist. Assign every list entry a number from 0 to 1, based on your personal values. For example, if being closer to your family is a “pro” that’s extremely high on your list, you might score it at 0.9 or 0.95. If you listed “near the mountains” as another pro, but you’re more of a culture hound than an alpine hiker, then it might only rate 0.2 or 0.3. Do the same for the “con” side. Leaving a job you love could score 0.8, for example, if your career is an essential part of your life. Add up each side, multiply by 100, and see whether the pro or con side wins out. You can also make a separate pro and con list for staying where you are. Compare the final values and see how you feel about the outcome. Often, confronting a “logical” number (which was actually weighted with emotions) can illuminate subconscious feelings. If you see the numbers but still feel pulled in the opposite direction, it’s worth doing some deeper exploration. You can also use this technique for smaller, less personal decisions, like which project or feature to tackle next.

2. Explore future scenarios

Considering the best- and worst-case scenarios is a common way to make tough choices. What’s the very best future you can imagine? The worst? And how would you feel if that disastrous scenario became reality? To expand on this technique, psychologist Gary Klein has studied a twist he calls the “premortem.” In a Harvard Business Review story, Klein explains why a premortem is the hypothetical opposite of a postmortem.

       “A postmortem in a medical setting allows health professionals and the family to learn what caused a patient’s death. Everyone benefits except, of course, the patient. A premortem in a business setting comes at the beginning of a project rather than the end, so that the project can be improved rather than autopsied.”

       Imagine that your decision was terrible. The project you chose to tackle was a crash-and-burn disaster. Now, explore every possible reason for the failure. Once you address this worst-case scenario, you can take steps to prevent it — and make a better decision in the first place. In fact, research shows that premortems (which are also called prospective hindsight) can increase our ability to identify future outcome causes by 30%. On the flip side, try to visualize that epic, best-case future scenario and gauge how you feel. If you’re not happy or excited, it’s worth considering why. Amazon uses a variation of both these techniques. Company developers must draft a hypothetical press release and FAQ announcement before they even write any code. By working backwards, the team tackles the most difficult decisions upfront and clarifies the product’s value proposition.

3. Avoid binary choices

We often get stuck choosing between this or that. Should I go back to school or start a business? Should I move to Seattle or stay in Denver? It’s easy to see the world in black-and-white, but there’s typically a grey option in the middle — or several shades of grey. Maybe you could spend summers in Seattle and winters in Denver. Or, you could live in Denver for another couple years and move to Seattle later. Sometimes the right choice is not one of two opposites. It’s a more creative, nuanced, or flexible solution.

4. Consult with others

Sharing your dilemma with others can justify or reinforce a choice, but more importantly, it’s a valuable way to gather valuable information. If you can’t decide whether to move, for example, don’t just survey your friends and family (who will also have skin in your game); talk to someone who made the same move. Ask how they feel now about their decision. For professional or business decisions, try hiring a consultant. Find people who have deep, niche expertise and learn as much from them as you can. The extra information you gather will almost inevitably help you make better choices in the future.

5. Avoid hidden decisions

For nearly 6,000 years, North America’s First Nations hunted the plains buffalo by chasing them over cliffs and finishing the kill below. This method enabled tribes to gather and store large quantities of meat, hide and fat for the long winter ahead. I always wondered why so many bison would just run over the cliff. They were usually pursued by hunters on horseback, for one, but it’s also an example of herd behavior. All the animals are just following the group, letting the flow take them where it will. Buffalo jumps are a good metaphor for hidden decisions or non-decisions, which we’ve all experienced at times. When you procrastinate or delay an important choice, you’re still making a decision — and it’s rarely a good one. For example, maybe you need to part ways with an employee, but you put it off to avoid a potential confrontation. If the employee is negative, unpleasant, or ill-suited to their role, the choice to wait and delay can poison the whole team. Non-decision is a choice with real consequences.

Those 35,000 daily choices can be daunting, but quick action is the enemy of decision fatigue. Choose fast and whenever possible, tackle your choices head-on. Use as many methods as you need to pick the best solution. Just don’t follow the herd. Choose what’s best for you — and then stand firm in your decisions.

One final note: if you’ve started a business or launched a product and you’re feeling overwhelmed by all the decisions, please know that it does get easier. Additionally, Five23 can help you analyze your chooses. Our packages can help any stage startup reach its full potential and take the guesswork out of the process. Once your business is stable, many of the big, foundational choices are done and you will reach equilibrium. Then it’s time to focus on the constraints. Determine where you can make the most important, impactful decisions, and use them to grow or refine your business. Remember: decision-making gets easier with practice, and a new choice is always just seconds away.

The post 5 Techniques that Help Entrepreneurs Make Hard Decisions first appeared on Five23.

For any entrepreneur, knowing how much money you need to raise is a big part of being ready to talk to investors. How you can determine the amount of capital you need to raise is key to getting the figures right. This post should help you solve the task of identifying how much capital you need to build your runway.

Identify Major Milestones

Investors usually look to fund a business to its next major milestone. These are milestones that show your business has reduced one or more key risks in its development, such as demonstrating market demand for your product or service through a critical mass of customers or users of your prototype, outgrowing current production facilities, or ideally, achieving consistent profitability. Start by identifying the major milestones for your business over the next few years.

Create a Plan

After you’ve identified those milestones, create a plan to achieve them. The process of developing a business plan will help you create a roadmap for achieving those milestones. Because the business plan is a big picture view of where you are going over the next few years, you should also dive deeper and create a more detailed project plan for achieving the next major milestone in your business — that is the milestone that you are looking to fund. Really spend some time plotting out each step, identifying how long it will take and what resources are needed to achieve that milestone.

Project Cash Flow

Now, translate your plan into numbers by creating a financial forecast. We recommend developing a monthly forecast for the initial year and an annual forecast thereafter. For each period, forecast your business’ revenue, expenses, delays in customer payments, and purchase of assets. Project cash flow by looking at the difference between cash inflows and outflows in each period. You can begin to see how much funding you will need by looking at the sum of the cash flow over the estimated time frame to achieve the next milestone.

Note: If you are having trouble with forecasting, we’ve offered step by step guides to getting started on financial forecasting and analyzing cash flow in previous blog posts (view them here).

Be Realistic

Go back and check your assumptions to make sure they are realistic. Ask yourself if your estimated time frame for achieving the next milestone is realistic based on the research you’ve done in your industry, the time you have available to dedicate to your business and your capacity to lead the business. Make sure the expenses you identified are necessary to develop the business over that time frame — that you are not inflating expenses nor are you missing any expenses. Also, add in a small buffer for inevitable mistakes or miscalculations in the implementation of your plan; we recommend a 5% buffer in either direction. Lastly, ask yourself if the forecasted revenue growth can really be achieved with the resources you will have.

Choosing the right amount to raise is critical to the success of your business. If you underestimate funding needs, you’ll end up raising less than you need and may find your business in a cash crunch. If you overestimate funding needs, you risk losing credibility with invests and may not be able to raise the funds you need on reasonable terms, if at all. So, before you start talking to investors, make sure you have identified your milestones and have put together a well-thought out plan and financial forecast.

If you’ve developed a plan and forecast, and you’ve identified how much you need to raise, you may be interested in our services to help you successfully raise funding. To learn more about how we help startups, click here. To see what is included in each of our packages, click here.

Still not sure exactly where to begin, feel free to contact us here.

The post Determining How Much Money to Raise (How to Startup Guide) first appeared on Five23.

Gain Experience

We learn a lot through experience. With the right mentors, you can gain experience from others who have already been there and done that and can provide insights from their own successes and failures. These insights are valuable assets that can save you time and money in developing your business.

Provide Perspective

When you are in your business every day, it can be hard to step out and think strategically. Having a mentor can give you a different perspective. Because your mentor is not caught up in the day to day details of the business, they can provide more objective feedback and guidance that is still grounded in experience.

Avoid Pitfalls

Because you’ve put a lot of work into the business, it can become easy to get very attached to your business plans. And, you might not recognize biases and blind spots that pose risks to your business development. Having mentors who constructively challenge your assumptions and identify weaknesses can help you avoid common pitfalls and minimize your risk.

Build Resilience

Starting and running a business is an emotional roller coaster. It’s encouraging to know you have a support network with mentors who believe in you and your business and are committed to helping you figure things out. And, calling on your mentors for guidance can re-inspire and re-energize your motivation to build your business.

Expand Your Network

A mentor can connect you with resources to grow your business. A good mentor should keep you in mind and think about introducing you to people who can support your business development, such as potential customers, partners, or investors. That’s not to say that a mentor is going to automatically open up their entire network — you still need to do the work to demonstrate you are ready to make effective use of those connections.

The post The Importance of Having a Mentor first appeared on Five23.

A Five23 Guest Post by Erik Hayton.

Erik is the CEO of Wedding Nook and a 4x Founder who occasionally writes, speaks and consults in areas of entrepreneurship and business development.

How to beat the odds; an honest look at entrepreneurship

If you spend as much time online as I do, you’ve undoubtedly experienced those hilariously-titled entrepreneurship articles clogging up your feed at one time or another. Most of them tell you how to ‘identify your passion’ in order to turn it into a revenue stream, or how to ‘become your own boss’ by following an unbelievably simple set of rules…

Inspiring, aren’t they.

What these articles fail to acknowledge is the cold-hard fact that your odds of making it are just plain terrible. Sorry.

Let’s talk numbers!

In the United States, only 4.1% of people own their own business (source).

If you’re one of them, you know that there’s a 90% chance you’ll crash and burn.

So…10% of 4.1 = 0.41% of us that are capable of making it through the first few years.

Now, 95% of U.S. business owners have at least a bachelor’s degree. That’s not to say that you can’t do it without a degree, but─  statistically ─ you’re worse off. (0.02%)

Surprisingly, only 1% receives venture capital funding. Something you won’t hear on a daily basis. 

If that wasn’t reason enough to think long and hard about a career change: The top 3 reasons people ‘become entrepreneurs’ are Money, Flexibility, and Control.

These reasons are not only terrible – they’re hilarious.

The average entrepreneur makes under $50k per year, works 66 hours per week and wears far too many hats to worry about control. You want money? Learn a trade; Want flexibility? Try yoga; but if you want control, you’re in for a nasty surprise. Your investors, co-founders, employees, contractors, suppliers, etc. they all need something, and you’re the gofer. Nobody has more bosses than an entrepreneur.

With these overwhelming odds against you, why would you even want to try?

Well for many of us, the odds don’t sound too bad. That optimistic little voice inside of us assures us that the upside is well worth the risk. Whether you set out to leave a legacy or chart your own destiny, you’re driven by solving problems or you simply enjoy challenging the status quo. There are many reasons that do make sense, but out of all of them, one stands out. Which brings me to my favorite statistic: 99.7% of all U.S. Businesses are small businesses.

Who knew that entrepreneurs not only hoped to change the world, but that it was actually part of the job description?

The world NEEDS entrepreneurs, and far more of them.

Luckily, there has never been an easier time to start a business. With all of the free resources and code online, you hardly have a reason not to try!

Need someone who knows something you don’t? Clarity, Cofounders Lab, Founder2be

Need an Investor? Angel List, F6S, Kickstarter

Want to now how much your startup is worth or need to secure financing? Five23

Not sure how to market? Growthgeeks, Sumome

Don’t even have an IDEA? Here you go: “101 Business Ideas“

I could go on, but other people have already made lists:

Growth Supply

Freelance Folder

Entrepreneur.com

Justin Mcgill

Changing the World

For those willing to assume the responsibility, ‘changing the world’ can be as simple as observing what’s around you. Maybe you work in finance and see some holes in traditional banking, so you start an online bank that is fairer than the competition (Musk); or maybe you had a bad experience with an airline, so you start your own, right there in the terminal, with a chartered plane (Branson).

By looking at the people who have succeeded more than most, a playbook emerges; “Never stop learning; and use what you know, to improve the things around you.”

Simple, but hardly easy! After all, if it were easy to change the world, we’d be living in far more interesting times. But all of the technology and resources in the world won’t help you if you aren’t willing to do whatever it takes to succeed. In our dopamine addicted, blue-light infected, ‘feelings are more important than facts’ dream world; you’re up against a hell of a lot of distractions and discouragement.

A recent poll of 9,348 entrepreneurs (courtesy of Five23) showed that the average entrepreneur starts 2.1 businesses before succeeding, and spends 11 months on each. That’s almost 24 months of grinding before you even sort of make it. That’s a lot of time without a decent income, family time, friends, facebook or free-time in general!

But if you can keep learning, stay focused and figure out how to persevere more than most. Then eventually your experience and tenacity will click, allowing you to beat the overwhelming odds, and finally be able to call yourself an ‘entrepreneur’; not because it’s a cool buzzword, but because you’ve truly beaten the odds and earned it.

Now go do something productive.

 –  Erik Hayton.

The post How To Beat The Odds (Honestly) first appeared on Five23.

Can you name a company that has gone out of business? There is a plethora of failed companies to choose from and we’re sure you will have no problem finding one. Companies like Blockbuster, Radio Shack and Pan Am have all closed their doors for good. Five23 investigated the top three reasons why companies big and small fail, and you might be surprised as to why.

Market Knowledge

All companies start to fill a gap in the market. Whether it be a boat repair shop or an accounting office, they are finding needs in their communities and fulfilling them. This sense of market knowledge is strong when an entrepreneur starts their business, although, overtime it may wear off. Analyzing the micro and macro levels of the direct and indirect market is important to understand trends and the needs of your customers. The data you can extract from this type of analysis can help your team develop strong products that your customers want. This will also allow you to track trends in the market.
Imagine if Blockbuster had the foresight to acquire Netflix when they started noticing their market share shrinking. Or what if they started their own dvd home delivery and online streaming service just weeks after Netflix did. Maybe we would be saying “Blockbuster and Chill”.

Financing

It may come as no surprise that one of the top reasons startups fail is due to lack of financing. Only 20% of all companies raising money actually receive the funding they are looking for. This means the other 80% never acquire the capital required to get off of the ground or continue developing their idea. Many hopes and dreams of companies are stopped short for this reason, and they don’t have to be.

There are two options to obtain the necessary financing for the company to advance: Investment and Profitability. Investment can be hard to obtain but possible (Five23 covers it heavily in our blog post “here” & “here”). The second option, to become profitable, is generally difficult for young companies, but is the easiest way to establish stability. Being profitable is the goal for all companies and the quicker entrepreneurs discover how to become profitable the better. Bringing in solid revenue is the best way to ensure a strong future for the company.

Stubbornness

A common weakness in entrepreneurs is stubbornness. In some cases it may help, but in most, it is an Achilles heel that will cause even the best businesses to fail. All companies need to adapt to the ever changing market (as we discussed before), and while some don’t always see change coming, the ones that do have to acclimate.

There comes a time when an entrepreneur sees a change that he / she doesn’t want to make. Although there are valid reasons for not completely changing a product or service, making small pivots is essential. The majority of the time, the reasons business changing decisions are not made, is because of an entrepreneur’s emotions and unwillingness to change the business they spent so much time growing. However, in many cases, if the change never occurs, the business may be passed up for a product or service that is more accurate to what is wanted by the market.

To summarize, paying attention to the ever changing market is one of the best ways to stay ahead of the competition. It may allow you to have a strong and profitable product that will lead to many years as a successful company, so long as you are willing to change to stay up to date with the needs and wants of your customers. Failing to do either of these items greatly increases the chances of the business going under.

The post Top 3 Reasons Companies Fail first appeared on Five23.