Expense Controls for Early Stage Software and Tech Companies–Can You Overdo It?

I’m sure you’ve seen it too many times before–the free-spending startup software or hardware company which burns through their funds like a cocaine addict on vacation in Columbia. It’s ultimately a sad tale, with great potential often wasted, many jobs lost and multiple lives hurt. But it is hard to feel sorry for the management teams that put these companies in precarious positions with poor judgment, lack of expense controls and a general lack of self-control—they should know better and end up getting what they deserve.

4 WAYS THAT STARTUP COMPANIES SPEND THEMSELVES OUT OF BUSINESS WITHOUT EXPENSE CONTROLS

• Spend it almost as fast as it comes in because the market is overheated. This was endemic during the Internet bubble years, when even formerly conservative VCs were imploring their portfolio companies to “spend money faster” and “get the eyeballs now, we’ll figure out how to monetize them later”. A lot of that was going on back then. “Expense Controls” became a “dirty phrase”. Crazy, as we all look back at it now but I see the same thing happen in more isolated cases even today. Unfortunately, I see quite a few VC-backed companies being encouraged to do similar things even today (albeit to a much less extreme degree).
• A more common situation where money tends to get spent way too fast is when a startup management team is staffed primarily with “big hitters” coming from large company backgrounds. I remember in particular a mesh networking company here in San Diego which burned through over $60M in VC money, while creating almost no revenue along the way. They appeared to have literally no expense controls. They hired an almost endless list of VPs from name brand, blue chip companies, paying them well over the going rates at early stage companies. The CEO came from a big telecommunications company (with no startup experience). He was paid a SALARY of $750,000/year. Yes, you read that right–I’m not even counting his bonus and option grants. This was in a company that was barely past the pre-revenue stage and nowhere near profitability. It still amazes me to this day.

• Another scenario I have seen quite a lot are pioneering companies that are developing a novel technology or product, attempting to create a truly new market. What happens often in this situation is what I’d call an “itchy trigger finger”. That’s when it’s still too early to create the critical mass needed in a market. Instead of continuing to be patient with conservative expense controls, marshaling their resources and continuing to develop their products while educating the market, these innovators get impatient. They blow through their investment capital with a premature, huge ramp-up in Sales and Marketing, well before their product or the market being ready for this expansionary phase. Their large expenditures in Marketing serve only to prime the market, to the great advantage of their fast-follower competitors.

• The final situation that I often see leading to overspending is the company that has been bootstrapping successfully (but also painfully) for a very long time–then finally is able to attract a round of Institutional Capital. Every startup has a long list of “like-to-haves” that they would spend money on–if they only had it. It’s understandable when you’ve been hungry for so long to want to “eat” – spend a bit. So it’s OK to knock off the most important expenditures at the top of the list when that initial funding finally comes through. But like a starving man let loose after hours at McDonald’s, some of these formerly prudent managers gorge on the new-found capital. Formerly conservative expense controls go out the door. They end up spending it like it’s ongoing cash flow–not the precious investment capital that it actually is. Not being miserly with investment capital is one of the cardinal sins indicative of bad startup management. In this particular situation, it is the otherwise sound managers who undergo a bout of “temporary insanity”– a particularly sad story.

So that’s one side of the coin–overspending. We’ve all seen it and when you’re not inside the eye of the hurricane that is a startup company, it’s not that hard to recognize. There is no doubt that this free-spending behavior has killed many a promising startup.

But what about the flip side of the coin–when managements are TOO miserly and spends too little? This is an area that I have not seen discussed very much lately in early stage tech circles.

Now please keep in mind, I’m not advocating spending funds that you simply don’t have. Borrowing is rarely a good idea for an early stage software or hardware company. If you don’t have the money–please, don’t try to find a way to spend it anyway! Conservation of capital is one of the basic pillars of good startup management practice. Runway is almost ALWAYS the most important thing to conserve and maximize in the early days.

Yet, there are some places where an early stage company simply HAS to invest, or the outcome will be almost certain crib death. Below are a few important examples:

STAFFING WITH GOOD PEOPLE

Good companies are built with good people. Great companies are built with great people. Period. Even the company with great brand equity and outstanding IP are doomed for a hard fall without the continued benefit of committed, smart staff. In a startup, it’s even more critical, because you don’t have any of the built-in advantages that a big company has, which might allow the enterprise to coast for a bit before heading south. Without good people, startup companies will not thrive for long. Even if a profitable business can be built it will soon hit a wall, as a result of lack of depth in the employee pool. The initial founders can only take it so far without a strong supporting cast–growth will eventually stall. I had a client, a young CEO, who did a great job building a strongly profitable, multi-million dollar business in a large and competitive market. But his growth stalled because he viewed much of his staff like desk chairs or any other overhead line item–an item to be minimized via expense controls. Don’t make this mistake. Your staff is your lifeblood, not a ball & chain to be jettisoned at every opportunity.

CREATING A GOOD PRODUCT

Almost important as good people to a software or tech startup is a killer product. Although there are many, many things that are important to a successful startup tech business, by their very nature, tech companies are almost always driven by a great product. There are exceptions, no doubt–but this is a pretty good rule. It makes little sense to enforece expense controls in product development (assuming that you’re spending the money wisely!), until you have created a product that can lead to winning in the marketplace. With a startup, that almost certainly means something that’s not “me too”–it needs to be faster, cheaper, or more capable than the competition.  A while back I was VP- Sales & Marketing for a small public company that was still in development of its primary product (a PUBLIC company that is pre-product is the subject for another interesting article…). The company was still losing money due to high development costs and a small revenue stream. This is a typical situation in a biotech, but not common in IT. Because the company was publicly-traded, there was a strong reluctance on the CEO’s part to raise money due to the resulting stockholder dilution. He was also always threatening to cut costs to make the quarterly numbers look better. This was INSANITY. There’s nothing more than I can say–cutting product development before you have a competitive product to sell is suicide. Worrying about quarterly results until you have made the company a going concern from a product perspective is stupid. You do what you have to survive, of course, but this was a company with access to the public capital markets. A strong product is the muscle that allows you to break though the barrier of embedded competitors with strong positions and brands. Don’t kid yourself and save your money for ANY other reason until you’ve hurdled this bar.

BUILDING A CRITICAL MASS OF UNIT SALES

Finally, you’ve built a killer product and have a savvy staff pushing it out into the market. With whatever you’ve got left in your tank–use it. Stomp on the gas peddle, spend whatever you can muster on outbound sales and marketing programs. This is where the proverbial “crossing the chasm” really takes place. There are a certain number of customers you need to sell before you get over the peak of that initially steep sales curve–and things start to get easier. Once that happens, people will know your company name and your product will have market credibility. Enough happy clients are out there so that word of mouth marketing kicks in. Instead of fighting for every new customer, they start coming to you in increasing numbers–without nearly as much effort. Your product is now showing up in the market share figures. The press and analyst community start to call you instead of you leaving endless unanswered messages in their voice mail boxes. Yes, at some point believe it or not, it really does get easier! But this happens only if you are able to close the number of initial sales necessary to reach critical mass in your specific market. Until you reach this point–SPEND WHATEVER MONEY IT TAKES–AS LONG AS YOU HAVE IT.

I’m sure there are more very important items that you can list, where spending too much or too little can cause big problems for startups. Let me know what your experiences are–post a comment below with your own examples or questions.

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