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Notes from a talk I gave at Berkeley Haas School of Business, April 4, 2011

I am going to assume that you know the basics of modeling cash flow. How to build a P&L, read a balance sheet and calculate working capital. Given that, if you are running a small, growing company here are my top 4 tips to manage your cash.

First of all – why is it so important? While VCs may be falling all over themselves today to fund new companies that think they are the next Facebook or Zynga that will not always be the case because good times come and go in the venture community, and it will certainly not be the case if you ever hit a bump in the road.

Part of your job as CEO is to keep the company funded with the capital necessary to run the business and grow – whether it’s your personal cash or from Sand Hill Road. Cash is finite, it’s very expensive in your time to raise (not to mention the dilution to your ownership), and you can’t save your way into growth so you need to make sure you have enough. I see many young companies in Silicon Valley forgetting this today because the money is flowing – but their chances are 1 in 10,000 their company is the next big thing; 80% of them will fail but by being imprudent with their cash they increase the odds that they are on the wrong side of the line.

When I was CEO of Simplex in 2000 cash became a crunch issue for us. We were growing fast, profitable and we needed more working capital to fuel our growth (hire sales people, open international offices etc.) but we could not raise cash from new investors and while our current investors were very supportive they were ready for a liquidity event. The investment community and the bankers were fixated on dot coms – eyeballs and click-throughs (as they are today) – and we were a traditional enterprise B2B software product company. And because the dot com bubble had just burst the public markets were closed to pretty much everyone.

We had no choice but to open a line of credit against our receivables, draw it down and manage every penny. $40M+ in revenue, living off a $4M line of credit until we could raise money in the public markets (which we did in 2001). Combine this with my experience managing FirstRain through the recession and I am a little intense about cash flow.

Tip #1: Build your own model

A good finance team will build you models every day and twice on Sunday but there is no substitute for building you own. Build a P&L, collection and cash flow model yourself. It won’t be perfectly correct because you’ll probably not get all the operating costs right, but by building your own you will have a profound understanding of the underlying assumptions you believe apply to your business.

What is the cost of every engineer? What does health insurance cost really? What is your true collection time? What is the monthly productivity of each sales rep and how many months does it take from hiring to positive cash flow for each rep? What ASP and average transaction size are you assuming – is it realistic? What percentage of your sales reps will fail or turn over – it’s a guarantee some will so how many do you assume? Building your own model will force you through the thinking. Send it to a trusted board member and they will then ask you all the assumptions that you had not thought of and by the time you are done you’ll have a strong gut feel for the cash levers in your business.

Tip #2: Cap your own salary

In most young companies the single highest expense, overshadowing all others, is salary. It’s very tough for any executive to argue that they should make more than the CEO (with the exception of the VP sales when you include his/her variable compensation). So if you cap your own salary below market you can better manage the cash outflow from the salaries of the executive team. This requires that you have enough equity in your option pool to strongly motivate your execs and key engineers (an important part of your negotiation with your investors) – and that you can explain with integrity how the leverage of their options exceeds the leverage of cash you might pull out of the business to pay them more in cash.

It’s a delicate balance because your team needs to make enough to live and not worry about their families, but no more, because in the end they’ll make more money from their options when you reach a successful liquidity event. Basic risk/reward. If someone wants too high a salary – exec or employee – their interests are probably not aligned with your team’s and your investor’s so don’t hire them.

Tip #3: Hire a tight fist in finance

In a small company every dollar counts but you can’t watch every transaction. As CEO, having a persnickety, detail-oriented, negotiating, thick-skinned finance lead at your side is essential. You don’t need a CFO unless you are going public, in fact hiring a CFO too early can hurt you (they tend to need staff), but you do need a controller who can negotiate better pricing with every vendor, manage your DSOs with a strong collections process, push out payables and play chicken with the landlord. Plus the books must be perfect every month, every quarter. You don’t have the time for any mistakes in your accounts.

Tip# 4: Test every decision you make

Every day, for every decision, ask yourself what is the impact on cash flow? For example should you hire more engineers now or 6 months from now, should you hire permanent staff or consultants – how will that change your revenue and collections? Does it drive top line growth? Your engineering team will talk to you in terms of releases and features, you need to translate it in your own mind into sales productivity.

Or when should you hire the next VP? You may be struggling with your own bandwidth but at what point will adding a VP change the revenue growth curve? Or conversely when is waiting hurting the business but you can’t see it because you are buried? Travel policy – everyone in coach of course. Food – build relationships with your local vendors. Office space – go cheap. Interns – yes if you can create a win-win with them. But don’t scrimp on health insurance – personal insecurity kills productivity.

It’s not easy. I have made every mistake there is to make – as you will find most CEOs have if they are honest with you. Growth takes risk, risk means mistakes. And often times I have seen VCs and boards push for growth (and hence cash consumption) too early because they are impatient so you need to keep a clear head on your shoulders. Keep modeling your cash, keep testing every decision against it, and work hard to keep payroll in line and you’ll give yourself the runway you need to prove out your business and give your team the best odds to succeed.

And when the time is right – spend your cash to punch through.

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