Sources of Money (A):
From within the Company
It often surprises me that first-time entrepreneurs rarely examine the company for its ability to generate cash.
The most obvious, and best, source of funding is, without a doubt, gross margin – the difference between your selling price and what it takes to build that product or provide that service. You need to charge as high a price as you possibly can. In fact, in my experience, you should be charging 25% - %50, or more, that your current prices.
You’ve said to yourself, “He’s out of his mind! If I raised my prices that much, no would buy from me.”
If that were really true, then I would question the viability of your business. Fortunately, though it’s not true.
You really believe in what you’re doing, don’t you? You are providing a product or service that uniquely provides your customers with value, aren’t you? [Even if you hesitate on that one, YOU are a unique resource that is bringing that value, so it is true.]
For most of you, you don’t need thousands of customers in the first year. For many of you, if you were to get 3-5 customers, you would consider that a success. For the sake of argument, in the latter case, that means you probably have to identify less than 30 potential customers from which you garner those initial sales. With a little bit of effort, I know you can identify 30 potential customers for whom you provide a “gotta have” solution that will support premium pricing.
Vendor and customer terms and conditions are another potential source of cash. If you don’t push in this area, you are probably looking at paying cash in advance to your vendors because you have a young company without a credit history. You will bill your customers and expect payment in 30 days, but not get it for 45, 60, or maybe even 90 days. The person responsible for payables at your customer knows that you wouldn’t dare threaten one of your only customers with a collection action.
So, from the time you purchase material from your vendor, receive it, put it into raw materials inventory, release it from inventory, process it in part or in whole, and place it back into inventory, as work-in-process or finished goods inventory, receive a customer order, ship the product, invoice for the product, and get paid, it could be 180 days between when you spend a dollar with your vendor and when you get a dollar from your customer.
That’s the case if you accept the status quo, and many of you do. You know you’re an early stage company. You don’t want to risk angering either your vendor or your customer. So, you think, it’s better to keep your mouth shut.
I beg to differ. You are a great company that is in stealth mode. Your vendors and customers are fortunate to have you dealing with them.
With those thoughts in mind, you go to your vendor and explain that you are a young company, and cash flow is tight at the moment, so you’d like to accept the vendor’s goods on consignment. You promise to pay as soon as your customer pays you. You explain that as you achieve success, you will remain faithful to those who help you in the early days. You point out that that could mean a very significant amount of future business. If the owner of your vendor is also an entrepreneur, you play that card, too.
You go to your customer with a similar pitch. Since they’ve already agreed to buy from you (at very high gross margins for you, see above), they appreciate and value your solution. That being the case, you explain to them that you’re an early stage business with cash flow challenges, and therefore you need 50% of the purchase price at the time of the order. You promise to smother them with service and to always give them a preferred position in future dealings.
An alternative to that is to quote your customer a very high price, but agree to discount it 30% or 50% or 70%, as the situation dictates, if the customer pays in advance. That lets the purchasing agent look good to his boss (“Look at the money I saved us with my superb negotiating skills!), and you get your cash now.
By the way, that high price is calculated by taking the amount of cash you need and grossing that up so that you can offer the appropriate discount. Since you are an early stage business and essentially every shipment at this stage is to one degree or another, customized, you need not be overly concerned that the bid to this customer bears no relationship to a bid, or even transaction, with another customer. You are providing a unique solution to their problem for which price is a minor issue.
If you were successful in getting both your vendors and customers to agree to these terms, you would accelerate your cash flow more than 180 days. You would have positive cash flow from day one because you will get cash from you customers BEFORE you need to pay your vendors. This could be an extraordinary amount of cash (or alternatively, the avoidance of raising cash through equity).
[Note: I believe I read an article several years ago that claimed Dell Computer made most of its money investing the float it created by charging its customers’ credit cards at the time of order and through just-in-time inventory, paying its vendors sometime after that.]
In the short term, you may be able to manage the components of your balance sheet to squeeze some cash out. This should only be done with advanced planning and with a compelling need to do so. This is your classic, “Robbing Peter, to pay Paul” situation.
You can delay paying your bills, loans, rent, etc., but only for a short period of time. If you have a large customer receipt due (and you’re 100% sure you are going to get it), then this is relatively easily done, particularly if you give the people to whom you owe the money a “heads up.”
On the other hand, if you are in a fragile cash position, you should talk to the people to whom you owe the money and try to work out some alternative arrangement. Your lender may accept “interest only” on the loan for some period of time. Your landlord may be willing to accrue your rent for a number of months. Your vendors may agree to some sort of payment schedule, or a willingness to give you a discount for immediate payment.
In any of the cases in which you have made commitments with you creditors, it is essential that you abide by them. In most cases, they will be willing to work with you as long as you’re up front with them. By the same token, if you prove to be distrustful or unreliable, they are likely to come down on you like a two-ton brick.
Do not play around with the money you’ve withheld from your employees’ pay. That is not your money. It is the government’s. You are only holding it for them. If you ignore this advice, officers with badges and guns can come and shut you down.
Next week we’ll look at some of the non-equity sources of outside capital.
Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University. (Website) Previously he was president & CEO of the Future Fund, general partner of the Pittsburgh Seed Fund, co-founder & investment advisor to the Western Pennsylvania Adventure Capital Fund, as well as vice president, venture development, for The Enterprise Corporation of Pittsburgh.