September 5, 2007

Understanding The Financial Side of Startup Companies' Growth

Anyone who wants to understand the financial reality of how startup companies grow should contemplate the following paragraphs written by Fred Wilson:

"But the ugly adoloscent phase is a cash consuming experience. Expenses always precede revenues. Scaling a web business requires servers, storage, and bandwidth. You need developers to maintain code, deal with scaling issues, and you still need to innovate. Revenues have to be suported, that means salespeople, business development people, and customer support people.

Revenues take a while to ramp and even longer to collect.

Your profit and loss statement says you have 200k a month in revenues and 500k a month in expenses. So you figure you are burning 300k in cash. Wrong. You are probably burning 400k to 500k. Because you had to pay three months rent in advance, buy an expensive netapps box, and you haven't collected a dime of last month's revenue yet."

I remember being at TradeDoubler, which got 10 million US dollars (back when the dollar was at 11 SEK/USD) in funding in 2000, in 2000-2002 when the company consumed a lot of cash every month. And each additional market launch increased short-term cash consumption. In hindsight the money was well spent, as TradeDoubler turned profitable, continued to grow and today has a market cap of 4-5 billion Swedish kronor. However, had the company not managed to secure funds from investors and turn cash flow positive, TradeDoubler would have been considered another dot.bomb. Hindsight is indeed powerful when evaluating both company performance and investment decisions.

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