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.
YouÕve said to yourself, ÒHeÕs out of his mind! If I raised
my prices that much, no would buy from me.Ó
If that were really true, then I would question the
viability of your business.
Fortunately, though itÕs not true.
You really believe in what youÕre doing, donÕt you? You are
providing a product or service that uniquely provides your customers with
value, arenÕt 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 donÕt 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 Ògotta haveÓ solution that will support premium pricing.
Vendor and customer terms and conditions are another
potential source of cash. If you donÕt 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 wouldnÕt 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.
ThatÕs the case if you accept the status quo, and many of
you do. You know youÕre an early stage company. You donÕt want to risk angering either your vendor or your
customer. So, you think, itÕs 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
youÕd like to accept the vendorÕs 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 theyÕve 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 youÕre 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 (ÒLook 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 customersÕ 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, ÒRobbing Peter, to pay PaulÓ 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 youÕre 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 Òheads up.Ó
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 Òinterest onlyÓ 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 youÕre 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 youÕve withheld from your
employeesÕ pay. That is not your money. It is the governmentÕs. 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 weÕll 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.