Running Out of Money

Posted on August 17, 2010

It’s the rare business that never faces a cash crunch. For most companies, whether privately held or publicly funded, the problem will arise sooner or later. Here’s how to respond when it does.

It was in “Cabaret” that we heard, “money makes the world go ‘round”. But it is in business where we feel the jolt when the money runs out and the business screeches to a halt. Simultaneously embarrassing and cataclysmic, running out of money is a complete distraction until the problem is solved.

I know running out of money seems like an obvious problem to avoid, but then why have so many of us (myself included) found ourselves in exactly this sorry state? Running out of money in an ongoing business is like running out of blood in your body. All the systems collapse.

The most common ways I’ve seen it happen in real companies are:

1. An established company runs up losses and the cash balance falls toward the bottom and/or/then the bank pulls out.
2. An early stage company runs out of investor’s money and can’t get more.
3. A shock to the system (fire, legal loss, main customer fails, etc.) stops the cash flow.

Please believe me that companies in horrible financial shape can survive for incredibly long periods without collapse. If you’re running one of those companies, don’t give up too soon. There are plenty of opportunities to recover. But to recover, it takes massive amounts of the CEO’s time, energy and faith, and that is where the distraction comes in. For example, I’ve been faced with not being able to make payroll. All I did from the time I knew I was in trouble until the payroll was made was to work on finding the money to make payroll. Customers were neglected. When a customer’s order couldn’t ship because a key vendor had gone unpaid for too long, all my focus was on finding money to pay them. I was totally focused on getting money, and completely distracted from everything else.

This is no different for investor-backed firms that have almost burned through one round of funds and need a second. Those CEOs spend most of their time fund-raising, making pitch after pitch to investors – sometimes 40, 50 or more. They are not developing product or planning or marketing. They are looking for money.

Big established companies, even publicly traded ones begin doing back flips for liquidity as they run low, although for them it is called, “the zone of insolvency”. They have to retain enough cash—often tens of millions of dollars – to allow for an orderly shutdown. If the street things they are short, it’s game over.

Strategies for Mitigation

For operating companies, the key is leaving room & time to fix the problems, which generally means stepping on the brakes earlier. Strong financial controls (and listening cautionary counsel) will allow for a set of triggers that push you to act incrementally, slowing the cash drain or reversing it early, without having to take dramatic action. When liquidity ratios are excellent and thickening, companies have lots of latitude. But at some trigger point, fiscal discipline dictates that the most risky, most cash draining activities must stop. Many other forward thinking projects can still be funded, but if you make cuts early enough, you won’t have to sacrifice as much. But too many companies miss this trigger. They have passion and hope that things will “work out” and that their “big break” is right around the corner. Then they breach the second trigger point; then the third. Usually the running out of money moment is the fifth or sixth trigger.

Think of your balance sheet as a series of crash barriers, like the freeway barriers for a runaway truck with failed brakes. If your firm encounters problems with a strong balance sheet, it can decelerate first by “crashing” into short term bank debt, then if needed, payables, then by slimming inventory and receivables, then by using some cash, and so on. But as you use up each crash barrier, your crash velocity had better be slowing, which means you’d be turning the company around.

Some companies survive the impact of a cash crash, but then it’s critical to re-build the crash barriers on the balance sheet, because it can happen again. That means running the business in a careful, conservative fashion until you’ve generated enough positive cash flow to re-build the balance sheet. I found that running a company at such times was not as fun. I could not jump in and be creative, or reach for the big wins (which entailed big risks). But that’s life.

Earlier stage, investor funded companies can be a bit different. They often don’t have debt, but are given only enough cash to accomplish certain milestones. The process is that once such milestones are achieved, more investment (a tranche) will be made. The mitigating key here is to have investors whose faith in the company are matched with management’s level of faith, and that those investors have the money to keep putting in cash as the company achieves its milestones.

For those CEOs that have never lived in the world of staged funding, it will seem like this is madness – starting and running a company knowing that it does not have enough money to succeed. But it is not madness, and all parties come together knowing that there is high risk, and that the company will not get further rounds of investment if milestones are not achieved. Companies that fail to achieve their milestones within a reasonable time frame don’t deserve to get more money. Enough said. Still, many firms run out of money even while hitting their milestones.

Just as investors select and then bet on companies, so too should founders select, then bet on investors. Not all investors are alike, and too often, we take money from the wrong investors. The wrong investors are those that can’t double down or triple down on their bet and give us more money when we deserve it. The wrong investors are those that are inexperienced and panic in the face of ordinary obstacles. The right investors understand the risks of the venture, and act accordingly. They know things won’t always be on time and accept change reasonably. Their tolerance for risk is appropriate, and they can put in more money when needed. Better still, they can lend a hand in leading or advising the company.

One last suggestion: Treat investor money as if it were yours. The days of big lavish parties are gone. Spend it wisely, carefully and strategically. No waste. You’ll need every nickel.