The Silicon Valley Bank (SVB) debacle has brought out many lessons for the Indian startups and other stakeholders in the startup ecosystem. While the government in the US has ring fenced the issue, it has thrown many alerts to doing business.
The debacle of SVB unsettled many Indian startups overnight. It brings to the spotlight the need for financial planning and risk management, which in this case was startups overreliance on a single entity for all banking and investment related services i.e. concentration risk. Today, financial planning and risk management is no longer a prerogative of large enterprises.
Every startup aspires to become sustainable and profitable by creating an impact in the society. The importance of sound financial discipline in building profitable businesses right from the ideation stage cannot be over emphasized. The need of the hour is to have a financial risk management mindset as backbone to businesses today. A successful business imbibes this mindset in its strategic and day to day operations. Some of the areas which every startup founder should focus on are illustrated below.
Startups raise medium to long term capital to meet their business expansion plans or product development plans. Today funding eco-system offers many options to the founders to raise capital in term of nature of instrument, valuation range, vesting terms etc. The founders, at times, out of desperation raise capital on unreasonable terms which end up becoming counterproductive to the business and the founder. A classic situation of not evaluating the pros and cons before onboarding an investor based on their terms and conditions leads to poor financial management which may in an extreme situation lead to shutting down of the businesses.
Startups while scaling up their business require to focus on robust working capital management and ensure that sufficient cash is generated month on month to build up adequate runway for the next 6 -9 months. Working capital management requires a good understanding of the working capital cycle starting from sourcing raw materials to collections from debtors. Selecting vendors/raw material suppliers based on favourable terms of payment or credit cycle while not compromising on the quality, decision to manufacture in house or outsource to reliable partners on sound terms and conditions and signing up purchase orders with potential customers willing to pay for the value of the product with credit cycles conducive to the cash flow cycle, are very important check posts while managing short term funds in business operations. Working capital funding support is available by way of debt or equity from investors, venture debts, banks, NBFCs and other agencies. The startups dealing with large corporates also can avail of dealer vendor financing arrangement that the corporates have with banks. However, planning the exact quantum of working capital support depending on the future performance and the estimated working capital cycle and gap is important, failing which the startup would face perennial liquidity crunch.
Startups in the business to business market segment run the risk of over dependency on handful of customers. The principles of early adopters are important while entering the market. However timely de-risking by building a balanced portfolio of customers would help the startups in many ways. Should there be a liquidity issue with the large customers, it would directly impact on the startups; negotiation power weakens in case of over dependency on few large customers. Choosing the right target customer as part of the marketing and sales process also helps reduce the financial risk of the startup.
Startups in the product domain face a unique challenge of pricing the product for its benefits and add-on services towards product performance during the life time value of the product. Add on services such as warranties, replacement of critical components are committed during the sales process with an objective to onboard the customer. Factoring the probable cost which may be incurred in the eventuality of such instances is underestimated, thus leading to higher cost of acquisition of the customers. This in turn leads to higher burn rate and liquidity crisis of the startups. Pricing strategy after taking into consideration the life time value of the product, results of the pilots, and feedback of early adopters when the startup is mounting the growth trajectory minimizes the financial risk.
The above are a few instances to show case the critical areas startups tend to overlook or ignore in the zeal to commercialize the product/ solution. Every critical decision or strategy would require an assessment of risk from financial perspective, which in turn would have a significant impact on the reputation of the startup and the founders. Risk cannot be avoided given the volatility in the business environment today however; risks can always be managed in time by evaluating the pros and cons in a structured manner. Startup founders have access to network capital through various platforms wherein domain experts for various domains available. Hence, it is for the founders of the startups to encash on the opportunities for getting the right guidance/mentorship from the network capital. A culture of managing risks at every stage of the business in a timely and effective manner is basic hygiene factor which every startup founder should adopt and infuse as part of the systems and processes of the business.