Free-spending startups can die in one of two ways: either cancer or heart attack
In a recent newsletter, I talked about how misinterpreting audience metrics can mislead digital news publishers into developing ineffective business models.
Another common mistake made by digital media entrepreneurs can have catastrophic consequences: it’s to lose track of cash flow and profitability. Many entrepreneurs have no idea what those terms mean or how to apply them.
Cash flow is the measure of how much you are spending vs. how much money you are bringing in each month or year. Cash flow tells you how fast you are burning the fuel (money) you have in the tank, and how fast you are replacing what you have burned.
And profit is simply your revenues (sometimes called “income” or “turnover”) minus your expenses. If the result is positive, you made a profit; if it’s negative, you had a loss, and you might need to take action so that losses don’t become a trend.
Depending on the type of media business you’re running, you might want to measure cash flow over a month, a quarter, or a year. But you should measure it.
If you are accumulating debt and not generating enough cash to pay it off, you’re setting yourself up for the financial equivalent of a heart attack. And if you are not monitoring cash flow, you might not see it coming.
The lenders who happily extended credit to you because of your brilliant sales pitch eventually may tire of your excuses when you miss several debt payments. They might demand 100% of the loan immediately, which often leads to bankruptcy or even liquidation — heart attack.
Burning the cash
Another form of financing that can be both a blessing and a trap is the sale of shares to outside investors. A startup promises investors that a cash infusion will help them generate growth and big profits. So, the investors put in their money in hopes that they will see dividends and an increase in the value of their shares.
But if the startup slowly burns its pile of cash without showing any profit or attracting any buyers of the shares, it drains the fuel of the organization. Eventually, the cash runs out. There is no more fuel in the tank, and the investors decide to cut their losses. They walk away from their investment, and close the doors — death by cancer.
If those investors were your family and friends, you might have a big personal problem — no invitations to Christmas dinner. But for most sophisticated investors, these kinds of losses are part of the deal. They expect 80 percent of their investments to fail.
Market validation
One of these sophisticated investors is Francisco Coronel, co-founder and managing partner of NXTPlabs in Buenos Aires, Argentina. A few years ago, NXTPlabs invested in some digital news startups based in Latin America and offered them several weeks of training in how to develop their business models. (I was one of their trainers.)
The reason so many startups fall into “Death Valley”, Coronel explained, is basically for one of two reasons: either they haven’t figured out how to generate cash from their businesss idea, or it costs too much to convert a potential client into a paying customer.
Coronel is the one who gave me the metaphor of cancer or heart attack for a business’s failure. He explains it in a 2-minute video, with English subtitles (below).
Final thoughts
Over the past decade, I’ve worked with dozens of startup news organizations and done research on many more. Their founders, as a group, have an irresistible charm and optimism. They believe so passionately in the work they are doing. They desperately want to serve their communities with trustworthy information.
So it is heartbreaking to see them fail. Many times these journalists simply don’t know how to measure how much fuel is left in the tank — measuring cash flow.
I believe that some of these business failures could be avoided with some training early on. I’ve written a simple accounting guide, with a budget template, that might help beginners. Better yet, get professional help. If you can’t afford a full-time accountant, find an experienced bookkeeper to help you keep track of your business’s results.
I’ve been working with a team to provide a more extensive accounting guide for journalists in English and Spanish, and when it’s available, I will update it in this space. In the meantime, take a look at the resources below:
Freshbooks: Accounting for Entrepreneurs: A Financial Survival Guide for Small Businesses
New York Times: Basics of Accounting Are Vital to Survival for Entrepreneurs
University of West Florida: Entrepreneurs Need to Know Accounting