Adapting to a world with higher interest rates — a guide for startups
Startups have more things to worry about than they have time — product-market fit, whether to invest in performance marketing or not, how much inventory is too much inventory, whether to hire that staff engineer from Google, just to name a few from a list that usually runs longer than the most well-funded startup’s runway.
One thing that rarely makes this list is thinking about the balance sheet. After all, no great company was founded on the bedrock of capital efficiency. And CFOs have better things to think about (see monthly burn and runway). Does it really matter if working capital is efficient? If the startup is running a positive cash conversion cycle? If it’s capturing market yields?
For a young, pre-product-market-fit company, the answer has always been, and remains, no. Focus on product-market fit. Make customers want what you have to sell. Make them rip if off the shelves. Once you get the formula right, you can worry about capital efficiency. Until then, conserve burn, extend runway, and try to hit the witchcraft of product-market fit.
Make customers want what you have to sell. Once you get the formula right, you can worry about capital efficiency.
For a scaling company in 2020 and 2021, the answer was, “It’s doesn’t really matter.” Risk-free yields were at less than 50 bp (a bp, pronounced “bip,” is 1/100th of a percent; 50 bp is 0.5%). Why bother? So you run a bit more efficient and make a few thousands of dollars/pounds/euros. That’s one kit for a new engineering hire. Gone in a heartbeat.
For a scaling company, in Q4 2023, the answer is a strong yes. Why? Two reasons:
- You have meaningful capital at hand. Your raise probably wasn’t $5 million. Your balance sheet runs past the seventh digit.
- No matter where in the world you are, your local federal bank (whether the fed in the U.S., the BoE in the U.K. or the ECB in the EU) is paying you for capital efficiency.
These things add up, and every bit helps. Running 5% more performance ads sounds good, doesn’t it — and you can do that without taking additional risks. It is now valuable to have capital and to deploy that capital to risk-free (remember, you’re not a hedge fund), government backed securities that yield 3% to 6%.
Do this well, and you’ll make money for nothing. In fact, you’re probably doing this in your personal lives (you marvel at the nonzero “interest” that hits your bank account every month) — why not do this for your company as well?
How should the star VP finance/CFO best do this? Here are few levers to pull today.
Squeeze your working capital in your favor
Working capital is (simplistically) the money you need to sustain short-term imbalances in the flow of cash. You sell a product for $1,000 but aren’t paid for 90 days. However, the bill for a $1,000 laptop you bought is due today. Guess what, you need to “use up” $1,000 of working capital to cover the 90 days before you even out.