Importance of financial literacy for startups
By Jānis Zēgners, Freelance CFO @ Zegners FinPlan
After entering the world of startups a year ago and recently attending Deep Tech Atelier and TechChill, along with numerous discussions with startup ecosystem players, I believe that now is a good time for reflection.
In October 2022, I was interviewed by Lelde Benke from Labs of Latvia who asked me about my observations on Latvia’s startup scene. At the time, I mainly spoke about the atmosphere within the scene. However, after reflecting on the topic for the past six months, I would like to add another observation: there is a need to improve financial literacy among startups.
Multiple surveys indicate that running out of cash and fundraising issues are among the top reasons why startups fail. According to a survey conducted by CB Insights, it is the top reason, with pricing & costs issues also being a significant factor.
Study “The Top 12 Reasons Startups Fail”, by CB Insights
Why do new entrepreneurs continue to ignore this “warning” and still ask me about the added value of financial literacy and financial planning?
Entrepreneurs know everything about their products/services but also spend a lot of time learning everything about sales & marketing. This is understandable to a large extent.
But make no mistake: You won't succeed in the medium- or long-term without taking care of business fundamentals, including support functions like HR (e.g. hiring the right people at the right time) and finance (e.g., optimising your cash flow and performance).
How does financial literacy help your startup?
Product vs business roadmap
Many startups highly focus on creating a product roadmap. But why do so few believe that there´s no need for a financial and business roadmap? Without a clear financial and business roadmap, even a great product or business idea may struggle in the long run, as demonstrated by many startups experiencing issues with commercialisation, like Quirky.
Gut-feeling vs data-driven decision-making
Several young entrepreneurs have admitted to me they do not take advantage of financial data in their decision-making, even after 1-2 years in their business activity and after investing thousands of euros into their business. They have been making decisions based on their “gut feelings” rather than data. This reminds me of a case study performed by Ranjay Gulati and Alicia DeSantola published in the Harvard Business Review ("Start-Ups That Last: How to scale your business", March 2016): The authors describe the act of improvising without proper planning and forecasting as "aimless riffling".
Pricing: Most pricing strategies are mainly based on external factors such as competitor pricing and customer demand. However, do you know if your pricing is sufficient to cover your costs? How many units or subscriptions do you need to sell to start earning profits (i.e. what is your break-even point)?
Variable costs vs fixed costs: I´ve noticed that many founders are only considering variable costs when calculating their break-even points. There are many opinions that fixed costs should not impact your pricing. Ideally, your goal is to reach a sales volume (with pricing solely considering variable costs) to cover all costs. But what if you have already started your business? You´ll have to find a way to set your pricing and reach a certain sales volume to cover all costs to build a sustainable and profitable business.
These examples clearly show how essential knowledge and data of your cost structure can be.
Reactive vs proactive management style
A financial plan (or operational plan) helps you to anticipate both risks and opportunities. With this information, startup founders can take proactive measures to address potential issues before they become problematic and expensive (and thus reduce your runway). If a business is constantly in firefighting mode, it risks losing sight of its larger strategic objective.
SaaS vs Deep Tech/Hardware business models
Most articles and experts who offer advice on building successful startups tend to focus on SaaS businesses without mentioning it specifically. This creates an illusion that every startup should be run like SaaS startups.
Deep tech and hardware startups are different to SaaS startups in many ways.
Deep tech or hardware startups require significant R&D investment and have longer product development and commercialisation cycles. SaaS startups, on the other hand, require less initial capital investment and have a higher potential for scalability.
Luckily, this issue was one of the top focus areas at Deep Tech Atelier this year.
However, I would like to see a higher focus on working capital requirements:
Let's assume you´re signing a big contract and expecting a very high profit. Great, right? But what if it requires significant investments into materials and your workforce? The period between paying suppliers, building products, shipping to customers and finally receiving payments can be very lengthy. As a result, it's important to ensure your sufficient cash reserves to cover this “funding gap”. Unfortunately, the level of cash that is “trapped” in production cycles tends to increase during growth phases.
Understanding your investors
Do you know the famous poker phrase "Don't play the odds, play the man”? A good understanding of the needs and motivations of investors will improve your chances to attract funding. Venture capitalists have their business models which require earning enough gains for their capital providers (i.e. limited partners or “LPs”).
Additionally, your business model and key challenges to scaling should not only drive your funding requirements but also who to raise from. Perhaps there are better ways to finance a high level of working capital than giving up equity (consider government grants or export financing loans).
As you can see, there are multiple benefits of having a high financial literacy.
A great leader should always look at every aspect of the business and have the courage to deal with uncomfortable topics.
I´ve noticed several positive signs of rising awareness of the importance of financial literacy. Not only are the Latvian Central Bank and other financial organisations holding annual “financial literacy weeks”, but “financial wellbeing” was also one of the topics discussed at this year´s Novatore summit (a female empowerment movement).
Furthermore, I'm extremely happy that financial planning is “among the most in-demand topics that Latvian startups would like to master”, according to an annual survey conducted by the Latvian startup association Startin.lv.
What startups want (Startin.LV members survey results, 2023).
If you have any questions or would like to discuss how to take your finances to the next level, please feel free to contact me: