Financial & legal work in a startup
This article is part of a series about how to manage a small software start-up, the first article & overview is found here.
Financial Planning
Many creative people have a profoundly ingrained distaste for most financial matters. If you build a company, though, there are some basics you have to get familiar with. You should be on top of all company finances at least once a month — I strongly recommend not outsourcing this completely.
Before even founding a company, you should inform yourself about the laws and regulations in your industry. You need to be aware that even when you found a limited liability company, the board can be personally liable in some circumstances. In Switzerland, the rules include:
- Obligation to keep proper accounting records up-to-date (balance sheet & income statement)
- Reporting obligation in the event of justified concern of overindebtedness
- Board of directors and management can be held personally liable for outstanding social security contributions (see this)
So it really is paramount to always check your financial situation and pull the plug in due time if you are unsure how to get more cash into the company.
When I search for financial planning, I mostly find information & tools about financial modeling (e.g. EY’s finance navigator), which is about estimating the economic viability of a company, project, or strategic initiative.
I agree that it is essential to understand the potential of an idea before putting your life savings in it. But I think it is even more paramount to know your liquidity in the coming months and being able to pay the bills instead of only guestimating your potential millionaire status in five years.
Therefore, I find the most important aspects of financial planning accounting, knowing what your assets are, and financial forecasting, knowing how long you will survive. This should be one of the top priorities; 29% of startups fail because they run out of cash (CB Insight).
Accounting
The first activity in accounting is to find a good accountant that you can work closely together and that you can really trust — don’t settle with sub-par service. We started with an accounting firm with its own platform where you could never see the current status of your finances. They also were unresponsive and even made several mistakes when handling simple tax filings of our employees.
Frustrated, I looked into modern accounting software, found Bexio (for Switzerland), and searched explicitly for accountants working with this software. I contacted Salman from Knefi and can’t recommend him enough. I think he set a good standard of what you should expect from your work relationship with an accountant:
- Always available over slack, phone, mail
- Sending receipts and invoices digitally (also via app)
- Automatic integration with bank data
- Constant up to date bookings on Bexio
- Monthly finalization & review of all numbers
When reviewing the numbers, get intimately familiar with the balance sheets and income statements. The two most essential items are cash in the bank account and equity, which is simply the cash plus all promises minus debt — I figured out far too late to review this number regularly. Equity is actually more critical than cash as you can also get cash from your invoices (check e.g. Advanon or Capchase).
Financial Forecasting
The most interesting aspect for me on financial forecasting was how few good tools there are in this space. Luckily though, there are more and more tools being built to facilitate small companies’ financial forecasting.
When we analyzed several tools, we chose Brixx as the best choice at the time as it was simple to use and didn’t need a Xero integration (even though it has one). If you use one of the major tools (Xero, Quickbooks, or FreeAgent), you might consider Float instead.
Most investors we talked to were impressed at the visuals and how easily we could show different scenarios; even though you would think this should be standard in the industry — it isn’t.
Scenarios that should be run through a financial calculation are, for example:
- Can you afford this new hire?
- What happens when you don’t sell an anticipated project?
- Can you afford a bigger office?
- How much money do we need to have a 6 months runway?
To keep the financial forecast up-to-date, the last month should continually be updated with the accounting numbers, and the sales pipeline should inform future cash positions.
For your own psychological well-being, be aware that your forecast will almost always be off; especially regarding liquidity, many clients might not pay their invoices in time, for example.
Transparency on Financials
As mentioned in the introductory article, one of our core values was “radical transparency,” which naturally included the company’s financial health.
The big worry about sharing the financials is that it will make employees worry and eventually leave if the numbers don’t look too great. But in reality, people will wonder anyhow about the company’s financial health and will feel more empowered by the truth and might come up with creative ideas to move the needle.
Interestingly, I found this topic much more delicate than being open about salaries, for example. You need to show your best communication skills and be very conscious of what you talk about in what way:
- All employees need to be educated about basic financial reporting to understand what they are seeing.
- When showing different scenarios, you need to walk the fine line between paranoia and optimism. I suggest always spreading optimism as much as possible.
- Especially in the starting phases, you might always be 2–3 months away from bankruptcy. Even though I wouldn’t hide this fact, I think it’s important not to outsource your worries to your employees — that’s not what they signed up for! Instead, show the way out.
Some companies, like Buffer, are openly transparent about their finances — I see this as more risky than beneficial in the starting phases and would aim for “only” internal transparency.
Legal Work
Just like financial management, most people underestimate the importance of legal work and outsource everything to a lawyer. Not understanding the basics will lead to frustration and a lot of time & money wasted, so it is a good idea to read a tailored book such as this guide before you sign contracts you don’t understand or pay for services that don’t matter.
After you understand the basics, I would encourage you to create draft documents yourself; in Switzerland, Wenger & Vieli has some starting templates. Even if your draft will be complete garbage from a lawyer’s point of view, you can already discuss the first high-level requirements of a contract with your stakeholders before involving a lawyer. Otherwise, you pay too much for a lawyer, just clocking time for a discussion you could and should have had before.
Try to avoid legal work as much as possible, in my opinion: As a software company doesn’t need patents, and simple documents such as NDAs and employee contracts can be created from public templates.
Some contracts, as for example a shareholder’s agreement, need more thoughts, of course. But even if you pay good money to craft well-thought-out contracts, don’t believe that they will stand the test of time; my unintuitive advice is not to plan ahead too much. With every new growth phase and new investors coming in, you will have to change these agreements anyway.
What’s important to understand about contracts is that they are only meant for the absolute worst case. When good business partners were chosen, the involved parties should be able to agree on a compromise in many scenarios without even following the agreements if they don’t fit the situation.
In the next and final article, I will finalize the series and reflect on my overall experience of founding a company.
