Tech companies, with their fast-paced innovation and scaling ambitions, are not immune to the financial ebbs and flows that can cripple any business. When it comes to managing cash flow, the stakes are high, and the challenges are unique to this high-growth industry.
Common Cash Flow Issues for Tech Companies
According to the latest business data and reports curated by Exploding Topics, 90 percent of startups fail. Pretty encouraging, right?
Across basically all industries, the average failure rate for year one is 10 percent – meaning one out of every 10 businesses is no longer open 12 months after launch. That number skyrockets in years two through five when 70 percent of all new businesses will close up shop.
While you can’t look at all businesses in a vacuum, studying the trends is interesting. For example, first-time startup founders have a success rate of just 18 percent. But if there’s one statistic that stands out as a universal truth for tech companies, it’s this: 16 percent of all businesses fail due to cash flow problems.
Cash flow problems are the number one cause of failure outside of poor product-market fit and incorrect marketing strategies.
“Cash flow problems contribute significantly to the business failure rate in the United States,” Exploding Topics explains. “Most entrepreneurs who launch with insufficient funding, product or service prices that are not market-related, or optimistic sales projections end up with a failing startup.”
Tech companies are known for their fast-paced innovation and desire to scale past all issues and restraints ambitiously. However they often find themselves victimized by costly cash flow issues. Here are some of the big challenges:
Tech companies thrive on innovation, and R&D is at the core of their operations. However, pursuing cutting-edge technologies and product development can be a double-edged sword. While R&D is essential for staying competitive, it can strain a company’s cash flow due to its high costs. This includes expenses related to hiring top talent, procuring equipment, and conducting experiments. Without the proper prioritization and allocation of the R&D budget, things can go sideways quickly.
As most tech companies scale, there’s a need to hire more employees to support the growth that’s happening. This is great, but it’s also a gamble. Hiring too quickly can lead to massive overhead and HR expenses. If sales slow down, management is left holding an expensive bag with nowhere to go.
Combine all of the rapid growth with irregular revenue and things get sticky in a hurry. Tech companies often rely on the launch of new products or updates to generate revenue. This dependency on product release cycles can lead to irregular cash flow patterns. During the development phase, cash may be pouring into R&D and marketing, causing temporary imbalances in the company’s cash flow.
The big trend for tech companies is to offer subscription-based products that deliver consistent and predictable recurring revenue. While this is nice in theory – and can be highly profitable once the business steadies – many companies fail to account for high churn rates. This is especially problematic when businesses use free and discounted trials to bring customers in the door. They might feel like they’re scaling rapidly, only to see 40 to 50 percent of these new users walk out the door within 30-60 days.
When you combine rapid growth with irregular revenue streams, it’s often like having a ticking time bomb beneath the surface of your business. Things might work well for a while, but it’s unsustainable. Eventually, something breaks. And that’s precisely why something must be done to counteract the underlying issues and improve cash flow…sooner rather than later.
5 Strategies for Dealing With Cash Flow Issues
If your company is struggling through cash flow issues, it’s essential that you don’t just sit back and hope things get better. Top tech companies – the ones that scale and thrive – implement proactive strategies for dealing with these underlying issues. Let’s explore a few of the top options you have available to you.
1. Optimize R&D Expenditures
To maintain a competitive edge in your company, you must invest in research and development. But as discussed above, investing too heavily in R&D can knock your cash flow and balance sheet out of whack.
One effective approach is to become more strategic by prioritizing critical projects that will deliver an immediate ROI. This ultimately boosts your cash flow and gives you more resources to focus on in the long-term ROI projects down the road.
Additionally, consider streamlining R&D processes to reduce costs and speed up the time-to-market. This may involve implementing agile methodologies or fostering cross-functional collaboration.
2. Master Customer Billing Cycles
As previously mentioned, many tech companies operate with subscription business models. The benefits of this are clearly documented – and you likely already know what they are – but the challenges are less commonly discussed. If you want to operate on a predominantly subscription-based model, that’s totally fine. (Many successful tech companies do.) You just need to have a plan for mastering customer billing cycles to have a more predictable cash flow.
One option is to implement tiered pricing models, which can help attract a wider range of customers and provide a steady stream of income. By offering different pricing tiers with varying features and services, tech companies can cater to cost-conscious customers and those seeking premium offerings.
Leveraging automated invoicing and payment systems is another crucial step. Automation reduces the risk of late or missed payments, improves billing accuracy, and frees up resources that would otherwise be spent on manual billing processes.
3. Form Strategic Partnerships
Have you ever considered building out strategic partnerships or collaborations with other tech companies? Assuming they aren’t direct competitors, this can open up new revenue and cost savings avenues.
Consider how entering into a joint venture or revenue-sharing agreement with a partner could complement some of your existing offerings. It could also open you up to entirely new customer bases, which paves the way for more customer onboarding and cash flow.
The key is to identify the right partners. This usually means finding:
- Companies that sell complementary products or services
- Companies that are not direct competitors
- Companies that serve a niche or segment of the marketplace that you don’t currently have access to
- Companies that can help you achieve lower expenses in certain areas
Now, it’s obviously not all about you. The other company is also going to want to find reasons to partner with you. That being said, it can take a lot of effort and due diligence to find the right partnership. However, once you do, it can instantly alleviate a lot of cash flow pressure.
4. Look to External Funding Options
In cases where internal cash flow is insufficient to support growth initiatives, tech companies can explore external funding options. These include seeking venture capital, angel investors, or crowdfunding.
Venture capital firms and angel investors often provide funding in exchange for equity, allowing tech companies to secure the capital needed for expansion. Conversely, crowdfunding involves raising funds from many individual investors or backers through online platforms.
If you do go down this route, carefully consider the terms and conditions of the funding source to ensure that it actually aligns with your company’s long-term goals and isn’t just a short-term stopgap.
5. Consider Chapter 13 Bankruptcy
Nobody wants to think about bankruptcy. However, if your cash flow issues are severe enough, it’s something to at least consider. And despite what most people think, it doesn’t necessarily spell the end of your business. In a lot of cases, it provides the relief you need to move on. It’s kind of like hitting the “reset” button.
“I like to think of Chapter 13 bankruptcy as a ‘pay what you can afford’ approach to dealing with overwhelming debt,” attorney Rowdy G. Williams explains. “It can be an uncomfortable 36 to 60 months, but there’s immense relief on the back end.”
Unlike other forms of bankruptcy, Chapter 13 gives you options for keeping your business. You basically spend three to five years paying what you can on your taxes and debts. (These debts usually come with a zero percent interest attached to them.) After that, you’re relieved from the responsibility to pay any remaining balance on certain types of debt.
With Chapter 13, you give yourself time and allow you to keep valuable business assets. While it’s not the perfect option in every instance, it’s often the best choice for tech companies and founders who can’t escape cash flow issues using other methods.
Put Your Business on the Fast Track for Success
There’s no perfect formula for success. Every tech company faces unique cash flow problems and circumstances. However, if you’re willing to lean in, understand the problems, and tackle each issue with proactive strategies proven to work, you’re much more likely to succeed. Hopefully, this article has given you some ideas and food for thought. Now, it’s up to you to get out and execute.
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