No Accounting For Startups

Startups that are searching for a business model need to keep score differently than large companies that are executing a known business model.

Yet most entrepreneurs and their VC’s make startups use financial models and spreadsheets that actually hinder their success.

Here’s why.

Managing the Business
When I ran my startups our venture investors scheduled board meetings each month for the first year or two, going to every six weeks a bit later, and then moving to quarterly after we found a profitable business model.

One of the ways our VC’s kept track of our progress was by taking a monthly look at three financial documents: Income Statement, Balance Sheet and Cash Flow Statement.

If I knew what I knew now, I never would have let that happen.  These financial documents were worse than useless for helping us understand how well we were (or weren’t) doing.  They were an indicator of “I went to business school but don’t really know what to tell you to measure so I’ll have you do these.”

To be clear – Income Statements, Balance Sheets and Cash Flow Statements are really important at two points in your startup.  First, when you pitch your idea to VC’s, you need a financial model showing VC’s what your company will look like after you are no longer a startup and you’re executing the profitable model you’ve found.  If this sounds like you’re guessing – you’re right – you are.  But don’t dismiss the exercise.  Putting together a financial model and having the founders understand the interrelationships of the variables that can make or break a business is a worthwhile exercise.

The second time you’ll need to know about Income Statements, Balance Sheets and Cash Flow Statements is after you’ve found your repeatable and profitable business model.  You’ll then use these documents to run your business and monitor your company’s financial health as you execute your business model.

The problem is that using Income Statement, Balance Sheets and Cash Flow Statements any other time, particularly in a startup board meeting, has the founding team focused on the wrong numbers.  I had been confused for years why I had to update an income statement each board meeting that said zero for 18 months before we had any revenue.

But What Does a Business Model Have to Do With Accounting in My Startup?
A startup is a search for a repeatable and scalable business model.  As a founder you are testing a series of hypotheses about all the pieces of the business model: Who are the customers/users? What’s the distribution channel? How do we price and position the product? How do we create end user demand? Who are our partners? Where/how do we build the product? How do we finance the company, etc.

An early indication that you’ve found the right business model is when you believe the cost of getting customers will be less than the revenues the customers will generate. For web startups, this is when the cost of customer acquisition is less than the lifetime value of that customer.  For biotech startups, it’s when the cost of the R&D required to find and clinically test a drug is less than the market demand for that drug.  These measures are vastly different from those captured in balance sheets and income statements especially in the near term.

What should you be talking about in your board meeting? If you are following Customer Development, the answer is easy.  Board meetings are about measuring progress measured against the hypotheses in Customer Discovery and Validation. Do the metrics show that the business model you’re creating will support the company you’re trying to become?

Startup Metrics
Startups need different metrics than large companies.  They need metrics to tell how well the search for the business model is going, and whether at the end of that search is the business model you picked worth scaling into a company. Or is it time to pivot and look for a different business model?

Essentially startups need to “instrument” all parts of their business model to measure how well their hypotheses in Customer Discovery and Validation are faring in the real world.

For example, at a minimum, a web based startup needs to understand the Customer Lifecycle, Customer Acquisition Cost, Marketing Cost, Viral Coefficient, Customer Lifetime Value, etc.  Dave McClure’s AARRR Model is one illustration of the web sales pipeline.

At a web startup, our board meetings were discussions of the real world results of testing our hypotheses from Customer Discovery.  We had made some guesses about the customer pipeline and now we had a live web site.  So we put together a spreadsheet that tracked these actual customer numbers every month.  Every month we reported to our board progress on registrations, activations, retained users, etc. They looked like this:

User Base

  • Registrations (Customers who completed the registration process during the month)
  • Activations (Customers who had activity 3 to 10 days after they registered.  Measures only customers that registered during that month)
  • Activation/Registrations %
  • Retained 30+ Days
  • Retained 30+/ Total Actives %
  • Retained 90+ Days
  • Retained 90+/Total Actives %
  • Paying Customers (How many customers made $ purchases that month)
  • Paying/(Activations + Retained 30+)

Financials

  • Revenue
  • Contribution Margin

Cash

  • Burn Rate
  • Months of cash left

Customer Acquisition

  • Cost Per Acquisition Paid
  • Cost Per Acquisition Net
  • Advertising Expenses
  • Viral Acquisition Ratio

Web Metrics

  • Total Unique Visitors
  • Total Page Views
  • Total Visits
  • PV/visit

A startup selling via a direct sales force will want to understand: average order size, Customer Lifetime Value, average time to first order, average time to follow-on orders, revenue per sales person, time to salesperson becomes effective.

Regardless of your type of business model you should be tracking cash burn rate, months of cash left, time to cash flow breakeven.

Tell Them No
If you have venture investors, work with them to agree what metrics matter.  What numbers are life and death for the success of your startup?  (These numbers ought to be the hypotheses you’re testing in Customer Discovery and Validation.) Agree that these will be the numbers that you’ll talk about in your board meeting.  Agree that there will come times that the numbers show that the business model you picked is not worth scaling into a company. Then you’ll all agree it’s time to pivot and look for a different business model.

You’ll all feel like you’re focused on what’s important.

Lessons Learned

  • Large companies need financial tools to monitor how well they are executing a known business model.
  • Income Statements, Balance Sheets and Cash Flow Statements are good large company financial monitoring tools.
  • Startups need metrics to monitor how well their search for a business model is going.
  • Startups need metrics to evaluate wither the business model you picked is worth scaling into a company.
  • Using large company financial tools to measure startup progress is like giving the SAT to a first grader.  It may measure something in the future but can only result in frustration and confusion now.

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44 Responses

  1. Thanks Steve, really excited about reaching this business stage. We’re working on traction/utlility and enjoyment of visits for Victus Media. Will keep the macro business scale of our endeavors in mind as we lock in to a sweet spot in the real time sematic information chain.

  2. Hi Steve,
    Thanks for a great post!
    What is the average time for customer validation?
    When I should know that something is wrong in my hypotheses ?

    Thanks

  3. Hi Steve,

    I bought your book a couple of weeks ago. It is the best book about software entrepreneurship I have read so far!

    I have a question about the Customer Validation step, but I’m not sure where to post it. When I validate my assumptions by selling to a few customers, I promise to deliver the product to them at some date. Now, let’s say that only 1 customer buys it and it becomes clear that the others do not buy it for some reason that requires me to go back to Customer Discovery. What should I do with the single customer I promised to build a product for that failed the validation step?

    Should I somehow make sure that the customers I try to sell know that we will only build the product if we manage to validate the idea (by selling to 5)? Or is this a risk we just have to live with? Of course, we can try to see if the customer would like the new product instead, but this is not certain.

    • Hey Frans, I would love to know the same thing. As I’ve been reading through the startup world I wondered the same thing. How do you “sell” your product, but then “unsell” it if you can’t deliver, or it doesn’t turn out to be profitable to keep going in that direction?

    • My guess is that the best solution is to keep the product very loosely specified and let the customers know that things might change and if they change, the customers who paid for the old version get their money back if they don’t want the new product anymore. Does this sound like a good idea? But doesn’t this make it much harder to close the deals (You pay us $50000, you may get the full version of the product in 18 months, but if we decide not to build it, you get your money back)

  4. Excellent read… Very true.

  5. I would say your post is really good as and AND rather than an Alternative standpoint. Traditional financial statements

    Yes, traditional accounting in it’s current state doesn’t provide good OPERATIONAL data but it is still essential for at least a minimum of 3 reasons.

    1: If you’re a Corp, you are required to maintain accounting records.
    2: It is very expensive for businesses to recreate the necessary accounting data at a later time for – for example tax returns.
    3: The balance sheet maintains balances for your physical resources (bank accounts) and keeps track of resource/obligation ratios.

  6. Steve, another great post on startup finance!

    First, a question– have you found any good sources of data for benchmarking the User Base metrics? I realize it’s going to differ widely depending on the type of business (e.g. LinkedIn would be very different from Facebook which would be different from Zynga, etc.) but even a few good data sets would be useful to know if we’re “in the ballpark.” At present, we mostly rely on experience with similar, previous startups or occasionally, with some input from investors (who are seeing multiple businesses in the space).

    Second, a suggestion– one way we try to have our cake and eat it too– aka link the Startup Accounting with Traditional Accounting– is to build the model by starting with a dashboard for the User Base metrics (registrations, activations, upsells, viral leads). This feeds into a revenue buildup sheet, which then feeds the traditional income statement, CF, and B/S. Then, we create a sheet that breaks the income statement into per-unit economics: ARPU, cost-to-acquire, etc.

    It makes for a nice input –> processing –> output data cycle. It is also a way to visually show where the revenue and cost lines cross, i.e. where we start to make a profit on each user or customer (which ultimately is what gets investors excited to pour more fuel on the fire), and where the ‘search for business model’ crosses over into ‘execution of the business model.’

    Awesome stuff, what’s next in this series? Waiting with bated breath. Nathan Beckord

  7. [...] financial tools to measure start-up progress is like giving the SAT to a first grader,” writes Steve Blank. “It may measure something in the future but can only result in frustration and [...]

  8. [...] Accounting For Startups By Joachim Blazer No Accounting For Startups by Steve [...]

  9. I think the common reason for this wrong focus on wrong numbers is background of too many VCs. Those who come from investment banking, law or management consulting often have no frame of reference other than financials of a mature company.

    Avoid VCs with wrong background if you can.

  10. nice post Steve. I believe strongly in the need to go through the exercise of building a financial model (can focus mind and expose hidden assumptions and flaws), and agree that the focus should not be on formal financial documents or even on the resulting numbers themselves (that is, until you are up and running and have real numbers). A startup’s initial model becomes an iterative living document to track progress, and thus should be using key metrics that are important to the business and that you’ll actually track. No one benefits by over-complicating any of this.

  11. This is one of the best posts I’ve read on startup finances.

    I was excited to put my startup’s first financial model together. I spent a few days filling in templates that I had from B-School. A few weeks later I realized how complex this process was. I eventually put what I think was a good model together, but it was far more complex than I had been prepared for, I was left feeling like I wasted a lot of time.

    I was frustrated that I had to do this when I fully realized that all my numbers were guesses. As our model evolved, and we eventually started working with advisors who had CFO level experience with startups in our space, I could really feel not just our financial model, but our entire business model strengthening.

    Putting together a full financial model forces a small startup, often run by people with little business experience, to think through every detail, hirings, capital purchases, sales cycles…

    The financial model is a living breathing model that reflect your best intentions for your business. It will never be right when you have little history to base it on, but it’s all part of the process to vet new businesses, and test various business models.

    For entrepreneurs with little background in creating these models, I strongly suggest finding an advisor with experience. Getting feedback along the way helps you create a more complete model, but also, like everything in the startup world, helps alleviate some frustration from a new process that can take weeks and months the first time an entrepreneur tackles it.

  12. There is a small typo in Lessons Learned: “whither”
    I enjoyed the article :)

  13. This is great insight. There is a huge disconnect between reality and conjecture that’s often lost in a startup.

    The problem with “pivoting” is that it instantly implies that some assumptions were wrong up to that point; and when the walls start crumbling the whole supporting set of assumptions could create a total implosion. Even without a full implosion, when key assumptions fail, you are in a rescue mode to try to find assets to leverage and it tends to get super ugly figuring out what to jettison.

    Arguably this is why the VC model fails. It’s better to start with MULTIPLE SCENARIOS, instead of having one “be all, end all” and attempting to “pivot.” That argues for a CEO with the majority equity and enough liability to take the risks and know the options … not a room full of finance guys who believed bad assumptions guiding the person that fed them the bad assumptions.

  14. [...] love this post at Steve Blank’s blog and wish I though of it: No Accounting For Startups His hypothesis is that you need set expectation with VC’s about the model so you can make [...]

  15. I have a bit of trouble with your defining a startup as “a search for a repeatable and scalable business model”. While a few entrepeneurs have managed to make successful companies this way, they are the exception, rather than the rule.

    Normally, a startup company has (or will have) chosen and will be following a thoroughly hashed-out business plan and credible revenue model before they hire their first employee.

  16. An extremely stimulating article. Let the search for scalability continue!

  17. Would you be skeptical about a team who pitched, for the first time, a non-traditional model, but proved its validity? If I’m sure my audience understands (because its an investor who has created a similar startup) the uselessness of traditional corporate models, why not just be blunt about it and portray the facts on your own accord?

  18. [...] No Accounting for Startups — This piece focuses on accounting for startups and how entrepreneurs can get obsessed (or pushed to obsessing over) data that isn’t really relevant for a brand new idea and company.  I love how Steve says that a startup is really just testing a series of hypotheses and you should do the same with your most important metrics.  I know that when we launched our company, it was fundamentally very different than the company that we have become.  It’s all about flexibility and obsessing over metrics that are meant for mature companies that have already been tested will simply lead to the rigidity than can kill a startup. [...]

  19. Hi Steve,

    Thanks very much for a very informative article. It’s already generated a lot of useful discussions for us.

    I had a question though – it seems that most Technology startups would have very high fixed costs (wages/rent/utilities/server/internet/etc), but very low variable costs. Especially for the SaaS model.

    In that context, would you be able to provide a bit of insight as to how the Contribution Margin is helpful as a startup metric?

    Thank you very much for your time and help,

    Jason

  20. A very interesting post – thanks! Totally agree that financial statements are not the best approach when it comes to monthly monitoring of a startup. I do believe in the necessity of having initial income statements and cash flow statements. If nothing else, it helps the startup think through their business plan – both strategic and operational. Thereafter when it comes to regular monitoring, it would have to be more tactical measurement and monitoring parameters. Have elaborated in it in a post: http://www.seedcatalyst.com/joomla/blog/blog

  21. steve,

    I absolutely agree that a startup should focus on core actionable metrics around its conversion rates and per user economics. Unfortunately, however, continuing to produce GAAP financials will be a requirement – especially for any funded startups. I don’t know any investor / board member who spends a lot of time on them. But you still need to deliver them.

    Mark

  22. [...] financial tools to measure start-up progress is like giving the SAT to a first grader,” writes Steve Blank. “It may measure something in the future but can only result in frustration and [...]

  23. Amazing post, Steve!

    As an VC, I’ve seen companies almost die due to the excess concentration of their entrepreneurs in “getting the numbers ready” month after month instead of focusing on what’s important: growing their business.

    As an Entrepreneur, I suffered seeing how my time was monthly wasted in putting the financial figures together, loosing precious time that could be used in what is important: growing my business.

    Why do this happen?

    – Most VCs are financially-trained and learn to asses the company’s situation through the numbers.
    – All VCs are afraid of loosing control over their investments, therefore having neat monthly financial figures let them have a sense of control over their investment.

    And if you add that:

    – Some entrepreneurs lack the financial training to set up the systems to gather financial information in an easy and painless way
    – Most important, as Steve point out, some of these figures are just misleading at this state of a company

    Your objective as an entrepreneur should be:
    – to reduce the sense of insecurity and lack of control over the company’s use of funds and general financial direction that your VC might feel (they wont accept it but its always there)
    – to reduce to a minimum the amount of time and effort used to collect the needed information

    What can you do?
    – You can convince your VCs of reviewing on a monthly base only those metrics that will measure progress more accurately at this stage, instead of all the financial data which is not relevant
    – You can set up the right financial systems/software to help measure basic financial information, and allow your VC access to additional financial figures every quarter or by request
    If none of these work:
    – You can try convincing your VC of using the right metrics as well as the financial ones, and to be measured by a mix of both
    – You can hire a seasoned part-time CFO who can at least free you of the hurdle of putting the numbers together

    Thanks for a great post!

    Vanesa

  24. [...] No Accounting For Startups Startups that are searching for a business model need to keep score differently than large companies that are executing [...] [...]

    • Steve –
      Great post!

      The “I went to business school but don’t really know what to tell you to measure so I’ll have you do these.” quote struck a chord with me (F#7b9#11 for you jazz musicians).

      The powers that be (those you take money from) sometimes expect that the entrepreneur has to instantly satisfy whatever capricious thought that comes into their minds. Hence requests for all means of documents related mostly to their past personal expertise and interests (less often these are required to satisfy their company’s internal measurement processes).

      I had an investor on my BOD that taught a university course on corporate governance. I was therefore continuously bombarded with forms to fill out that were used for his corp gov classes (why not kill 2 birds with 1 stone?). Endless forms detailing things like – timely and balanced disclosure, remunerate fairly and responsibly, safeguard integrity in financial reporting, promote ethical and responsible decision making, etc., etc., you get the idea.

      Of course there’s nothing wrong with corp gov, it has it’s place, but it started becoming a key focus of BOD meetings. He believed that if the corporate gov checklists were all filled out and reviewed at every board meeting, then everything else would magically fall into line (we weren’t public, we were a brand new start-up). I eventually put a stop to it.

      abcz

  25. Having a clear focus on how to make attractive and effective organization, is the only way to grow a new business.

    Excellent article!

  26. I would say your post is really good as and AND rather than an Alternative standpoint. Traditional financial statements

  27. Thanks for the great article Steve. I’m referencing this article from my blog post “Why Are You Keeping Your Books.”

  28. [...] During the beginning stage of a startup company you’ll probably focus on record keeping for compliance – you can hire a traditional tax CPA who will book all of your expenses for tax compliance on an annual basis or use an online SaaS company like Mint, FreshBooks or Outright.com and be comfortable. But we suggest you move towards establishing your accounting system for strategic reasons as soon as possible – which may involve co-sourcing your accounting functions to a third party expert. Be sure that they not only track all of the transactions accurately but are also able to provide your company with the information you seek beyond the traditional standard reports: balance sheet, income statement and cashflow report. Steve Blank suggested metrics that may be more important than the financial statements itself which included: monthly burn rate (cash flow), customer acquisition costs, customer lifetime value, etc. for a startup company. See his blog post here. [...]

  29. [...] = 'josephlogan';Steve Blank has a great book, a great blog, and a great mind: Startups need different metrics than large companies.  They need metrics to [...]

  30. No accounting?
    Accounting is trivial especially in the startup phase,

    how many startups died of big dreams but no sense of reality..
    Sky-high prospects but no insight in liquidity, that is fuck-up #1

    Cash rules!

  31. Steve,

    I have presented in Board meetings (not VC sponsored though) numbers that meant nothing to anybody but took lot of time to prepare.

    I would have liked the meetings to focus on validating or trashing the basic premises or assumptions on which the entire business model was structured. To accept them as sacrosanct and worry about the numbers is putting the cart before the horse, imo.

    What would also make the BMs effective and productive is checking up the alignment of the processes and activities with the Vision, fi there was one in the first place! Its easy to get distracted by our own excitement or what happens in the market place and make that as the foundation for our future plans. The Board really needs to step in and keep things aligned towards a common purpose.

    Cheers

    Badri

  32. [...] Steve Blank suggests keeping accounting simple when in startup mode, to keep business complexity (time and effort) to a minimum. I think the same should go for office space, marketing, and other startup time sinks. window.onload = function(){prettyPrint();}; [...]

  33. [...] Steve Blank mentioned in his recent post, an early indication that a business has found the right business model is when the cost of [...]

  34. Steve,

    I love your blog, and this post in particular. As you may be aware, Fred Wilson posted a diametrically opposed view about the importance of accounting to a startup:

    http://www.avc.com/a_vc/2010/03/accounting.html

    Do you have any thoughts about difference and similarities you have with his point of view? Do you stand behind your “worse than useless” comment or is it a rhetorical flourish?

    Just trying to figure out if there is any genuine disagreement between two of my favorite bloggers.

    Cheers!

    • Michael,

      I think a key idea got lost in the translation – my post was not about “accounting” it was about how accounting substitutes for metrics about your business model.

      VC’s and entrepreneurs confuse the two.

      Fred’s post talked about “accounting” which he defined as “Accounting is keeping track of the money in a company.” I think that’s a great definition.

      Unfortunately at board meetings “accounting” is all that some VC’s have you measure. My point is that the metrics as you search for your business model will not be found in “Accounting.” It will be found by agreeing on a set of business model metrics. They may be: customer acquisition cost, viral coefficient, average selling price, etc. And that these metrics are more important in the early days of a startup than Just the ones for accounting.

      I didn’t see anything in Fred’s post that talked about metrics, just about the value of accounting. Since Fred’s firm is leading the renaissance in Venture in NY you will be doing accounting in his board meetings :-)

      See if you can sneak in some metrics.

      Hope this helps.

      steve

  35. [...] Accounting Stumbled upon this exceptional older post from Steve Blank about accounting and financial documents in startups (not boring, trust me): One [...]

  36. [...] del plan de negocio original se vuelven irrelevantes. Estos inversores me enseñaron las métricas adecuadas para la búsqueda de un modelo de negocio, cómo explicarle a la junta [...]

  37. [...] Steve Blank mentioned in his recent post, an early indication that a business has found the right business model is when the cost of [...]

  38. [...] Blank posits in his post that: “Startups that are searching for a business model need to keep score differently than [...]

  39. We find that the accountant is the most key advisor that a company can have. A good accountant, a CPA with a diverse background, provides more of a holistic consultative role to a new company, and can be key in its long-term success..

    Find a well rounded CPA firm to work with, and one who actually deals regularly with start-ups. Especially here in Los Angeles’s Silicon Beach there are a few of us who provide services locally and nationally.

    Find an accountant which can develop a rapport with. If you feel comfortable consulting your advisors (CPA, attorney, etc.), then they provide far more value.

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