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Wednesday, August 29, 2012

Avoiding sticker shock from service providers

I do not have the funds to pay this !

Few companies will operate with employees as the sole source of workers for your company.  Your mentors, advisors, and board members may work on a fixed fee, or may require billing per time worked.  Legal, accounting, and other contracts are least likely to work on a fixed fee basis and will bill by time spent.  Getting those bills in the mail with totals that make you feel like passing out are difficult.  Debt generally increases and becomes a larger problem while raising added capital.  Legal fees alone work leading to a closing can become very large.

Investors will require you to provide financials for review prior to closing.  One of the areas of concern is outstanding debt or fees due.  Owing fees for services payable at the close of a financing is more common than you think.  Having the debt portion being too high becomes a concern because no one wants to invest in past work!  In addition, the amount of residual cash after payment must be enough to conduct the work promised to the investors.

It is possible to swap some of the debt for equity.  This can cause dilution that may be more acceptable than spending the cash.  Assuming the service provider is willing to take the equity, the reduced debt translates to a reduced cash payment.  The investors may want a discount from the negotiated price to deal with the dilution.  Basically, any dilution causes a reduction in your holding percentage and you take a haircut too.

Most likely, you will have times when debt accrual must happen.  As an entrepreneur in a startup, there is no cash to work with except from personal savings.  Certain providers are essential and working a pay it later arrangement is required.  There are things you can do to monitor and limit the debt accrual, but these should not be at the expense of the quality of work required.  For example, having a poor job on legal agreements will create pain and cost you money later.  Inferior manufacturing work will cause loss in product quality and poor market acceptance.  Some areas require quality work and costs accrued and compromise is not acceptable. 

The best you can do is to identify the areas where cuts are acceptable and areas where they are not.  Secondly, you must develop a mechanism to track the expense accruals so you do not have sticker shock.  You can slow work down or defer it if costs get too high, but this only works if you know the expenses and the projected rates of accrual.

Managing many times includes managing expectations.  In the case of expenses, your expectations need the management.  Knowing where you are in expenditures is your only tool to knowing when to manage the workflow and alter accruals or payment methods.  Discussions with your service providers early along with constant monitoring will save you a lot of pain later.  Working out alternate payment methods or stock swap alternatives up front will provide for an easier time later.  In short, avoid sticker shock by monitoring.  Develop payment alternatives early or later by negotiating with the providers.  Surprises on amounts owed are never funny!