How to grow your startup while being cash-flow positive
Organic Financing is the healthiest way to grow
Feb 2024
Startups need to burn cash to grow. Right?
This has become the conventional wisdom for modern tech founders - but it’s simply incorrect and, in fact, is an extremely dangerous way of thinking.
In almost all cases, growth can and should be cash-flow positive - i.e., the faster a startup grows, the more cash it generates. This is strictly better for founders than growth fueled by burning cash -- better economically and better from a control and mental health perspective. But a decade of plentiful capital has ingrained a starkly different model in today’s founders: that their top priority is to focus on achieving certain metrics to raise their next round, not growing in a sustainable cash-flow positive manner.
For much of the past 15 years, a founder that prioritized profitable growth was looked down upon as being unambitious and not seeking to ‘win’ their space. They were seen as the boring tortoise, instead of the exciting hare that raised hundreds of millions and made waves in the headlines and on Twitter.
It is now time to reset the mental model of a founder to what has always been true - building a company with positive cash flow from the early stages maximizes both founder economics and control, while minimizing their startup’s risk of death and therefore the founder’s mental stress levels. Building a company this way also sets the right type of culture in the company from the very beginning by directly aligning financial success with customer willingness to pay and internal thrift.
Ultimately, this approach is the most reliable way to be successful over the long-term. But there are exceptions that are discussed in the footnote.
Organic financing is the healthy option
There are many names for growth powered by cash flow but the simplest way to think of it is ‘organic financing’ - growth from cash generated by customers, instead of outside investors. It has been called other names like bootstrapping or self-funding but both of those labels are misleading and create needlessly negative perceptions.
Organic financing means your cash position is proportional to the quantity of actual customers who want your product multiplied by their willingness to pay for it.
In other words - cash becomes the truest indicator that you have ‘made something that a lot of people want’.
The better your product, the more your customers want it, and the more they will be willing to pay upfront before receiving its benefits. This creates positive working capital that can dramatically reduce the need for ‘inorganic’ external financing - like venture capital or debt - or even eliminate the need completely.
Because your cash position is so aligned with customers' pull for your product, it necessarily creates unparalleled focus and motivation for your founding team. Make your customers happy and you will get the funds you need. It’s that simple.
There is zero incentive or wasted mental focus in other areas, including wondering what your friends, VCs, media or random people in the street think about your startup.
When the entirety of your thoughts and energy are pointed in the exact same direction, that unlocks your maximum potential as a founding team.
‘Winning the market’ is often a mirage
Too often founders fool themselves into believing they must raise capital to compete - to either stay relevant in a market, or to ‘win the market’ and be the number 1 player.
It is rarely the case that the winner in a market is the one that raised the most money. Efficiency, focus, perseverance and a financially savvy culture is what wins in the long-term for most markets. And many big markets - especially in B2B - evolve to have multiple winners in different niches, not a single big winner.
But the winner-take-all market is the narrative that founders and VCs tell themselves to justify the huge piles of cash they are lighting on fire. It makes sense to spend on expensive marketing campaigns and large engineering teams when the financial projections show that the winner will own the entire market by themselves!
Take Atlassian, makers of Jira and Confluence. They built project management tools - a product in which many competitors exist - such as Microsoft and Asana. And yet they financed organically till IPO and won with their maniacal focus and resourcefulness. The company is worth over $50B today.
Are there other successful competitors in the space like Gitlab? Yes. But did that take anything away from the Atlassian founders’ outcome? Absolutely not.
Playbooks
There are three major playbooks to run a startup organically - (1) get paid upfront (2) defer expenses (3) incentivize employees with cash from profits. We’ll explore each of these in detail below.
Get Paid Upfront
Getting cash upfront from customers is what drives the entire cash-flow positive model of a company. But how do you get that precious cash from customers as far ahead as possible?
It turns out that customers are quite willing to pay upfront for products not delivered yet - in some cases for products that are not delivered for many years - if they are sufficiently excited about it.
Tesla famously did this with its $1,000 deposits for car orders, which it received several years in advance of delivery. Boom Supersonic collects large deposits upfront for its supersonic airliners. Bill Gates actually didn’t even found Microsoft until he got a customer to write him a check for the first Altair BASIC interpreter!
And modern software companies can do this too - I’ve personally experienced getting millions of dollars upfront from customers for software yet to be written (with protections for the customer of course). A company can get multi-year contracts paid upfront if the deal is positioned correctly.
Ask yourself the question - if the customer isn’t willing to pay upfront for your product, do they really need it at all? Have you sold it correctly?
If the answer isn’t a resounding yes, you may be working on an insufficiently acute problem or have an insufficiently compelling solution to that problem.
The following is the basic formula for designing a business around a cash flow positive model:
Step 1) Founders invent a novel product to sell to customers in a certain market for a certain price that allows for a healthy 50% or more gross margin.
Step 2) Founders approach a wide sample of customers to demonstrate the product and ask directly if they would pay a certain price upfront
Step 3) If not enough say yes, repeat step 1 over again with a different product-market-price combination. Only if a certain threshold percentage say ‘yes’, then proceed.
Step 4) Strike deals such that the customers pay upfront in return for a guaranteed delivery of the product, with refunds if not delivered. Startup must be 99% sure they can deliver the product, or have the ability to make good on the refunds if not.
Step 5) If enough say yes to have minimum financing to build the product, then proceed. If not, then repeat step 1)
This can work for almost any market where the technology is relatively cheap to build to a standard such that customers can start to realize some benefits from it.
In the rare case that a startup does not deliver the product and cannot provide a full refund, the founders must offer to deliver some other related product that solves problems of the customer. An early adopter customer who took a risk on a startup is often a benevolent party that will work with the founder to find constructive solutions.
Note that the number of customers spoken to must scale to achieve the minimum financing required. If the product costs $100/ mo and one needs $1,000,000 to incrementally build out the product, then the startup must get 1,000 customers to pay a single year upfront ($1,200 per year) to finance the next stage of development.
A significant benefit of this approach beyond the organic financing benefit is that it robustly yet cheaply tests the interest customers have for the product. If the customers are not willing to pay upfront, either the market does not have the budget for this product or it does not solve a big enough need - and founders are better off iterating to a new combination.
Deferring Expenses
Along with getting paid upfront, in order to remain cash flow positive, it is critical to defer expenses for as long as possible.
In the last decade, it grew fashionable in startups to build large teams, and inexperienced founders often boasted about team size as a vanity metric to other founders to show how many people they were ‘managing’. But headcount is the most expensive cost, and therefore any hires must be delayed as long as possible.
A good example here is Github - founded in 2007 and scaled to millions of users using self-service tools, but kept their headcount incredibly low throughout. This allowed them to delay external institutional financing until 2012 and maximize their ownership.
The truth about headcount is that the cost structure is increasingly inefficient with scale and therefore there are diminishing productivity returns to every dollar spent on headcount. Ultimately the most efficient spend is just on a highly motivated founding team. Once you start adding headcount, you’ll also need to add managers and support staff, and add benefits and office space, and several other items of overhead that accrue much faster than you think.
To build a healthy spending culture, rigorously treat your team size as fixed. Hiring is only meant to happen when all other options fail, not as a primary option to solve new problems.
Of course growing businesses eventually need to add headcount, but the standard for when to do so is ‘you’re refusing customers who are begging to give you piles of cash because of lack of headcount’. Anything less extreme than that is wasteful and highly inefficient.
Defer your own salary too as much as possible. Make it an incentive for yourself - you’ll get paid when the company gets paid. In the early days, this by itself is highly motivating to a founding team. Every dollar coming in the bank accounts feels like a personal win, and founders can start attaching their own hopes and dreams to it - as they should throughout the whole lifecycle of their company.
For other capital expenditures and vendor expenses, you’ll be surprised how much you could negotiate away. Hardware costs can sometimes be deferred for months. Legal costs can be deferred indefinitely for early stage companies. Vendors understand that smaller startups are cash strapped - lean into this and push all costs back, especially the big ones.
Incentivizing your team
Being cash-flow positive from day one allows you more flexibility to incentivize your team with cash vs stock. Most tech startups are focused on stock option incentives but actually cash can be a much more powerful incentive as it can be tied to near-term actionable goals that an employee can feel empowered to impact.
Working towards a far off exit or IPO has a much weaker motivating impact than a year-end bonus plan or even a small share of annual revenue or profit. Organic companies have highly motivated employees with better retention rates because they actually get to take home a prize to their families regularly instead of promising them an uncertain reward in the distant future.
Organic companies also have the massive benefit of having almost zero downside risk. Whereas inorganic companies can fail to raise their next round and hit a wall, dying instantaneously, organic companies tend to be much better protected on the downside. Employees will rarely have to worry about a sudden existential crisis. The worst case scenario is a lower profit year, which is nowhere near as stressful and worrisome as sudden death.
To incentivize employees in an organic growth company, pay them a regular market salary but add a 50% bonus on top of it - half of which is tied to individual achievements and another half to company profit goals. This ensures the employee’s financial outcome is directly tied to the financial success of the company as well as their own performance.
Is this antithetical to the ‘deferring cash expenses’ mantra explained earlier? Yes but this exception is worth making. Because employees get this cash incentive as a direct proportion of profits, the net effect should be maximum motivation for your lean team to achieve your north star financial goal - positive cash flow.
Pulling everyone in the same direction will help you get the best results.
Organic Financing can grow just as fast, with less drama and stress
It is a myth that organic financing grows slower than inorganic.
Because the founders take the time to make sure they are truly solving a big enough problem, and are less likely to fool themselves on customer willingness to pay, the resulting growth is often way faster. And there is the additional benefit in that there is almost no downside risk of suddenly running out of money due to change in sentiment from disinterested venture capitalists or a different macroeconomic cycle.
Before the zero-interest rate phenomena of 2010-2021, companies were commonly funded this way and were not capped on growth. Microsoft for example was financed like this from inception and has grown to become the largest company on Earth. In total Microsoft only raised $1M in inorganic financing in its history.
Even Steve Jobs learned the value of organic financing the hard way. The second stint of Steve Jobs at Apple from the year 2000 onwards was funded organically instead of inorganically. Why? It is partly because Apple was inorganically funded in the 1980s that Jobs had to bring on the Board of Directors that ultimately fired him.
Other companies that successfully grew organically:
Atlassian ($54B market cap)
Mailchimp (acquired by Intuit for $12B)
Veeva ($30B market cap public company)
Zoho (over $5B market cap)
Patagonia (worth $3B)
Epic ($4.6B annual revenue)
Github (sold for $7.5B)
Qualtrics ($12.5B sale)
Just like these companies, prioritize organic financing and you’ll be happier while being even more successful.
Thanks to Kat Manalac, Garry Tan, Immad Akhund, David Rusenko and Sam Chaudary for reviewing copies of this essay and providing feedback
Exceptions
Yes there are exceptions to this approach. Founders will need to prioritize raising money in the scenario that they are building something where there is clear consumer demand but will cost a lot to build. This is mainly hardware startups and biotech.
There are also consumer marketplace companies like DoorDash, Instacart and Uber / Lyft where economies of scale come very late in the game, and it is a winner take all market with competitors raising gobs of cash to initially give away a dollar for 80 cents. In that case the only path to success is inorganic financing - and lots of it.
Just remember that for every DoorDash there are dozens of dead delivery companies whose founders ended up with nothing.