By Tomasz Tunguz from Redpoint Ventures for his blog
Your sales team is starting to close some terrific accounts. As your startup grows, your sales team will experiment with different sales techniques. For example, qualification, pricing, positioning, incentives and contract structure. This is a wonderful phase for a startup. However, there’s a common mistake to avoid.
Your VP of Finance should model the impact and approve each experiment. Many startups don’t do this at the early stages of go to market. Failing to consider the cash flow impacts can balloon your burn.
Customer contracts determine how and when customers pay you. Cash flows in. Sales commission plans govern how and when your startup pays account executives. Cash flows out. The inflows and outflows should match.
When the inflows and outflows align, things work well. A customer signs on, sends a check to the company. The startup receives the cash and distributes a fraction to the sales team.
Mismatched cash flows create hairy problems. Let’s say a startup sells software for $250,000 ACV. This quarter, four account executives close contracts. The commission payout totals approximately 20% of the sale or $200k.
Your commission plan promises sales teams payment immediately. Contracts permits customers begin to pay 60 days from now. End result: your quarterly burn just increased by at least $200k. And this scenario assumes annual upfront payment. If you promise your customers monthly payment, your cash shortfall lasts five months, not two.
Worse, imagine you have paid commission to an account executive. Before the 60 day window, the customer cancels the contract. You have to decide whether claw back the sales commission from the account executive or eat the cost.
Discounting also presents cash flow timing risks. Imagine the sales team offers four months free on a 16 month contract. Your startup fronts the commission four months before being paid.
The impact can be serious. One startup doubled their burn in a quarter because of novel sales tactics. Bookings went through the roof and so did the burn. Because the impact became apparent more than a quarter later, it took the business more than 6 months to react burning through millions and forced an early fundraise.
When experimenting with novel compensation or new sales tactics, for use in the contract, ensure that your cash flows are well-timed.