One of the most incisive and controversial issues debated in Silicon Valley during 2014 deals with the high rate of failure among tech startups. Many business analysts who cover the tech industry have even drawn comparisons to the Dot-Com of the late 20th century, when tech companies failed spectacularly and turned Wall Street upside down.
An entire culture has emerged around the concept of tech startup failure; there is even FailCon, an international event that reunites tech business personalities who lecture audiences about their funding mishaps and the poor reception of their ideas. Whereas tech journalists tend to focus on the evaporation of venture capital and the demise of dubious ideas, the reality is that many tech businesses fail due to a lack of cash flow.
Why Cash Flow Matters for Tech Companies
Bootstrapping is a financing method often discussed within tech circles; it involves building and managing a company with virtually zero funding because cash cannot be acquired by any means. The success stories involving bootstrapping are certainly impressive and romantic; to wit: Facebook, eBay and even Microsoft. However, the tiny number of these successfully bootstrapped enterprises indicates that they are outliers.
Many tech businesses fail due to a lack of cash flow, and this is a problem that extends to small businesses in other industries as well. Without cash flow, small tech companies fail to attain the liquidity they need to operate. Even the leanest companies will face expenses such as:
- Website hosting
- Telephone and Internet service
- Legal consulting
- Search engine optimization
- Hardware devices and software applications
Once tech startups begin doing business and getting clients, they start running into invoicing difficulties that precipitate a cash crunch. This is a major problem insofar as dealing with the expenses listed above, and not being able to pay for them can lead to business insolvency and failure. This is often the case when tech business land major clients who set their credit terms for settling invoices as far as 30, 60 and 90 days.
Unless tech companies receive significant amounts of venture capital, their sole lifeline will depend on cash flow. Small business owners who are not able to handle this issue are likely to consider suspending operations and even shutting down their enterprises.
Factoring Funding for Tech Companies
In the last few years, factoring funding has emerged as an efficient method for tech companies to obtain cash flow relief when they are unable to secure traditional financing. In the wake of the 2008 global financial crisis and the credit crunch, many small and medium sized enterprises were able to stay afloat thanks to factoring.
In essence, factoring is a form of debtor financing that makes economic sense for tech startups. The axiom of a business needing money in order to borrow even more money is very much in effect these days, and this detrimental to the sustainability of the tech industry.
There are various methods of factoring, and one of the most common for tech companies is through invoice financing. This is a simple solution; let’s say, for example, that a mobile app developer is contracted by a major telecommunications firm to create three Android apps. Once the apps are delivered and accepted by the client, the developer presents an invoice for $5,000, which must go through the process of being vetted, approved, paid and disbursed. In some cases, this process could take up to 90 days, thereby creating an accounts receivable and cash flow issue for the app developer.
What if the mobile app developer could receive a cash advance equivalent to 70 percent or more of the outstanding invoice within 48 hours? This would certainly give the company enough cash flow to settle current expenses and to look for future clients. Invoice factoring is also known as accounts receivable factoring, and it often involves simply sending copies of invoices to the company doing the financing. Funding rates in factoring are based on the industry and on the type and amount of accounts receivable, and they tend to be very reasonable.
Why Factoring Makes Sense for Tech Companies
Remember the FailCon events mentioned earlier in this article? At a July 2014 event in Dubai, one of the most acclaimed presentations was on the importance of maintaining positive cash flow. Overdue payments from clients are often the bane of a tech entrepreneur’s existence, and this is a challenge that often drives them to run up their credit cards, take out high-interest personal loans and borrow from friends and relatives. This is hardly an ideal financial situation for small tech companies; defaulting on credit cards, personal loans or on friends and family makes for a very uncomfortable aftermath.
Factoring is a much better option for tech companies because this is a financing industry that has been maturing significantly over the last few years. When compared to credit cards and other last-option methods of financing, factoring simply makes great economic sense for tech startups and other small businesses.