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The 3 Biggest Start-up Killers, Part Three: Bad Controls

Today we finish our three-part series on the hazards that kill start-ups. As entrepreneurs and consultants, Steve and I have had season tickets to the start-up demolition derby for many years. While we aren’t sages or gurus (no-one is), we’ve learned quite a few things up watching businesses go boom over the years. And the three monster trucks on the field that crush start-ups left and right are

  • Bad planning
  • Bad organization
  • Bad controls

    While bad planning and bad organization sink a business like an iceberg, our third start-up killer is a bit more subtle and sneaky. Bad planning and bad organization will take out your business with a machete, but “bad controls” takes a razor blade to your business and bleeds it with a thousand cuts.

    “Controls” are not the same thing as “control.” Now, I can always muck up your mind with MBA mumbo-jumbo and spend the next several paragraphs wandering around in abstract-land. For instance, here is the SEC’s “official” definition of a control:

    [A control is] a specific set of policies, procedures, and activities designed to meet an objective. A control may exist within a designated function or activity in a process. A control’s impact may be entity-wide or specific to an account balance, class of transactions or application. Controls have unique characteristics – for example, they can be: automated or manual; reconciliations; segregation of duties; review and approval authorizations; safeguarding and accountability of assets; preventing or detecting error or fraud. Controls within a process may consist of financial reporting controls and operational controls (that is, those designed to achieve operational objectives).”

    My, that’s mighty helpful, ain’t it? So forget all the fancy-talk.

    Simply put, “controls” is the “discipline” that your business follows to make sure that its operations and financials are efficient and correct. I could call controls, “rules,” but they’re a bit more than that. Why? You can always ignore “rules.” Controls, on the other hand, are both the “rule” and the “discipline” to follow that rule.

    For instance, you could have a rule mandating employees to come to work on time. But that guarantees nothing. You could, on the other hand, demand that they come to work on time and punch a timecard when they do come to work. Employees coming to work on time is a rule. Employees punching a time card is a control. See?

    A control, then, is both a “rule” (or embodies a rule) and the following of that rule. And while controls are important in every area of your business, they are fatally crucial when dealing with money flowing in and out of your business.

    Left on their own, people like to wing it, to improvise, to just do what comes naturally. But businesses never thrive on doing whatever you want to do in the moment. They only thrive when everyone follows rules, rules that are designed to make sure the business doesn’t lose money. Since I can spend the next five paragraphs playing around in the abstract, let me give you a few examples of specific controls the lack of which lost a real-live startup or small business real, honest-to-goodness money. These examples will give you a real sense of what a control is, how it works, and why it’s necessary. You can take it from there and look at your entire business from the perspective of internal controls.

    I was asked by a friend to come in and help close down a retail store. Now, if you think starting a business is hard, you should try closing one! The amount of work is truly staggering. In going over their books, we found, to our horror, that they had been paying suppliers for inventory they had never received. To the tune of about $1,000 to $1,500 a month. Now, that my be a rounding error for your typical big box store, but bleeding that kind of money contributed mightily to this small retailer’s failure. Even if the business had not failed, it would be far better to have that extra grand and a half each month rather than donate it to wholesalers.

    The business lacked one simple financial control: matching invoices to delivery receipts. Here’s how they did it without any internal controls, the “fly by the seat of your pants” method that so many small businesses and start-ups follow. They received inventory and filed the delivery receipt. They later received invoices and paid the invoices — a process completely void of any internal controls.

    Instead, they needed to take each invoice and compare it to the delivery receipts. Any inventory on the invoice that did not have a delivery receipt, they should not pay for.

    Here’s the rule: don’t pay for inventory you don’t receive. Here’s the control: always match invoices to delivery receipts (or work orders). Pay only for the items that match (that is, for the items you actually received).

    I just tangentially brought up a few other controls. Purchase orders: you order nothing until you create a purchase order. You match the purchase order to the delivery receipt. Work orders: you allow no work until you create a work order. You match the final work with the work order. I could spin off a dozen more based on just this one problem alone.

    I’ll give you another example. Back in my halcyon days as a marketing strategist and designer, I took the lead requirements and design position developing an online project management system for a new startup. The product was brilliant, but the start-up wasn’t exactly rolling in dough, so the lion’s share of its promotions budget was dedicated to paid search advertising.

    About three months after starting their search advertising initiative, they got hit with an $11,000 invoice for just one month of click-throughs. Turns out — either for real or fraudulently — they had a particularly good month with click-throughs. However, they had only budgeted $500 per month for their paid search engine marketing campaign. “HOLY SHOOT!” doesn’t even begin to describe the moment. And to top it all off, all those extra clicks did not make much of a bump in their conversions — and even if it had, they were at full capacity handling the conversions they were already getting. Fortunately, they had the moxie to negotiate the bill down (to $5,000) and the resources to pay the final bill, but unpleasant surprises like this could easily sink a start-up.

    Could you pay an $11,000 invoice if your business got hit with it?

    They failed to establish controls over their paid search advertising to stop the campaign when the month’s budget was eaten up. Anyone who has been even tangentially involved in paid search advertising knows that establishing controls like this are blissfully easy to do — they’re right there when you set up with network like Google or Yahoo! (although, at the time this story took place, it wasn’t quite as easy — possible, but not as easy). So this was a monumental business failure, to say the least.

    Here’s the rule: never let paid search advertising exceed $500 per month. Here’s the control: set up the maximum monthly pay with Google to $300 and the maximum monthly pay on Ask. com to $200.

    As another example, I recently posted about the click fraud running rampant over at Facebook. Advertisers were paying up to double the actual clicks they were receiving because of outside click fraud (not Facebook). The advertisers who had one simple control in place were able not to bleed money: they compared the click-through counts from Facebook with their own server logs. And they refused to pay for click-throughs that didn’t show up on their server logs.

    Here’s the rule: don’t pay for fraudulent click-throughs. Here’s the control: match the click-through records from the advertising network with your server logs. Don’t pay for click-throughs that don’t match.

    There are literally a million ways businesses can go wrong by not following rules guaranteeing that the business operates efficiently or that money flows in and out of the business properly. If there’s a part of your business that can lose money, then you need to have controls governing that part of the business.

    You can see why, at the beginning of this post, I said that bad controls can bleed your business from a thousand places. But, without going out and buying a textbook on internal controls, you can see how they work. While nothing should stop you from going out and buying a textbook, especially one on financial controls, here’s the general idea:

    1.) Wherever your business can lose money, you need rules to prevent that loss.
    2.) Wherever your business has rules preventing the loss of money, you need “controls” that are the “how” of following those rules.

    It’s tempting to let controls slide when you’re making tons of money. It’s no fun to follow rules and a million little extra work regulations. It often feels like imposing controls will somehow disrupt the “creative spirit” of your startup or small business. I cannot count how many entrepreneurs have expressed this very sentiment in their resistance to imposing some discipline on their business. I always have the same answer: without controls, you’re losing money, “creative spirit” or not. When there’s a business downturn — and there will be a business downturn — you’re going to wish that all the money you pissed away in the good times were in your bank account when the bad times hit.

    That’s how most businesses survive downturns.

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