Budgeting In A Growing Company

I failed to post a MBA Mondays post last monday. Sorry about that. I had something else on my mind when I woke up, wrote about that, and didn't realize that it was monday and I was supposed to do an MBA Mondays post until late in the afternoon.

So we are now picking up from where we left off two weeks ago. Which is in the middle of a four to six post series on projections, budgeting, and forecasting. We covered budgeting in a small company two weeks ago. We are now going to talk about what happens to the budgeting process once revenues start coming in, headcount gets to between 50 and 100 employees, and you are now a full fledged high growth business.

Once you have real revenues, 50+ employees, and a real business, you should have a full time finance person on your team. It could be a CFO or it could be a VP Finance. There are tradeoffs between the two. If you think you are going to be an independent company for a long time that will go public or do a large number of private financings and M&A transactions, then you will want a CFO. If you plan to keep the business simple and head for the exits within a few years, a VP Finance should be fine. I should do a post on the difference between a CFO and a VP Finance and I will, but this is not the time for it.

So your budgeting process should start with your lead finance person. He or she should run the process with you as their partner. Your budgeting team should also include the leader of your sales or revenue operation and your head of engineering or tech ops if you have one. The way I like to think of these two people is the person who "owns" revenues and the person who "owns" capex. This group is sufficient to run a budgeting process in a 50 to 100 employee company.

There are three inputs to the budgeting process in a company of this size; a detailed revenue plan/model, a comprehensive cost model including headcount, and a set of key performance indicators (KPIs). 

Start with the revenue plan/model and do it bottoms up (meaning identify where the revenue is going to come from and how much of it you are going to be able to pull in during the year). The sales leader will give you a plan that he or she thinks they can hit. Dial it back. As much as I love sales leaders, they are optimists. Very few of them can properly estimate revenue in a high growth relatively early stage company. I believe they generally do a good job of identifying where the revenue will come from but a poor job of estimating how much of it will come in during your time frame. Things always take longer. So dial the sales leader's numbers back.

Then once you have a set of revenue numbers, lay out all the KPIs that it will take to hit them. What is needed from the product team? What is needed from the engineering team? What is needed from the bus dev team? What is needed from marketing, customer service, HR, etc? The KPIs are the glue between the top line model and the cost model. Spend a lot of time on this part of the process.

Going from KPIs to a comprehensive cost model is not that hard, especially for a seasoned finance person. The key is being comprehensive. If you are growing headcount aggressively, will your current space be sufficient? If not, you'll need numbers for more space. Things like legal and recruiting costs really start to pile up at this stage. They may not be very large in your historical financials. Plan for them and budge them.

And make sure to budget for capex costs. Some companies rent their capex via leases or managed hosting. If you do this, your capex will show up in your operating costs. Some companies acquire their capex with cash. If you do this, your capex will show up on your balance sheet. Either way, capex can eat up a lot of cash. So budget for it correctly and make sure your engineering or tech ops leader is held accountable to the capex budget.

In my last post on this topic, I said that budgeting time is October and November so that the board can approve it in December. That is generally true for a 10 person company but not for a 50 to 100 person company. I like to see budgeting start in September for a company of this size and I like to see the Board look at the budget in November. That way if there is a disconnect between management and the Board, another revision to the process can occur before the year starts on Jan 1st.

The budget is not just for the Board. It is first and foremost for the team. So make sure to share the budget with the team and make sure they are all bought into it. If they are uneasy about it, listen to them and don't force a plan on the team that they do not think they can hit.

A company at this stage will have a senior team and they should be accountable to the budget. They may even have incentive comp associated with the budget goals. I like to see the entire senior team participate in the budget presentation to the Board. I like all of them to talk to their parts of the budget. That shows they understand it, they have bought into it, and they are behind it.

To be brutally honest, very few budgets are met in companies of this size. These businesses are still very much in flux and things change a lot during a year. But I still believe in the value of doing budgets. The process is incredibly helpful in establishing what can be done and what can't be done. It focuses the mind and the company. And if you realize half way through the year that you are not going to meet your budget, you can and should do a forecast. We'll talk about that in a few weeks.

Next up is budgeting in a 150+ person company. We'll do that next Monday assuming I don't have another brain fade.

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#MBA Mondays

Comments (Archived):

  1. RichardF

    Do you happen to know how many of your portfolio companies lease their hardware/are in a managed hosting environment vs purchase through cash Fred?Leasing can be a complex area re accounting treatment and tax (depending on the country you live in) but I think leasing rather than outright ownership through cash purchase is a great way to smooth the cash burn and make it last longer

    1. Mark Essel

      That makes three of us interested in the lease versus buy question Richard.I’m also concerned with human resource growth costs, and when to hire more (and how to find and attract the best staff).

      1. RichardF

        The human resource growth cost is a difficult one to manage. It’s a real balancing act as well; hire too many too soon and your burn quickly ramps up, don’t hire quickly enough and the product can start to suffer. Attracting the best staff is also a difficult one – doesn’t seem to matter what the economy is doing. Right now here in London it’s still pretty difficult to hire decent java/rails/scala coders.The area I have always found that can quickly get out of hand is admin/support staff and related costs, particularly when you start hiring VP of this or that .

        1. Carl Rahn Griffith

          The biggest warning-sign is when you get your first stationery cupboard and people open it and moan if it is not awash with pens, ink cartridges, paper clips, marker pens, etc.Alarm bells time.

          1. RichardF

            lol – too true Carl

      2. PhilipSugar

        This has just been my experience, but I’ve only found leasing effective for office space and physical racks in a datacenter (you buy the space in the rack, electricity, and data connection). Furniture you buy on the cheap. Leased furniture is always too nice. Same with computer hardwareI’ll expand on the computer hardware. If you pay cash you can get a screaming deal versus leasing. You can buy Dell Rackmounted servers for less than $2k. That means you can have 32 load balanced servers with two AAR’s for around $50-$60k. You can run literally hundreds of millions of transactions in a day with that setupAs Carl pointed out hire one less admin that concentrates on spending money. Carl, I would also say if you show up and find out somebody bought (probably leased) a huge copier you need to sound the panic button.

        1. Mark Essel

          Thanks Phil, appreciate the advice

    2. fredwilson

      most lease or take out capex loans

  2. Dan Ramsden

    This is more conceptual than procedural, but it would be great to hear your thoughts on operating leverage, and when fixed vs. variable cost structures are the preferred approach. This could be where finance meets operations with issues such as outsourcing vs. in-house. Big topics, maybe an idea for a future post?

    1. Mark Essel

      You read my mind Dan, asked a related question above.

    2. fredwilson

      yes, great topic for a future post. thanks for the idea

  3. robertavila

    Sales operations as they must be are just as optimistic in large corporations as they are in small start ups. That is their nature. The challenge has always been how to make budgets and plans that provide the correct guidance for production and investment while at the same time providing the proper incentives for sales, whoes reach should always exceed their grasp….

    1. Carl Rahn Griffith

      Indeed – managing the delta between sales achieved and sales expected via the sales pipeline/forecast is the biggest challenge. Your overheads are typically fixed/linear and the hope is all too often that sales/revenues will be exponential in growth – when in fact linear would be pretty good, and enable a sound basis for planning and real growth.Sadly, because of a lack of strong management/planning, often the operating costs go exponential and the revenues are flat/linear, at best.

  4. Mark Essel

    While the techniques for budgeting a growing company are invaluable to folks at each of the phases, I wonder if in a future post you can touch upon the forces that lead to head count growth into the hundreds or even thousands. We have seen from businesses like Craig’s list and Twitter that fairly small headcount businesses can accomplish large revenue or fiscal growth goals.I’m curious in the area of modern web tech startups what are the key drivers behind human resource growth (and correlated overhead costs like space and equipment).Isn’t it advantageous now to keep startups super focused on mastering the market they lock in traction for and outsource segments of the business to reliable companies in complimentary areas. For each business the decisions and situation may be different: -insource customer service to the team to keep them fully aware of the vibe of users and fast responding like Paul English has done with Kayak-server rental or purchase and associated staff to maintain/upgrade the equipment

    1. paramendra

      Craig’s List and Twitter just so happen to be superstar companies. Very few end up there. But being a profit making dot com is also a great place to be.

    2. fredwilson

      we like to see companies try to operate lean and some of ours dobut headcount is largely driven by the ambitions of the senior team

  5. Morgan Warstler

    “The sales leader will give you a plan that he or she thinks they can hit. Dial it back. As much as I love sales leaders, they are optimists.”Word.Questions: with as many companies online where advertising is a crucial piece of the revenue, why is it so hard to estimate revenues? And doesn’t that mean revenue is more a function of number of users? How important is a kick ass ad sales team vs. a stronger marketing team for user growth? Ultimately on the spreadsheet does it usually come down to users*adrevenue? And how bug does the user base have to be for a VC to think the ad revenue will be meaningful? Do you have a user base size at which you assume real brands will care?

    1. fredwilson

      i think revenue is more driven by feet on the street than number of users until you’ve got a mature business

      1. Morgan Warstler

        So if you have 500K users vs. 2M users, you don’t apply revenue guesstimates based on users? It really is based on feet on street. How do you write that formula in the spreadsheet?

        1. pfkrieg

          If users generate the inventory – the impressions – the biggest variable is how much of that inventory you can realize and at what price. If you are using AdWords, you can estimate pretty reasonably, but it’s suboptimal. That’s why Google makes as much as they do – their rev share benefits them. To really scale, you need to have your own sales people who can sell more inventory at better prices. That’s a typical sales funnel forecast. How may reps, how many prospects, how many opportunities (i.e., campaigns). What’s the stage, expected close rate, etc. Salesforce.com has a Media vertical market edition that focuses on online sales, to forecast results.

    2. Fernando Gutierrez

      Even in advertising based business you need sales reps because not every sale/client is equal. There can be huge differences in value (and then in revenue for you) of the same ad to one client or to another one (depending on demographics of your audience, time of the year, conditions…). Chasing the appropriate client to match it with your product is something you can only do with good sales people.

  6. LIAD

    curious what %age of AVC readers work in a startup and of those the breakdown between working in a 0-10 people and a 50+ people company

    1. Mark Essel

      start the statsMe and a cofounder: 2

    2. fredwilson

      i have run some surveys over the yearswell over half the readership works in startups but i never broke it down by size

  7. paramendra

    Brain fade? :-)I think it is perfectly okay to miss out once in a while.

  8. charlieahern

    Interesting point about dialing back sales projections. Sales managers who want to justify more feet on the street may estimate on the high side, but managers who attempt to sandbag quotas may try to low-ball.Once the annual budget is done that’s about the time to start doing solid monthly and quarterly forecasts.

    1. Fernando Gutierrez

      Totally agree. Sales people are optimists, we have to be to overcome the constant rejections and objections. But we are also results driven and usually compensation is directly related with sales. We like to be able to make our quota and get our bonus, so a lot of sales people will hide some of their cards to avoid overly optimistic quotas.I think that with time the finance guy knows the sales guy well enough to be able to correct his numbers, be it down or up. Until them, probably is better to be overcautious because the consequences of falling short on revenues are usually worse than the opposite.

  9. ShanaC

    what if you don’t know at 50 where you are heading?

  10. Megan Cunningham

    I just want to say, Fred, that this MBA Monday series is insanely helpful. You know I’ve been running Magnet for 10 years but despite our success and growth there are still knowledge-gaps that you just can’t learn first hand or ever retain all the knowledge of your advisors when you’re an entrepreneur. One thing I did at the end of last year (financially traumatizing as it was for all of us-) was apply for the Sulzberger Fellowship program at Columbia. It’s designed specifically for media companies (from throughout the world) to send their innovative executives to get a crash-course in change-management, finance, marketing, etc. It’s a year-long program, the professors are from Columbia’s biz school and the coaches are first-generation McKinsey guys who are absolutely brilliant. They are open to advising you at any point throughout the year one-on-one, and really take the role incredibly seriously. I have to say it’s been a life-changer. But as an enhancement/companion, your Monday MBA posts are really sensational. Thanks for the terrific service to the community of entrepreneurs!

  11. Bhsiao2000

    Hi,I found a site where you can purchase a very detailed Excel spreadsheet program to help you through these steps. My company is probably too small so I haven’t tried it but: http://www.http://wynplan.com/

  12. Gerald

    I would be curious if Fred has ever worked for an operating company.

  13. fredwilson

    20-30% of revenues minimum

  14. pfkrieg

    FredI think you’ve got a typo – no? I’d express cash as % of expense, not revenue. I always viewed cash as days expenses outstanding (like DSO) – you want to see your burn reserves expressed as time. I’d view cash that’s 30% of expenses as 108 days of burn (360 day year convention). Match that to your cash flow projections, and you understand how much time – if any – you have beyond that.