Budgeting In A Small Early Stage Company
Today and for the next two weeks, we are going to talk about budgeting on MBA Mondays. Since the budgeting process works differently in companies of various sizes, we are going to focus on three company sizes; 10 people, 75 people, and 150 people. Today we will talk about the 10 person company scenario.
As I said in a previous post, I have been working with Matt Blumberg and Jack Sinclair, CEO and COO/CFO of our portfolio company Return Path on these budgeting posts. I have been involved with Return Path for ten years now and I've watched Matt and Jack run excellent budgeting processes and so we are getting the benefit of their work and learning in these posts.
Last week we talked about projections. It is important to run a projections process before you turn to budgeting. Think of budgeting as a refinement of the projections process where the goal is to predict what is going to happen in a particular calendar year.
I believe that budgeting should be done on a yearly basis. If you want to start budgeting and you are in the middle of the year, that is fine. Just budget for the rest of the year and then do your first full year budget in the late fall.
The late fall is budgeting time. October and November are the best months to do it. If you have a board, you should be able to present your budget for the next year to the full board in December so they can approve it before the year starts. If you don't have a board, then you should be able to lock into a budget with your team in December.
The budgeting process starts with a financial model. If you have done projections, then you should have a financial model already built. If haven't done projections, then go back to the projections post, follow the directions, and do some projections. Then come back and read this post.
The first step in budgeting is to review the key business metrics and lock them down based on what is realistic for the next year. Be very realistic. A good budget is a conservative budget. In a ten person company, the budgeting process can be done by a couple of the senior managers, typically the CEO and the most financially savvy of the other team members. These two people can run the process all by themselves without any input from the rest of the team. That will change quickly as the company grows, but in a very small company you do not need to involve the entire team in budgeting.
If the company is pre-revenue as many 10 person companies are, then the focus will be on hiring and people costs. And the budgeting process will largely be about spending and how many people the company can hire and how much money the company can spend and how long its cash will last before needing another round of funding.
If the company has revenues, they will not likely be large yet at 10 people, so the revenue forecast will be a bit tricky. In the first few years of revenue generation, the revenue model changes a lot and the drivers of it change too. I would encourage everyone to be conservative about revenue budgeting early in a company's life. Most budgets are missed because revenue does not come in as planned.
Make sure to include a cash line item in your budget. Most budgets are done as profit and loss statements which is how they should be done. But you should back into a cash projection based on the profit and loss numbers and include that line item in your budget. If this is new material to you, go back to my posts on profit and loss, balance sheet, and cash flow to see how these three statements work together.
Once the budget has been locked down and approved by the board and/or by the senior team, you should share the budget with your entire company. Some executives don't like to share the entire line by line budget with the team and I can understand that. Some executives don't like to show a cash line that runs out with the team and I also understand that. But you should at least show the key business metrics and some of the most important line items in the budget with the entire company. This will be their roadmap for the next year and it is important that they understand it if they are going to be expected to help you deliver it.
All that said, I favor being as transparent as you can possibly be with your company. It is hard to hide information from the company. The important information leaks out eventually and if and when it does, you won't be there to provide context. So the more information you provide, the better off you will be.
Once you have a budget, you need to measure yourself against it. Each month report the actual numbers versus the budget and track how you are doing against each key business metric and line item in the budget. At some point during the year, you may want to do a reforecast. We will talk about that exercise in a few weeks.
Next week we will talk about how this process changes as you grow to 75 people. It a very different process at that point.
Excellent, lucid post as usual, Fred.I’d just make one suggestion – aim to move the presentation to the board back a month or two (which means starting the process around late August / September). Otherwise there’s a sense on the board that they’re being asked to rubber-stamp the budget, as there’s no time before the year starts to ask for clarifications or amendments.
That’s a great point Les. I think the process with the Board starts as early as September, with a presentation of initial thoughts on strategic priorities and key metrics for the following year. This allows management to incorporate feedback from the board into the process, and ensure everyone is on the same page before too much work is done.The October meeting is ideal for providing more detail and feedback to the Board as management goes further into the budgeting process. Generally by this time, management should be clear as to whether the plan is holding together as they initially thought it would in their initial projections.This constant communication throughout the planning process avoids surprises when December rolls around and management is looking for Board approval of a plan.Of course, this means the management team should be building those initial projections in August…although I tend to find that I’m updating those models throughout the year anyway.
Good chronology, Eric.The exec team of one of the companies I’m on the board of start their forecasting in March of the previous year – needlessly early of course, but it means we get a first look (at board level) around September/October, AND the exec team get a real good look later in the year at how accurate their forecasting process is.
Gee, I thought that budgeting went like:Early on, look at the fairly predictable monthly cash inflow, and plan to spend a significant fraction less than that.Once get significantly more cash coming in than just have to have, then start saving.Then as the cash accumulates, don’t commit to more on-going expenditures than it appears that will have no difficulty covering the expenses for for at least a year. E.g., don’t hire anyone before it is quite solid that can pay them for at least a year.Since there is some on-going uncertainty from exogenous causes, we need a real-time ‘control’ system:If have a budget and are getting significantly less cash then planned for, then take the total current cash c and the number of months m to go in the budget and start spending at not more than c/m per month.As the company grows, for some first-cut budgeting, get an estimate of expenditures per year per person (that is, divide total annual expenditures by total number of people and correct for inflation, raises, etc.) and then budget just by counting people. So, just by counting people also cover travel, floor space, office supplies, etc.This can work if have high margins, and if don’t have high margins then change the business until do.
Gee….in a venture capital backed company, you thought wrong.
lol, brutal diss richard. well played.
This is a fine way to do budgeting for organic growth startups/companies.
So you think budget first then projections?
I just want to emphasize Fred’s advice to be conservative. Better to be able to do more with less and have more at the end (but don’t sacrifice potential use of funds that will pay back down the road…just don’t be frivolous). Also if your seeking funding and investors see business forecasts and budgets that are not realistic/conservative they will think upper management themselves are not believable.I also recommend revisiting both your forecast and budget quarterly. If you have someone in charge of sales and someone in charge of ops or accounting for a 10 person business it should be those two and the CEO. Depending on your business and the sales cycle (I worked for a small firm that had 6 month to 4 year sales cycles from initiation to close) the person doing the budgeting doesn’t need any negative surprises. And the CEO can then react if needed. This could mean helping the sales side bring sales in or the cost side to ensure critical operational needs are funded.
“Be very realistic. A good budget is a conservative budget.”This is true, but it depends how you define that. If I’m conservative with my cash, that means I’m not spending it.But in a conservative budget, I think you need to be aware of the upper limit of the money you might spend. You may plan to conservatively spend $X on office equipment, but you may have underestimated the cost/prices are higher than expected, in which case you don’t have the money in your budget.To counter this, we have a line in our budget to factor in a 5-10% margin for unexpected cost.I’m not saying you have to plan for a worst case scenario all the time, but it helps to have a margin for error in mind.
I would say a budget is as much about managing costs as it is about managing revenue expectations. Yes, you need to be careful about how much cash you spend, but also (and IMO more importantly) you need to set certain revenue targets – and the budget measures whether you’re on track to achieve those.
Good ole 3 sigma brackets, having flex or breathing room in a budget makes sense.
Which is one reason why it is so crucial to compare your budget vs. actuals. This way if there are any unexpected variances, at least the board is assured that the company is aware of that fact and working to mitigate any potential issues.Also, most companies I’ve worked with have a de minimus level of materiality that allows management to stay focused on key issues (e.g. focus on all >10% variances, unless they are under $10k).
I would add to being conservative in your budget – it should mean there is a more realistic chance you will hit your targets. If you do hit or exceed your targets, your board will have more confidence in you and the future of the business, and it will also help instil confidence in future round investors.
At our company, we prepared 3 sets of financial projections when we were raising money (Best case, worst case, and base case). However, we quickly learned that you can throw away your best case projections. Hopefully you reach your base case projections but, realistically, be prepared to run your business for awhile at the worst case scenario.
“All that said, I favor being as transparent as you can possibly be with your company.”could not agree more. you’ll find it a lot harder to recruit & keep talent if you keep things from them.fred, what’s your take on the ideal CEO salary compared with some of the other originating employees? i know a number of factors would be involved, but do you look any more highly on a founder who is taking less than some of his employees to prove his loyalty to the mission at hand?
Employees should always be paid first and in our budget, they’ll be paid more than myself (founder).That being said, some of this depends on your goal with the company. Sure, you can bootstrap a company to profitability, but if your goal is to flip it quickly, the company won’t be profitable once you hire professional executives at $xxx,xxx salaries.Might not change a lot for you, but it’s worth keeping in mind.
Starting to appreciate the build up of MBA Mondays on the metrics of health, projections, and now zeroing in on THIS years detailed plans. There’s a level of financial maturity I have to reach to signal confidence to team members and investors. Revenue light startups are so vulnerable to running out of runway fast, it’s a miracle any of them pull it off and turn the corner.Reminds me of the betting strategy in roulette. Bet on a color. If you win take away your winnings. If you lose double down. Repeat until you win.Even a light revenue stream can extend the small startups life substantially. Just need to w aware of the zombie startup that will not die or grow, better to sell off that level of business and keep searching for another viral pattern.
“Reminds me of the betting strategy in roulette. Bet on a color. If you win take away your winnings. If you lose double down. Repeat until you win.”1) The best game for this would be craps, on the “Don’t Pass” line. That’s the table bet with the least house advantage.2) This “strategy” is one reason casinos put a “max bet” limit that is a consistent multiple of the “min bet” at a table (usually 100x).
Pro gambling knowledge 🙂
The casinos don’t mind this strategy because the green in roulette and the twelve in craps are the factors that give the casinos their advantage.They’ll pull the max if you ask.
No, they don’t mind any “strategy” except quality card counting atblackjack. 🙂
You are right they don’t really mind any strategy except card counting….they most certainly do not like that.
I’ve found that it’s a good idea to have a FUBAR line in your budget. Someone drops the pappy, you fire them and say “no prob, we still have room in FUBAR to rehire”.
Haha, that’s just the right way to put it.I’ll need an angry poster of you on the “office” wall with a cracked bottle of Pappy.”Drop the pappy at your own risk”but by all means keep juggling it
Very timely post as I was literally refining my startup’s model last night. Thanks.
Why run projections first? The reason I have right now, is that projections are a maybe where as budget is the here and now (sort of)
Shana your projections are aspirational, what could be. You need to run these first to give yourself an idea of whether your proposal is worth taking forward and help you decide what resource you require to achieve it.
some people i know are not doing that….
Maybe its just me, but I think a monkey can hit expense numbers. I’d like to spend this money….how hard is that?Budgeting expenses is super easy.Now what’s hard is matching expenses to revenues and changing when things are not going as planned.Maybe that’s what the 75 person post is going to be about but to me there are tons of 10 people companies that have to deal with how do you match up expenses and revenues.So maybe its not an employee number deal it is a stage of company deal. If you’re not worried about revenues you’re stage one. Trying to match revenues to expenses (in some form) stage two. Profitable stage three.Certainly from a VC’s point of view you want these stages to correspond to some large sizes (you have to get big returns) , but from a technology company point of view the stage does not correspond to the sizeTo me the biggest difference that people that come from big companies to small companies is the fluidity in budgeting, and this is most pronounced in small companies.I’ve had people that have come from big companies that literally can’t get their mind around the budget is going to change because numbers didn’t come in right (either up or down).
Phil, my assumption with Fred’s post is that it relates to a 10 person, pre-revenue VC backed company, where there is little or no expectation of revenue. So stage 1 as you put it.Like you I’ve seen plenty of people coming from large companies (big pharma particularly) that just cannot get their head around the fluidity of budgets in small companies.
Yes. I hope I didn’t come off as negative. I think Fred’s post are super valuable to all technology companies whether they are vc funded swinging for the fences or just great technology companies.Of course since this blog is a vc it is from that viewpoint. I’m just saying that stage doesn’t relate to size.
not negative at all.
Most reasonably capable executives can create an income statement projection and budget but few can do the balance sheet. In companies where inventory and/or receivables are meaningful, this can have a big impact on cash. Here’s my tip for creating a balance sheet forecast:1. List the major balance sheet accounts.2. For any account that is minor or very difficult to predict, hold it constant.3. Make projections of the main balance sheet accounts: inventory, receivables, payables.4. Hold equity constant to see how much cash is needed–sometimes referred to as letting cash “run red”.5. Total liabilities and equity.6. Set total assets equal to liabilities and equity.7. Put a formula in for cash that is equal to total assets less all other asset accounts.
One of the best tools I’ve seen for this is Alight Planning. It’s sort of like Excel on steroids in two ways – first, it groups your sheets by the sections of a income statement and balance sheet, and it uses “unit/rate/amount” architecture so that you can easily structure your key metrics without the complication it takes to do the same thing in Excel.The best part is when you get done – hit a button and out pop your income statement, balance sheet and cash flow statement.http://www.alightplanning.com(PS: I have no financial ties to this company. One of my advisors sits on their board and I’ve used their software. It really works.)
I fully endorse Fred’s observation that a budget should also include the derivation of a “cash on hand” line item.I like to follow the discipline of deriving “results from operations” (more of a statement of cash flows terminology) or earnings and then appending uses of cash (e.g. capital expenditures) and sources of cash (e.g. borrowings) and derive a “cash on hand” number.I think that budgeting is a fairly precise science and one that should require a bit of work. It is easy if you document all of the assumptions on a separate page and then begin to “wiggle in” on the real numbers as your experience grows and the real numbers appear.Break down everything that can be broken down to provide context and learning. As an example break down payroll taxes by line item and make sure the formulae are right.Identify the top 2-3 items of revenue and the top 7-10 items of expense and track them perfectly with a monthly trend analysis via spreadsheet and a graph of each one.I also am a big proponent of ratios. Track them constantly as they can often be the canary in the coal mine.Reforecast budgets on a quarterly basis and have a good review. Don’t be afraid to admit you have no earthly how something is trending at first but you will get much, much better at it as you work through it.
I agree that people often forget to project cash and just focus on profit/loss. In my 12 years of experience as a Director of Finance and Operations in start-ups, technology and Web companies, I devised a system of spreadsheets, ideal for the 10 – 50 person company that can’t afford sophisticated software, that allows management to project profits and cash on an almost daily basis and gives the decision maker a look into these items months into the future. Any sudden changes can, with a few updates, be instantly absorbed.My employees have liked working with them so much, they started to use them for their personal finances.
Yeah, let’s scale it and see what happens at 75 and beyond.
Hi Fred, would you consider doing a piece on Business Plans as part of MBA Mondays please? I’ve searched the archive but I haven’t found anything save these 3 posts (1, 2, 3) on other sorts of plan. http://www.avc.com/a_vc/200… http://www.avc.com/a_vc/201… http://www.avc.com/a_vc/200…
yes, maybe a series of posts
Good anecdote Charlie. Looking forward to your homerun and seeing crapple diminish at the same time. You can take Stevie ;)note: I totally dig some Apple products, just frustrated with their big bro business model.
I too have had an issue.I think many people (including a guy who I’ve founded a company with and would do it again) just don’t like to see the running out of cash.You’re totally right you could be working at BigCo and the next day, somebody decides to get rid of an entire team and you’re gone.But many people don’t like to see cash going away…they can’t function with that on their brain.
All really great points. Exactly how we’ve built our budget and a more articulate explanation of my initial idea.We use 5% for the variable to costs in our budget, but I think 10% is fair for certain items. I think the point in an early stage venture is to show that you’re aware that the numbers will change and you’re trying to account for everything effectively.Marketing is just such a department in flux. Always easy to spend on marketing, but tough to determine the ROI.
here i am. indeed, crapple sucks. down with crapple!
Kid spent too much time basking in the warmth of his mother’s love yesterday. He’s still recovering.Give him a few days and he’ll be gloomier than ever. In a good way.
ugh, disqus keeps deleting my comments with multiple links. i spent a good amount of time hatin’ on jobs/crapple, got deleted here but it’s on my disqus page: http://disqus.com/kidmercury/
It depends on how much of the company that you own. If you own 50% or more, then I can see that. If you own 10%, then you should be paid market.
I would add to your list of critical personal expenses, possibly childcare.If her kids aren’t in a secure and safe environment, CEO Mommy cannot charge out into the world and build big things.
I may not be the most reliable advisor on this subject as I have a truly weird view of things. I like to buy a person’s complete and absolute attention. I want to over pay folks.I don’t want anybody worrying about their personal affairs, I want them completely focused on my business.I happened to meet today w/ a team of folks I have been assembling for a weird little business and I told them I would make them do the work of two people (these are all MBA types and very good people and would willingly do the work of two people anyway) and I would pay them 150% of what would be viewed as a market wage.Of course, they have to hit a number I have in mind for free cash flow. We are almost already at that free cash flow number, so it is very attainable.Then I will pay them even more if they hit a greater number of free cash flow. Five times the lower number.I define free cash flow as earnings + non-cash compensation + depreciation – capital expenditures.One of the guys had worked for me for about a decade some years ago and was asked out of earshot if my word was good and he affirmed that that was exactly what I had done in another deal that was very, very successful.This approach works for me but then maybe it is not for everybody.