Author: Oswald Yannick
A couple of weeks ago, I got a question on Qoorio on budgeting in an early-stage company. Doing so in a company of 5-15 or 20-70 people is, of course, very different from setting up a budget for a company at Series B+ stage of, let's say, 100+ people. Let's focus on the former here.
Here is the answer. There is no scientifically accurate approach to budget break-downs at the early stage. Your budget entirely depends on your strategy, and where you should spend your time and money to achieve it. As we discussed in a previous post, the only golden rule there is that a founder should never have to kill a great product because they burned through cash too quickly trying to scale something that is not ready, yet.
The key is to have a strategy with proximate objectives first.Only then can you turn to budgeting.
The goal of a strategy is to formulate a hypothesis around what proximate objectives you need and can achieve to reach the next stage, which, in most cases, is your next fundraising round. Think of budgeting as a refinement of the objectives setting process: How do you allocate your finite resources best to achieve these objectives?
I call this early-stage startup strategy setting 'The Startup Jiujitsu'! Jiujitsu was developed to combat the samurai of feudal Japan as a method for defeating an armed opponent in which one uses only a small or no weapon at all. Jiu' can be translated as 'flexible, or yielding", and "Jitsu" as 'art or technique'. 'Jiujitsu' thus means 'yielding-art'. Its core philosophy is to manipulate the opponent's (in our case the market's) force against him with precise and super effective movements rather than confronting or opposing it with one's own force alone. Startups have to do the same. We only have limited resources, but have spotted a huge market opportunity that is coming our way. We need to channel our resources on key actions to have a shot at dominating it...
Step 1. Form an hyopthesis: 'What does Success look like?'
One of the best business books I read is 'Good Strategy. Bad Strategy' from Richard Rumelt. Richard puts it well: 'Where does scientific knowledge come from? You know the process. A good scientist pushes to the edges of knowledge and then reaches beyond, forming a hypothesis about how things work in that unknown territory. If the scientist avoids the edge, working with what is already well known, life will be comfortable, but there will be neither fame nor honor (= success). In the same way, a good business deals with the edge between the known and the unknown. Only there are found the opportunities to keep ahead of rivals. There is no avoiding it. That uneasy sense of ambiguity you feel is real. It is the scent of opportunity...'
So, what exactly is a good vs. bad strategy? Is there a way to systemically craft good strategies? Let's look at Richard's 'Kernel of Good Strategy', and at an example later on.
First, do not confuse strategy with vision or ambition. You became an entrepreneur because you diagnosed a massive, but concise challenge to be solved. The mission alone to solve it is not a strategy, though.
Be precise. Do the startup Jiujitsu! By focusing all your efforts on a few core initiatives, startups can knock out the biggest competitors. It’s about uncovering the smallest number possible of critical factors to solve, the Guiding policy, then directing your energy and resources to address those factors through focused, coordinated action.
Hope is not a strategy. Coherent actions are. Once you have your guiding policy defined, you need to set up coherent actions, and a budget to execute them.
Step 2. The Startup Jiujitsu! Define bold proximate objectives.
To realize a grand vision, one of a leader's most powerful tools is the creation of good proximate objectives - some that are coordinated, and close enough at hand to be feasible.
'Kennedy's call for the US to place a man on the moon by the end of the 1960s is often held out as a bold push into the unknown. However, landing on the moon was a carefully chosen proximate strategic objective.' Kennedy's 1961 political speech remains a model of clarity to date. I suggest you look it up on the web and read it.
In his speech, he first diagnosed 'world opinion' as the problem he wants to solve:'The dramatic achievements in space which occurred in recent weeks should have made clear to us all, as did Sputnik in 1957, the impact of this adventure on the minds of men everywhere.' He argued that the Soviet's strategy of focusing its tech resources (which were poorer than the US resources in key areas...) on space was leveraging to its advantage, the world's natural interest in these out-if-this-world achievements. But being the first to land a man on the moon would be a dramatic affirmation of American leadership.' And it would all about channeling its resources on the right proximate objectives.
Right there is Kennedy's startup Jiujitsu move! While seemingly impossible to achieve, the moon mission had been judged, and ultimately made, feasible with the help of proximate objectives. The president did much more than simply point at the seemingly impossible mission... He had laid out exact and feasible steps to focus on along the way - unmanned exploration, larger booster rockets, parallel development of liquid and solid-fuel rockets, and the construction of a landing vehicle. You must identify the critical aspects of the situation - this provides a startup a focal point to design its strategy. By leveraging all its resources on this focal point, startups can make the impossible possible.
The important duty of any startup leader is to absorb a large part of that complexity, passing on to the organization a few simpler problems: The most vexing problem for the design of the soft landing of a machine on the moon was that no one had a clue what the moon's surface was like! It might be soft like powder, it might be a nest of needle-sharp crystals, etc. The leader of the mission did a wild but educated guess: 'If this (Southwestern desert) is what the smoother parts of the earth look like, it is probably a pretty good guess as to what we'll find on the moon if we stay away from the mountains... Look, the engineers can't work without any specification. So this is my best guess. If it turns out to be a lot more difficult than this, we aren't going to be spending much time on the moon anyway...'. This was a strategically chosen proximate objective. The leader turned the moon landing into a solvable problem.
Proximate objectives are projections, a set of numbers, both financial and operational, that you make about your business for various purposes, including raising capital. While these projections are not budgets and much more 'big picture' exercises, this does not mean that they are 'fluff'. On the contrary, they are linked to key business metrics.
Step 3. Define your key business metrics
There are usually three to six metrics that will be sufficient to determine the business's overall health and growth trajectory and it is best to focus the team on them. These key business metrics will be drivers of revenues and growth, but not all of them. Product engagement is, for example, often an essential key metric, especially at the early stages.
Do leverage your investors to drive this process! Great investors have a good overview of the market, and know what is required to reach the next stage and attract new investors.
I like sending out regular emails to the entire company with some metrics and how they are trending. Some companies even buy big screens and mount them on the office walls to publish the metrics on them. I like that approach, but it is not for everyone. These figures are the company's roadmap, and employees must understand it if they are going to be expected to help you deliver it. And of course, you should share the metrics with the board and key investors.
It is a good idea to evaluate regularly what your company's key business metrics should be, at least once a year around the annual budgeting exercise. Some of these metrics will change every year as the business grows and develops. (We will dig deeper on this topic in another post).
Step 4. Set up a budet, to support your Jiujitsu moves...
Budgets are financial models, meaning a broader set of numbers, both financial and operational, that the management team prepares each year, usually in the fall before the start of the new calendar year, that outline what the company plans to achieve in the coming year. They are presented and approved by the board. During the year, it is important to communicate openly with your investors on where the actual performance varies from the budget (in both positive and negative ways) and reevaluate your forecasts.
This budgeting exercise should be done on a yearly basis (at least). Having a clear set of strategic actions to align everyone is so important in the wild west that is startup life.
Let's get back to the initial question on where the budget focus should be. If the company is pre-revenue as many 5-15 person companies are, then the first focus will be on hiring and people costs. The budgeting process will primarily be about spending (as initial revenues are low), how many people the company can hire, how much money the company can spend, and how long its cash will last before needing another round of funding.
In general, the first budget of a company will be mostly about product development (or R&D). Depending on your product, this period can vary from a couple of months up to more than a year (e.g. our company K Health spent more than a year developing its complex medical ontology parsing system and database). The earlier you can get your product out there in the hands of real users, the better. As soon as you have the feeling that something is working, get more users on it, take a step back, reevaluate, and get again more users on it. Along this process (read this post for more insights on it), your 'sales and marketing (S&M)' costs are increasing substantially. Your business metrics will be your guide here on how far you should stretch your budget in terms of growth spending. Quickly your S&M spending will be the biggest line item in your budget (depending on your product, usually at Series A, but most definitely post Series B), and will usually reach 50%-60%+ of total spending. This should remain so for the next couple of years if your Jiujitsu moves work out as planned...
Finally, make sure to include a cash line item in your budget. 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.
Once you have a strategy, you need to measure yourself against it and reassess. Each quarter report the actual numbers versus the budget and track how you are doing against each proximate objective, key business metric, and line item in the budget.
Last weekend, I had the opportunity to go to the Swiss Alps to get some 'fresh air'. It has never felt so great to get out and 'recharge' for a bit. If possible, I recommend everyone to do so from time to time in these weird times.
Life is awesome,
Yannick
About the Author:
My name is Yannick and I am an early stage VC @ Mangrove Capital Partners and a Kauffman fellow, Class 23.