Budgeting: Now that you’ve raised round A funding
Almost all blogs on budgets begin with some statement on how tedious yet important budgets are. This one is no different (Budgets are tedious. Here I said it!) Budgets are both a pain and a necessity without which reaching synchronized growth that properly harmonizes expenditures and revenue is impossible. Budgets are also an excellent way to focus on what can and can’t be done. After you’ve raised your round A, your budget will need to factor in when your next round will happen and what you’ll have to show for it. I hope to give you some hands-on advice and practical guidance on what to do the day after.
So now that you’ve raised a VC round A of $3–6M, you’re not only done with investor presentations, VC meetings and the mandatory e-mail thanking everyone for their efforts, you are also responsible for a large amount with several zeros behind it in your company’s bank account. This is the pivot point after which budget, forecasting and projections are a whole different ballgame. Entrepreneurs I spoke with at this stage had hard questions about their budget. Questions like the frequency the budget should be managed at, how to internally allocate the budget between rounds, how to model your revenues and which software to use. In some cases, it is easy and desirable to learn from others. Sometimes you need more than just a cookie-cutter response. This blog, a follow on blog that will be published later in November and our Aleph.bet session (see bottom of post for more details) will attempt to address some of these questions.
Aligning expectations
While the pre-round A budget is about conserving cash and getting to a large funding round, now you actually have a large funding round at your disposal. How long are the funds going to last before you’ll need to raise an additional round? You and your investors should agree on the answer to this question. When entrepreneurs become overly conservative about ensuring funds survival, while investors expect them to spend aggressively, there is a serious misalignment of expectations. Post round A you are expected to build the most aggressive plan (that’s why you took institutional capital, remember?) you can realistically manage and budget accordingly. Don’t hedge and save money, exchanging growth for survival. It isn’t what the investors planned when they chose you.
Round A funding is there to accelerate growth, product delivery and market reach. I know there is fear of the next round, and whether the company will manage to raise it. That’s a fact of life; it should not mean conservative spending and watered-down plans. After all, we’re venture investors, not private equity players.
Once we established that, how the budget is used and allocated between the different activities and teams becomes the big issue for the CEO. I want to direct you to a great post by VC Ben Horowitz, which discusses the problem of post funding budgeting when there seem to be no financial constraints and the company is in high growth mode. Ben’s point is that in some cases, the budgeting process can spiral into a dire case of internal empire-building, causing the budgeting process to over-run into a bloated headcount.
Rely on Unit Economics
One way to create boundaries is to use comparable benchmarks for expenses, revenue and margins. If there is a company like your company, or a business in your line of business, there are some fundamentals you can compare yourself to, and check if your projection makes sense. One of the increasing popular ways to create such measures is unit economics. A measure based on a single unit of cost or revenues, for example, ARPU (average revenue per user) or sales per employee. If you normalize your costs and revenues by the number of employees (in the case of costs) and the number of clients or users (in the case of revenues) you’ll be able to compare yourself to other players and set a benchmark.
Revenue?
When the company is pre-revenue, budgeting is very much a case of funding and growing a team of people. These budgets are relatively easy to control, and you’ll quickly know if you can meet them or not.
When the company has revenue, budgeting is trickier since fluctuations in revenue may hinder your ability to make the budget. In this case, I would advise a cautious forecast of revenues for the budget, so you don’t fall into a cash-flow black hole. To avoid that, it may be useful to recognize present and future costs in your ramping up phase, and tie these measurements back to unit economic measurements for valuation and growth prediction.
At this point, revenue isn’t king. Sometimes you want to give up on revenue to grow market share. One of our cash-generating companies decided to do just that and gave its product away for free. It worked very well for them. You don’t need to run after revenue, and revenue isn’t necessarily the basis for making the next investment decision regarding your company. The fact that you raised an A round doesn’t mean you can’t take a strategic decision to forsake revenue in return for market domination.
Learning from the experience of others
Budgets are so simple, yet so complicated. As in the case of Ben Horowitz, smart and capable entrepreneurs make rudimentary mistakes when it comes to the process or the assumptions. In order to remove some of the fog, Aleph is hosting an Aleph.bet session on the 24th of November, targeted at CEOs/CFOs/COOs of companies in their growth phase (our threshold is 1m users or $500k in revenues) to hear from some of the industry’s more experienced finance and operations people on planning and budgeting practicalities. If you’d like to participate, please drop me a line yael@aleph.vc
