CEOs shouldn’t worry about their budget all the time — on a day-to-day basis they should work on managing their company, building an awesome product, developing key relationships, identifying distribution channels, etc. But CEOs should carefully review their company’s financial numbers at least once a quarter, even when there is plenty of funding in the tank.
The reason we have so much talent in Silicon Valley building and investing in for-profit technology companies is that markets richly reward successful ideas, no matter who invents them. But to remain competitive in a free market, companies must exercise discipline to meet quantitative goals, and eventually become cashflow positive. As we have written elsewhere, metrics synthesize a huge volume of information about how efficiently and effectively you are accomplishing your mission. A clear budget and a comparison of spending to revenue reveals whether your project is being sustainably managed, and whether it will add value to our economy in the long term.
A common mistake among new entrepreneurs who have raised large rounds is that they have essentially infinite resources. As a new entrepreneur who is extremely confident in the product you are building, you may wonder: why waste time on precise budgeting and defining goals? But building an intuition for how your burn-to-output ratio is evolving is important for any CEO.
A good place to start is your monthly spend. Any CEO who doesn’t know to within 5% error how much they spent in the last few months and how much they will spend in the next few months is not doing their job. A reasonably mature company must track both expenditures and, on the other side of the equation, incoming cashflow (not bookings — cashflow).
Engineering is the art of managing scarcity — it’s easy to design and build a massive bridge that will last forever if cost is not an issue. Similarly, to build a new company you must manage scarce resources. Almost any company would be easy for talented people to build if you could spend an infinite amount of money to get to where you want to go. The challenge is to keep your monthly burn at a sustainable level, and punctually achieve your milestones.
Before you meet with a board member or senior advisor who is going to talk to you about your budget, you should familiarize yourself with the following data points:
· Current cash in bank (not projected cash, actual cash). If the cash hasn’t hit your bank account, don’t count it — that’s tantamount to lying to your investors. You should also note any large expected near term changes such as money you hope hits soon, or major payments due.
· Monthly gross expenditures, gross receipts, net burn over past several months, and projected monthly burn in near-term and a year from now. For businesses with high volatility in their monthly numbers, quarterly numbers may make more sense.
· How much you plan to spend over the next year. At your current pace, how many months do you have left before you are out of cash, if you don’t raise more? If you plan to raise, how many months will the new round last you?
To illustrate the point, let’s take an unnamed startup in December 2017, and see what the CEO knows:
· Annual recurring revenue (ARR) is $25M at the end of ’17, with contracts paid annually upfront. This figure will grow to at least $42M next year.
· Cash receipts have been about $2.5M a month in the past 3 months, and are trending upward
· Monthly spend has been about $5M a month, burn has been about 2.5M a month.
· With hiring targets, spend will reach $6.5M a month by the end of ’18. Given current goals, burn will stay around $2.5M net.
· The goal for December ’19 is to get to $65M ARR, and only raise spend to $7.5M a month, meaning that at the current rate of closing deals, the burn should actually fall to $1.5M a month by the end of the year.
· The goal for December ’20 is to reach $90M ARR, with an annual burn of $12M and a near-breakeven run rate at the end of the year.
As an investor and an advisor, I might respond to this information by noting that this burn rate and hiring plan is slightly, but not unacceptably high for current ARR. This looks like a platform-esque company, not a lean enterprise solution, but the fact that the CEO has a handle on ’18, ’19, and ’20 makes this burn manageable.
With $35M in the bank from a $50M round in mid-2017, this company has about 14 months left, and is going to need to raise a big round in the middle to late part of the coming year. For a good CEO, 9 months is yellow alert, 6 months is red alert, and 3 months means you screwed something up and may need to start looking at other options like selling or merging your company. This CEO should start thinking seriously about the next round, and what she’ll achieve in the next six months, to convince investors that her plans for the next three years make sense and that her company is valuable.
The CEO originally intended to raise spend to $7M a month, but after mapping out how spend and burn would evolve in the coming years, agreed it was prudent to keep it at $6.5M maximum (and hopefully a bit lower). According to the current plan, another $50M round should be enough to take the company to profitability and an IPO in ’21 or ’22. But if the price is good, I would advise this entrepreneur to raise a safe $75M just in case things don’t work out according to plan. If the entrepreneur wants to build a new division onto the company in the future, and chooses to raise spend again vs going to break-even, they will require a larger round and an investor who shares their vision.
It’s vital to get a sense of how burn and spend underpin the budget decisions which largely determine everything else in the business. A CEOs core responsibility is to ensure her company will succeed, and measuring these changing data points is the only way to stay informed.
Of course, this thought exercise has nothing to do with the most important parts of the business: the product strategy, the marketing strategy, the technology culture, the shifting competitive landscape, the leadership, vision, internal culture, etc. But in discussing all of those, it’s important to have the numbers as a backdrop.
Before you meet with your board, consider getting a sheet together of your cash-in-hand, spend, and monthly or quarterly revenue from year or two ago to a few years in the future. Learn the numbers and develop opinions about them! As with any business conversation, budget chats should be conducted with rigor.