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Start-up Cost Projections For First Time Entrepreneurs

Q: At a pub in Los Gatos, CA a casual conversation with some young, first time entrepreneurs lead to an interesting comment:
"…the business plan outlines our estimated (operational) expenses but how do I know an investor is not going to look at these numbers and say…’are you f’ing kidding me’ and  right then and there we can loose this guy (his interest)…"How can an entrepreneur build these projections most accurately and in a way that will maintain credibility with potential investors?  What could be defined as the "best practice" for entrepreneurs dealing with this subject?

A: (Brad) As I’ve said in the past, I’ve never met a financial plan for an early stage company where the revenue side was correct.  However, I’ve met plenty where the cost side was correct (or – at least – appropriate).  The key here is simple – you want to have a cost structure that makes sense, covers all the bases, but doesn’t assume a big revenue ramp to be supportable.

If you are in the very early stages (e.g. a few people and an idea), recognize that your investor is likely going to be funding you for about 12 months to see how things play out.  The biggest mistake first time entrepreneurs make is that they fall prey to the idea that they need to put together a five year P&L forecast and cash flow projection.  I can guarantee – with 100% certainty – that this model will be wrong.  As an investor, I don’t really care about this; rather I want to see how you are thinking about getting to “the next stage” of your business.  You get to define the next stage, what it’ll cost you to get there, and what things will look like when you get there.

If you are a first time entrepreneur, go find an experienced entrepreneur to act as a mentor.  She can be a first line of feedback your cost model and likely will know a few “financial people” that can help you put together a simple, yet credible model.  In addition, when you spend time with potential investors, don’t try to bluff.  Tell them it’s your first time building a model like this and that – while you had help – you know you lack experience and are looking for feedback.  Try to engage the investor in the process. Listen the potential investors feedback and iterate on your model.

Simple message – don’t be afraid to ask for help.

May 25th, 2009 by     Categories: Financials    
  • http://adamwexler.blogspot.com adam wexler

    hey brad,

    i think that's great advice. i'm probably one-step ahead of this situation with my own startup (it's pretty fresh in my mind..) & I just hate putting together my financial statements when I don't want to “live” off of them. Similar to what you said, I think the most important factor is to show your competency when it comes to constructing a financial picture.

    In this day-and-age, much of a company's value cannot be reported on a spreadsheet (see Twitter) & the accurately portraying the expense side of the equation should become the main priority.

    -adam w.

  • Paul

    That's fine and dandy… but what is considered “credible”, realistic startup costs vs. not?

    Is asking for $500k to grow your team to 5-6 people credible? The answer is probably yes. What if there's a competitor who's raised $10M and you need to be able to match their potential manpower and speed? What do you estimate your costs at then?

    • http://collectivesys.com Jerry Ji

      > you need to be able to match their potential manpower and speed

      I think your urge to match competitors' manpower is only good for winning the cold war in an arm race, not for business, particularly startup business.

      Plus, I believe in the laws of The Mythical Man-Month.

      • Paul

        If you're sitting down at a poker table, and you have $500 in chips, and one of your opponents has $10,000 in chips, you are definitely an underdog and are very likely going to lose. No matter how well you play you will get bullied around, and unless you happen to get really good cards, odds are you're dead from the getgo.

        Basically what I'm trying to illustrate is that without sufficient ammunition to go up against the enemy, you are at a distinct disadvantage and may end up with a bullet through your head.

        My question to VCs is, how does one turn that fact into credible cost numbers? Or am I completely off-base, and Jerry Ji is right, and competitors should not factor into the equation at all?

        • http://www.feld.com Brad Feld

          Competitors matter, but only in context. The poker analogy doesn't work – if you find yourself overmatched one on one, then cash out your chips and go find another table where you are better matched. Or – take a totally different strategy and go play blackjack instead.

    • http://www.feld.com Brad Feld

      Sure, but it's not just “what you need to grow the team to 5 – 6 people.” It's more about what you are going to accomplish with the team. And – some small teams can accomplish as much or more as much larger teams / companies. Just because someone raises $10m doesn't mean they have their act together.

  • http://blog.excelsiorstudio.com/ Cory Armbrecht

    My co-founder and I have always been confused how to show future growth. How do you make a hockey stick figure without making a hockey stick figure? :) I love your approach, “don't bluff”. But I also feel that by saying “This is what I know, but this is what I don't know” will also make us look not ready, or not enough experience, etc. We got a couple early stage VCs we're looking at in the Boston and NYC area, and I'm worried (but supportive) about taking this approach. I believe honesty is the best approach, just proceed with caution I guess?

    • http://www.feld.com Brad Feld

      Well

  • PhilSugar

    I agree totally. You should be able to have a perfect model of what your costs are going to be and you should be able to say what/where that will get the company from everything but a revenue side.

    There shouldn't be any bluffing it should, be if we have these five or (however many) people and these resources we will launch, and make six months of iterations.

    Just because somebody raised more doesn't mean a thing. Since you have competition (and you do) there are many organizations out there with more resources…..its how you use yours.

    I've written before about how much it annoys me when I see a “financial type” (I am one) looking at year three revenue projections with great detail.

    I've mentored some people and had to thrash around with them when you get somebody questioning these numbers. I didn't want to provide them but for some reason quite a few east coast investors think you are amateur if you don't provide them. In the end I guess the conclusion should have been they were looking at the wrong investors.

    It kills me when I see somebody freak when I change one simple number and everything changes. “You can't change that go back to the original !” If only sales were as easy as changing a field in Excel. It should illustrate how accurate the numbers are if its that easy to change.

    That being said I do have models but they change based on the previous quarters revenue. I.e. we bring in this much we can now spend this much.

  • http://www.jasonspalace.com/internet-professional/internet-blog jasonspalace

    “go find an experienced entrepreneur to act as a mentor” sometimes these are harder to find, even harder to obtain time from, hardest to trust (if you don't know them). it's been a pressure concerning myself with 5 year projections and P&Ls for a technology that doesn't exist and has nothing on the market to compare with. instead i am working on focusing on my projections of internet traffic and estimated user traction, something my expertise may show a little more accurately. and i just wish there was a “given figure” to account for all general expenses (rent,utilities,furniture,etc). and if this number already exists, then i just gave myself away as a first time and for life internet entrepreneur.

    thank you for the insight!

    - jason nadaf

  • http://www.prime-targeting.com/expert-entrepreneur/ Famous entrepreneurs

    You’re confident you’re sitting on the next million-dollar idea. Whether you’ve already secured funding or just trying to figure out what it will take to get started, an accurate estimate of start-up costs is necessary to reasonably predict financial performance in the first few quarters. Of course every business and every industry have different cost requirements, but these steps can help you start the number-crunching. When approaching banks and other lenders for money, try to include a substantial cushion for beginning operations to ensure you’ll have enough money to set up an office, take orders, hire employees if necessary, and cover other related costs. Be reasonable with your revenue assumptions in the early stages and be conservative with cost projections. It’s also possible to structure a small-business loan to defer payments during the initial operating period.

  • Jim Franklin

    It's interesting to see how much startup costs have come down in the last ten years. Now for a web company, I'd say it's $300-500k per year for a team of a half dozen or so to get going.

    Also, I've seen a team raise $5M and kick the pants off a team that raised $20M. That's when I became a believer in the efficiency of the fast follower strategy.

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  • Sara William

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