how startups should budget in uncertain times
I embodied the classic startup founder profile: I temporarily left my studies at Stanford to launch a business, and following its unsuccessful outcome, I needed to carefully manage my finances to continue my student loan repayments.
Living with roommates in Menlo Park and driving an older Nissan Sentra, my most significant fluctuating expense was food. Consequently, ramen became a nightly staple. Occasionally, I’d treat myself to sushi on a Friday if funds allowed, and a fortunate circumstance – such as a friend’s parents offering to pay – might enable another small indulgence with friends on Saturday.
The core strategy I adopted during this period is a common one: minimize spending until revenue becomes more reliable. Numerous startups currently face a comparable dilemma: ramen or sushi?
While certain companies are experiencing success during the COVID-19 pandemic, its longevity remains uncertain. Consider the realm of online educational resources: currently, there’s widespread demand for these tools. However, when in-person instruction resumes, a portion of learning will likely continue online, given our newfound familiarity with the format, though it’s improbable that it will reach 100%. A greater challenge than predicting the exact percentage is the ongoing inconsistency across different regions, demographics, and industries. This mirrors my current experience in San Francisco: before deciding on ramen or sushi, I must first verify which restaurants are open, and then navigate their frequently updated operating hours and menus.
Presently, startup financial planning shares this characteristic. The fundamental assumptions used for projections – already subject to some degree of fluctuation in a startup environment – are now even more unpredictable. Metrics such as the conversion rate from marketing qualified leads to sales qualified leads, the number of stakeholders required for contract approval, leads acquired per event (and the definition of an event itself), and net renewal rates are all in flux, and these changes vary depending on customer segment, location, and product type. The prevailing environment is one of constant change.
Steering Through Ongoing Uncertainty (and Revisiting Plans Each Quarter)
What’s the best way to approach budgeting in the current climate? Most organizations revised their plans back in April. It’s prudent to anticipate a comparable review process on a quarterly basis. “Have we reached a stable state? How can we determine this? Are we truly secure in that assessment?”
Beyond the standard metrics businesses traditionally employ for forecasting – such as rates of growth and conversion – it’s now essential to account for a range of external influences. These include the effects of the recent period on both existing customers and potential clients, their ongoing budget adjustments, and their evolving strategies for managing unpredictability in the near future. While conditions may appear to be settling into a new pattern, the possibility of renewed COVID-19 outbreaks and associated restrictions remains, and the United States is entering an election period with the potential for additional governmental actions.
Consider this a guide for making decisions about resource allocation or external activities:
Establish initial expectations and evaluate performance, then revisit these regularly and as needed
Review your financial plan each three-month period. Furthermore, if spending deviates from projections in any given month, implement necessary changes.
A quarterly review schedule is suggested because typical sales processes often extend beyond a few weeks, making it challenging to gather sufficient data and implement modifications based on a timeframe of only two or three weeks. The following are the essential metrics you should track:
Revenue
Examine the anticipated income from both existing clients and potential deals currently in your sales process. Begin with a detailed, data-driven forecast, and also include a sensitivity assessment to establish a realistic range and level of confidence regarding revenue projections. Thoroughly analyze each transaction and cost, categorizing them for clarity. The objective is to accurately forecast this quarter’s revenue and also identify key trends: For instance, renewals are consistently occurring with customers in the education sector, specifically those located in the northern regions of the country.
Organizations with over 1,000 employees are currently experiencing an average sales cycle of 90 days from initial contact to contract completion, while larger enterprises—those exceeding 10,000 employees—with allocated budgets for this type of solution continue to finalize deals in an average of 45 days, with the exception of those based in the Asia-Pacific region.
Lead flows and conversion rates
Historical data offers less predictive power now than it did before the onset of the COVID-19 pandemic. The fourth quarter of 2019 represents the most recent period of typical performance—however, it may not be particularly useful for forecasting the third and fourth quarters of the current year due to the numerous influencing factors and existing uncertainties. As a starting point for projections, consider anticipating a 20% increase in leads during the fourth quarter compared to the second quarter. While this outlook might be more conservative than some prefer, current indicators suggest a positive trend.
Following this, you can develop various projections based on that initial estimate: Determine the budgetary implications if lead generation mirrors the results of the second quarter. Then, assess the impact of a 40% improvement over the second quarter’s lead volume. Conduct a focused analysis of opportunities originating after March, tracing their progression through your sales process. Identify the necessary stages, the time required for completion, the number of individuals contributing to the decision, and any deviations from previous patterns. By developing and evaluating these potential outcomes, leadership can arrive at a balanced and informed strategy.
Demand generation
What level of financial commitment will you dedicate to initiatives that create demand – an area that currently offers cost savings due to reduced travel and event expenses? Are you allocating more resources to digital marketing? During periods of instability, it's crucial to identify which marketing channels are delivering results and to measure the impact of those investments on your sales conversion rates. This allows you to adjust program spending based on demonstrated effectiveness – a strategy that may introduce some budget variability until you establish reliable data regarding campaign outcomes and the consistency of those results over an extended timeframe. To optimize your approach effectively, accurate attribution is essential.
Collections
A key element of effective budgeting involves carefully evaluating anticipated cash inflows. When pursuing a new agreement, it’s crucial to determine, “Upon successful completion, what are my expectations for receivables? What have past trends indicated?” Considering the unique financial situations of your clients, it may be prudent to incorporate a safety margin. For instance, if collections typically occurred within 60 days, your budget might need to account for a 120-day timeframe.
Clients requested extended payment arrangements during the second quarter and this demand may persist. To enhance your budgeting process, it’s beneficial to model various possibilities – using historical collection rates increased by 30 days, or by 60 days, for example.
Eventually, I secured employment and my income became more stable. As a result, budgeting became less challenging, allowing me to indulge in sushi more frequently while still maintaining a reserve of ramen for unforeseen financial difficulties.
We can confidently expect that ongoing instability will be a factor. Nevertheless, establishing a robust system will ultimately lead to a consistent and manageable budgeting process.