Say you have a great idea, along with a plan for turning it into a product. You even have the chops to pull it off. That’s great. But do you know how much it will cost? Many first-time founders don’t. And yet, understanding the expenses you will face as you put your startup together is critical, as it will inform how much money you’ll need to raise to have a shot at success. While every startup is different, these tips from founders and their advisors will help you get started on a realistic budget for your company.
"Understanding the expenses you will face as you put your startup together is critical."
When entrepreneur Eli Portnoy launched his mobile advertising startup, Thinknear, in 2011, he figured $100,000 from friends and family was a good amount for him and his co-founder to get going. “We thought this could cover us to get to where we were able to raise venture capital,” he says. But Portnoy admits he never stopped to really think about what it would cost to ramp up. “It was a gamble.”
Luckily for Portnoy, the gamble paid off, though just barely. He stretched the money to cover the duo’s meager salaries, a bare bones market research effort (mostly books), a website and a Google AdWords campaign. Just before the money ran out, they had a prototype they could show investors. This time, they also developed an actual financial plan and forecast into their pitch. “We felt $1.5 million would give us an 18-month runway,” he recalls. The round closed at $1.63 million. Since the business was acquired within a year, he didn’t have to find out whether they had budgeted enough.
"Nearly one third of startups that fail do so because they run out of cash."
Many founders aren’t as fortunate. Nearly one third of startups that fail do so because they run out of cash, according to a survey by CB Insights. It’s the No. 2 reason for failure, behind lack of market need for the startup’s product.
Of course, figuring out your costs doesn’t guarantee you’ll make it. But it can help you come up with a realistic financial plan — and a sense for how much you should try to raise. Developing careful and prudent estimates is more important than ever in a post-COVID-19 world, as startup capital is likely to be more scarcer than it’s been in years.
So what does it really cost to run a startup? The answer will vary widely based on the type of business you are building as well as geography. “You can spend a third less here than in Silicon Valley and accomplish as much because the overall cost of living and business support is lower,” notes Peter Adams, managing partner of Rockies Venture Fund in Colorado.
You should start by getting a good understanding of the basic expenses most young companies will face. You can then supplement that by doing research on companies that are similar to yours. As you think about fundraising, a good rule of thumb is to aim to give yourself about 18 months of runway — to develop a minimum viable product or reach your next milestone — before you’ĺl need to raise money again.
"Starting a business is cheaper than it used to be."
The good news is that wherever you are, starting a business is cheaper than it used to be thanks to things like coworking spaces, liberal work-from-home policies and cloud services. The list below will help you get going on an exercise that can make or break your company.
Talent
Startups are all about talent. Employees will account for the biggest part of your budget, sometimes skyrocketing past 50% of your overall expenses. In the Bay Area, for example, the average salary for an engineer is $154,000, according to Indeed. Across the country, that average dips to $108,000, still not pocket change for most startups. Offering equity could help bring the tab down, but only a bit. Using contractors may cost you more initially, but may give you flexibility in the long term.
If you’re building a B2B startup, you’ll likely need help with sales. If so, think not only about skills but also about the culture fit. “People hire someone because they’ve been so successful in sales at IBM, but they’re going to fail because they’re asking, ‘where’s my assistant?'” says Dan DeGolier, founder and fractional CFO at Ascent CFO Solutions. Startups require early employees to understand that they will have to do without some perks.
Plan for any other key hires you may need depending on what you’re doing — say a merchandiser if you’re in ecommerce or a designer if you’re building hardware — and hire wisely. “The biggest costs were definitely payroll,” recalls Portnoy, who now runs Sense360, a customer data business.
As you calculate your people budget, don’t forget to account for two important items. The first is how much you need to pay yourself and any co-founders to make ends meet. The second is the cost of benefits, which can come with hidden surprises. “Consider whether employees are going to expect health insurance and whether it will cost more in year two, because it goes up by more than GDP each year,” says DeGolier.
Marketing
Marketing expenses can come in many guises:
- Digital ads
- Discounts and promotions
- Technology to support campaigns
Regardless of the type, you’re likely going to have to spend some money to acquire customers. “The whole reason for expenses in a seed round is to prove product-market fit, so marketing is going to be a lot of your expenses,” says Adams.
Some digital marketing costs start small but add up as you scale. Cloud tools like MailChimp, for example, allow you to target thousands of customers for as little as $300 per month. But add in Google AdWords or Facebook Ads for $1-$2 per click multiplied by the number of people you need to reach, and the bill will rise quickly. You may also need:
- Social media management tools
- Design templates for email campaigns and digital flyers
- Access to press release platforms like PRWeb
The list goes on, depending on the needs of your business.
Many companies will also need to spend on:
- Content marketing
- Sales collateral
- Events
- PR efforts
Much of that will be people costs, although events may also require physical products for booths, giveaways, and travel costs for team members attending.
This is a highly iterative process. You don’t build a budget one time and that’s it.
Technology
Startups used to spend a ton on on-site servers and a whole host of pricey software packages. The cloud has come to their rescue. Now, you can host your startup remotely with plans from Amazon Web Services (or its rivals) that start at less than $100 per month. You can also explore AWS Activate, which offers credits and support on a sliding scale for bootstrapped and pre-funded companies.
Many of the business software tools you will need are available on a freemium basis. Whether it is Zoom, Dropbox or Slack, the basic services are free. Once you grow you may find you need to upgrade to paid versions. (Some of them offer special discounts for SVB clients.)
The services you may need, in addition to basic productivity and communications tools, could include:
- Website hosting
- Optimization and SEO tools
- Automation apps like Zapier to link all your services
A good CRM will also likely be crucial to your sales success.
Other tech costs potentially include computers and phones. Currently, the trend is for employees to bring their own laptops and phones, but as the company expands, you’ll need to factor in providing equipment for your workers (it's also more secure than personal computers). DeGolier has taken a different approach for his own company. Instead of purchasing the same equipment, he pays a “tech allowance” so that employees can get the types of computers and phones they prefer.
Office
Once you’re staffing up, you’ll need somewhere to put your employees. On that front, things have changed significantly. Many knowledge workers work remotely, reducing the cost for start-ups. Still, over time, you’re probably going to need or want office space for some percentage of your employees. Rents in tech hubs like New York and San Francisco are highest, followed by those in places like Austin, Boston or Seattle.
"You're probably going to need or want office space for some percentage of your employees."
If you have an office, you’ll need furniture, which can cost over $1k per employee, including desks and chairs. And don’t forget to calculate extras like conference room and kitchen costs, which you’ll need as your startup grows.
Administrative costs
There are some necessary one-time costs as well as some lower ongoing costs that you shouldn’t ignore.
Registering a business typically involves low state fees plus the cost of legal support. In Kentucky, you’ll pay $40 to incorporate an LLC; in Nevada, it’s $425. If you are creating a C-corp, the recommended option for many startups, you may end up having to pay for a lawyer. Alternatively, you may be able to use cloud services LegalZoom or RocketLawyer to get basic paperwork in place. You may also need lawyers to put in place operating agreements and understand how to protect your intellectual property. Keeping the books in order won’t be free. At first, you could do it yourself using Quickbooks. But as you grow, complexity will increase fast and you will likely need help to manage your finance and accounting. You should also consider insurance, which can add hundreds or thousands to your annual bills. At some point, you may have to spend on services to manage your cap table.
Finally, don’t forget about payroll processing. Your accountant may handle this when you’re a team of a few people, but you may want to consider a cloud-based system like Justworks or Gusto as you expand. You can also try a professional employer organization, like Trinet, that shares in all the liability with you as a “co-employer.”
"Don't forget about payroll processing."
Be ready to adapt
When it comes to startup costs, expenses will fluctuate over time. Customer needs may change which can throw your costs in different directions. Market forces outside your control may cause you to re-examine your plans. Even in the natural course of business, costs may go up and down. That’s why it's important to plan your financial forecasts that include a base case, a pessimistic scenario, and an optimistic scenario.
“Make sure you raise enough to stay alive,” says DeGolier, who adds, “This is a highly iterative process. You don’t build a budget one time and that’s it.”
