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One of the biggest unknowns for many entrepreneurs is how much money they need to survive that critical first year in business. This is a worrying state of affairs given that nearly one-third of startups that fail, do so because they run out of cash. Pre-pandemic research found that the average UK start-up spends £22,756 in its first year. However, this cost will vary significantly from business to business. A precise understanding of the expenses you will incur as you build your startup is critical. It will inform how much money you will need to raise to have a chance of success. These tips will help you get started on a realistic budget for your company.
Luck is not a smart strategy
Entrepreneur Eli Portnoy launched his mobile advertising startup, Thinknear, with £72,000 raised from friends and family. “We thought this would cover us to get to where we were able to raise venture capital,” he says. But Portnoy admits he never stopped to think about what it would cost to ramp up. “It was a gamble,” he admits.
Luckily for Portnoy, the gamble paid off. He stretched the money to cover salaries, a limited market research effort, a website and a Google AdWords campaign. Just before the money ran out, he had a prototype to show investors. Importantly, he had also developed a solid financial plan and forecast, which was included in the investor pitch. “We felt a million would give us an 18-month runway,” he recalls. The round closed at just over a million.
Portnoy was lucky, but luck is not a strategy that will pay off for many. In fact, running out of cash is the second most common reason that startups fail.
The actual cost of running a startup
Understanding your costs doesn’t guarantee success. But it can help you come up with a grounded financial plan and a sense of how much you should try to raise. Developing prudent estimates is more important than ever in a post-COVID-19 world, as startup capital will likely be harder to come by.
So what does it cost to run a startup? You should start by getting a good understanding of the basic expenses most new businesses will face. Researching companies similar to your own can be a good way to get an initial understanding of what these might be. As you think about fundraising, a rule of thumb is to give yourself about 18 months of runway to develop a minimum viable product or reach your next milestone. You need enough in the bank to achieve this before you need to raise money again.
The list below will help you commence a financial analysis exercise to map out how much money you need to lunch your startup.
Talent
Startups are all about talent. Employees will account for the biggest part of your budget, sometimes skyrocketing past 50% of your overall expenses. However, startups can take a smart approach to managing HR costs by using contractors based outside of major city hubs.
For example, in the London area the average salary for a software engineer is around £83,000, according to Reed. That compares to a national average of just over £50,000. By hiring out of London, startups can significantly reduce the cost of talent acquisition. Hiring on a contract basis is also a smart move. Though it may cost more in the short term, it offers valuable flexibility.
If you’re building a B2B startup, you’ll need to plan for key hires in line with the nuances of your business. Most startups will need sales support but other priorities will vary. For example, e-commerce businesses will need a merchandiser. But, whatever your hiring priorities, you’ll need to factor in a culture fit, as well as skills. Startup life means that early hires must be prepared to do away with the trimmings that come with more established businesses. There must be a willingness to make your own coffee and be your own PA if you work for a startup.
Finally, 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. Factor in items such as pension payments, bonus payments, or holiday and maternity entitlements.
Marketing
Marketing expenses can come in many guises — digital ads, discounts and promotions, technology to support campaigns. But, whatever the method, marketing is critical. Hannah Neuburger of EU-Startups says “marketing is one of your most powerful tools to get your startup up and running”. This makes it one of the core expenses to factor into your plan.
Some digital marketing costs start small but add up as you scale. Cloud tools like MailChimp allow you to target thousands of customers for as little as £215 per month. But if you seek to advertise, on Google or Facebook for example, the average cost per click is £0.78. Multiply that 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, and access to press release platforms. The list goes on, depending on the needs of your business.
Technology
Startups used to spend a lot of money on on-site servers and a whole host of pricey software packages. But, the cloud has come to the rescue. Now, you can host your startup remotely with plans from cloud providers that start at less than £75 per month. Many cloud providers offer support and benefits for startups, including financial incentives.
It is also worth looking at business software tools that are available on a freemium basis. For example, for Zoom, Dropbox or Slack, the basic services are free. Once you grow you may find you need to upgrade to paid versions.
The services you may need, in addition to basic productivity and communications tools, could include website hosting, optimisation and SEO tools, and automation apps. A good CRM will also likely be crucial to your sales success.
Other tech costs potentially include computers and phones. Helpfully, the current trend is for early employees to bring their own laptops and phones, but as the company expands, you’ll need to factor in this equipment for your workers. You can even consider tech allowances for employees to purchase the types of phones and computer they prefer.
Office
The idea of the ‘workplace’ has changed significantly since the COVID-19 crisis forced many of us to work remotely. This has the potential to reduce your costs, at least for the short term.
Still, over time, you will likely need or want office space for some percentage of your employees. Not only that, the estimated 125-225 sq ft necessary per employee may no longer be sufficient if social distancing requirements remain in place. Knowing what rents will be, post-crisis, is difficult as the office market has been upended. Yet one thing unlikely to change is that rents in tech hubs like London, Cambridge, Manchester, or Edinburgh, will remain the highest. Seeking to locate outside of these hubs is a smart move while you scale.
If you do have an office, you’ll need to fit it out. Even at the basic level, this can cost from £35-£40 per square foot, with office furniture costs working out at £500-600 per person. It’s also worth thinking about where your employees will be based in relation to your office; you could incur significant travel expenses.
Administrative costs
Legal fees, accounting and payroll are some of the key costs to consider when it comes to business administration. While registering a business involves relatively low fees, you will need to factor in the cost of legal support. However, there are a new breed of cost-effective, online legal services such as Law Depot, that can help you get basic paperwork in place. You may also need lawyers to put in place operating agreements and help you to 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 or Xero. 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 PaySlip Maker or Workday as you expand.
Be ready to adapt
It is important to remember that planning startup costs is an iterative process; things will fluctuate over time. Customer needs may change, throwing your cost structure in a different direction. And, as the last year has demonstrated, market forces outside of your control may cause you to re-examine your plans. Even in the natural course of business, costs may go up or down. That’s why it’s important to make sure your forecasts include a base case, a pessimistic scenario and an optimistic scenario.
While the economic outlook may be uncertain, startups have proved they can be resilient and many have thrived even over the last year. While you should not put your dreams aside, do remember that starting with a reasoned and realistic approach to financial planning will increase your chances of success. Make time to understand and research the costs of running your particular startup; this will help you understand how much you need to raise to hit those all-important first milestones.
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