Taming the Annual Budget


While you are thinking about the overall strategy and initiatives for the upcoming year, you must also prepare a budget that enables you to fund these efforts. Generally speaking I’m in favor of a bottoms-up approach to management. However, when it comes to budgeting, a top-down approach is more efficient. The senior team (CEO, CFO, COO) should develop an overall financial model which includes top-line growth targets for bookings, ARR (Annual Recurring Revenue) and expenses including headcount. This budget model should include sufficient investment to ensure that the top initiatives will succeed.

Think carefully about the skills and headcount required on new initiatives so that you’re not inadvertently overloading people and undermining initiatives that are strategic to the company. For example, if you’ve got a critical new Engineering project, it needs an owner who is 100% focused on that. It can’t be a part-time job for someone who already has more than a full-time role already.

Typically, you might converge on the financial targets using a couple of different approaches:

  • Extrapolation from prior year performance based on a targeted growth rate

  • Bottoms up quota-based revenue model, factoring in retention, expansion, churn

  • Deal-based revenue model, based on average deal size, segments, geographic regions

  • New initiatives to expand the product offering, distribution channels or geographic reach

In the startup stage, there is no one-size-fits-all model for the annual forecast. It typically requires a triangulation of multiple approaches. For example, if you grew at 70% in the prior year you might adjust that number up to reflect your optimism around new product initiatives and your desire to be attractive to new investors in anticipation of further fundraising.

If you’ve got a direct sales model, you’ll want to understand how much new bookings are required and whether you have enough sales people to achieve those targets. If you’re seeing traction with larger customers or anticipate a new premium priced offering, you might expect larger deals and some expansion with existing customers.

There’s no one single way to build the model, but you want to make sure that you’re funding the right initiatives and staffing to achieve the desired results. If you’re expecting sales to double, you want to make sure there’s sufficient management, training, headcount and lead generation to support those efforts. As the number of customers expands, so does the requirement for customer success, support and so on.

Each department should create their own annual plan and budget. This will not be as sophisticated as the company’s annual plan, but should fit in with major initiatives. For example, if there’s an overall company goal to expand into Europe that will have implications for language translation, local sales and marketing, local language support, marketing events and so on. 

Each department will have their own departmental specific initiatives through the year. For example Engineering might have goals related to improving uptime or performance. Sales might have goals related to hiring and training. Marketing will have goals around product launches, lead generation, pipeline, analyst relations, PR, etc. A departmental plan could be as short as one or two pages, and ideally no longer than five. The plan should include a definition of what success will look like and identification of any key risks that should be addressed.

Departments Must Be In Sync

You’ll want to make sure that there is coordination between the departments so that Product, Engineering, Marketing, Sales are all in sync. If there’s a product launch expected in Q2, you want to make sure Engineering and Product are clear about delivery dates and major features. Marketing and Sales need to be collaborating on launch plans, training, lead generation and so on. You also need to make sure that you don’t set every major initiative and new hire to start in Q1. You will need to temper ambitions so that things are spread through the year.

I have found the best way to do this is to have departmental leaders share their plans with their peers and collaborate together to understand who is doing what and when. This works best if the executives can get on the same side of the table and work out their needs and priorities together. It also helps to understand the “client relationship” between departments. For example, Engineering is there to build the features that the Product team needs to win in the market. Marketing is signed up to deliver content and lead generation so that Sales can close more bigger deals, faster.

While you might not get 100% alignment across every issue facing every department, you want to avoid too many gaps. I have found that Sales always wants more leads than Marketing will sign up for. But if they can narrow the gap to 15%, that’s close enough. Especially, if there’s a possibility of larger deal sizes, or expansion which can provide some relief for required lead generation. But you want to avoid a gap that’s larger or requires a miracle in the fourth quarter.

Drive Toward Efficiency

Once a company has product-market fit and traction beyond $5-10m in ARR, you will typically want to drive increasing operational efficiency. So, if revenues are to double in the next year, that may require doubling or close to doubling the size of the Sales team to ensure proper quota coverage. However, you want to be careful that other departments such as Marketing, Sales, Support, Engineering, HR, Finance expand at a slower rate. Otherwise you may never get to break-even cash flow positive. 

There can be some back-and-forth discussion or negotiation with the department heads on headcount requirements. Are they hiring individual contributors or managers? At what level of seniority or location? Also consider whether to trade-off headcount for program expenses such as use of part-time contractors for specialized skills. Asking departmental leaders to create their own bottoms-up budgets and headcount plans without top-level targets and constraints takes too long to converge. You are best off assigning them their departmental headcount and dollar budgets and asking the departmental leaders to live within those constraints. How they spend the money and what roles they require is up to them.

Be Flexible

No plan or budget can be set in stone. The business will evolve as things proceed and it pays to be flexible. For example, if instead of hiring more Engineers, there’s a need for more QA, that’s a trade-off that the head of Engineering should be able to make, as long as they are living within the overall budget constraints.

It’s worth having a mid-year check-in on the budget to make sure that things have not gone off the rails. In particular, if hiring and expenses are running high and revenues are lagging, that may require you to reconsider which initiatives to double down on and which should be scaled back.

That said, you want to be careful not to set the expectation there’s more headcount to be had with an all-new budget process. You want to make sure you’re building a disciplined approach to growing the company.

The Peril of Growth At All Costs

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I’ve had good luck working with many Venture Capital (VC) firms over several decades. For the right kind of high-growth business, they can be very helpful in providing not just the investment capital, but also opening doors to hiring executives, providing strategic guidance and financial counsel when needed. I have worked many times with Benchmark Capital, CRV, Index Ventures, Kleiner-Perkins, Matrix Partners, PointNine Capital, Redpoint Ventures and Scale Ventures. These are among the top firms out there and they have a long track record of working well with founders, CEOs and executives. There are many firms beyond this list that are equally good.

But when I speak to founders about raising venture capital I remind them in very clear terms: Venture investors do not care about them, their product, their team or their customers. In the end, VCs care about getting a return on their investment. And more often than not, the top firms are looking for home-run returns of 10x or better on their investment.

The entire thesis of venture capital is based on making dozens of investments wherein there are a couple of outsized 10x - 100x returns, a couple of smoking craters where the company shuts down or is sold cheap, and then a large number in the middle that get to some kind of a decent outcome over the long haul. VCs are in the home run business, and if your business is not growing at or close to 100% year over year and on it’s way to $100 million in revenue in a few years, it isn’t interesting to them.

There are plenty of great businesses that are simply not a fit for the high-growth model that VCs prefer. So before you go down the path of attempting to raise money from venture investors, you must be honest about your ambitions and your business’s potential in the market. How big a business can you build? How big is the market?

Much like novelist and screenwriter William Goldman said of Hollywood in the 1980s: “Nobody knows anything… Not one person in the entire motion picture field knows for a certainty what's going to work. Every time out it's a guess and, if you're lucky, an educated one.”

Venture capitalists look at hundreds of deals and invest in only a handful each year. They turn down perfectly good businesses for a variety of reasons: lack of time, conflict of interest with an existing investment, beyond their area of expertise, too capital intensive, unproven founders, unproven business model etc.

If you decide to pursue venture capital remember that this is a long-term relationship. They are buying a portion of your company for an eventual payoff that could take five to ten years. They will be your partner, advisor, mentor and owner during that time. As with a marriage, it pays to get to know them before you get hitched. If you are uneasy about the venture partner you are working with, if they rub you the wrong way, if your views on fundamental topics differ widely, think twice before you take their money.

There’s a danger in venture capital which is worth remembering. Like William Goldman’s “Nobody knows anything” comment about Hollywood, much of venture capital is about making bets where the outcome is clearly not knowable. Even the most successful VCs are wrong at least as often as they are right. There is a grave danger when investors (or founders) believe that VCs are infallible.

In late 2020 for about a year we were coming off a surge in ecommerce growth due in part to Covid, public tech stocks and private company valuations soared. It looked like the whole world would go full-on digital / remote / everything online all-the-time for the rest of eternity. Valuations for SaaS companies reached and then exceeded historic highs. Companies with ten or twenty million in revenues were valued at a billion dollars. And soon it was more than that.

If you were selling into that frothy over-valued market, good for you. There’s nothing wrong with being lucky. There were three companies where I was an advisor or board member that sold for very nice prices during that period. The founders and executives of theses companies had built something valuable and were pleased to be taken out at more than generous prices.

The side-effect of an over-valued market, is that the investors encourage a dangerous game of “growth at all costs.” This idea of “blitzscaling” has paid off for companies like Airbnb, Facebook, Google, Linkedin, Uber and the like. The idea is to grow so rapidly that you leave any potential competitor in the dust.

Unfortunately, most companies are not like Airbnb, Facebook or Google. Focusing on growth above all else means that business fundamentals (like product market fit, efficiency and profitability) get short shrift. If a manager is busy hiring the next ten programmers how much time is he or she spending on managing the last batch of hires? Growing a business at 100% or more year-over-year is stressful and often chaotic. It’s easy to get caught up in the rush of non-stop expansion and taking on new initiatives that you can overlook the need to find repeatable, efficient go-to-market patterns.

And even worse, the Silicon Valley fundraising process encourages founders to think of themselves as being in that rare 1% of companies destined for hyper-growth success, despite statistical evidence to the contrary. I recall several meetings with top silicon valley VC partners when I was at Zendesk and Duo Security where they told us “we were one of a handful of companies that mattered.” It’s hard not to let that all that flattery go to your head. After all, what founder or executive doesn’t think of themselves and their company as special?

Not surprisingly, during the boom times founders and executives ramped up their hiring, increased their marketing budgets and tried to spend their way to high growth to justify the sky-high valuations. In good times, investors are fond of “pouring gasoline on the fire” which I’m pretty sure you are never supposed to do in real life.

So when the public tech stock market swooned in mid 2022, there was a reckoning to be had. Newly minted public companies were trading 40-75% off their peak. Some companies got ahead of the issue and did layoffs. Even the Blitzscale companies like Facebook, Google and Twitter did massive layoffs impacting thousands of employees. ("Thanks for working so hard, sorry we screwed up!")

Unfortunately, many companies moved too slowly or cut too little to make a fundamental difference in their trajectory. If you’re going to do a layoff, make it count by cutting at least 15% and eliminate under-performing areas of the business. Don’t try to keep doing everything you did before with fewer people.

Many of the companies that raised money at peak valuations will have a hard time adjusting to the new reality. Valuations that were once at historic highs are now at record lows in 2023. Venture investment has fallen off a cliff, and if your company can’t get to breakeven / cash-flow positive in the next twelve months, your survival is at risk.  It’s not easy, but you’ve got to reorient the entire culture of the company that has been built on “do more, hire more, spend more” to get a level of efficiency that enables your company to continue without raising additional capital. 

Companies can easily find themselves in a no-man’s land where they don’t have enough runway to get to profitability and no-longer have the high growth rate to make them attractive to new investors. If you’re lucky you might get an inside round from your current investors. Or maybe down round, at a lower valuation. (There are worse things, believe me.) My suspicion is that as we get to the end of 2023 and into 2024 there won’t be any rounds for some of these companies.

When that happens, you’ve got to figure out how to land the plane. That might mean selling to a larger competitor, a strategic partner or to Private Equity. Any of those outcomes can be preferable to going out of business or becoming a zombie company with stagnant growth. However, few companies want to acquire a money losing operation. So you still need to figure out how to get to healthy margins, even if it’s inside a larger company.

This is where you can put your VC investors to use in helping ensure that you not only have the right product for the market, but you have a well-thought-out pitch and introductions to potential buyers to help ensure a long-term strategic fit. 

Are you concerned about your company's burn rate? Let me know what questions you have by adding a comment below. 


Zack oaxaca beer

I've started a new blog called Build To Scale that takes over from earlier writing I did about open source businesses. This is intended as a guide for founders and startup executives to help them build and scale a high-performance business. I will be building on lessons learned over several decades helping to build and scale companies like Duo Security, Zendesk, MySQL and Active Software, companies whose combined value grew to more than $20 billion. 

Some of the topics I will cover include:

  • Finding product / market fit
  • Fundraising
  • Building a high performance culture
  • Managing objectives
  • Scaling sales and marketing
  • Managing engineering
  • Managing through a crisis
  • Mergers & acquisitions

It's not easy to build a business and I am grateful to those who helped me along the way. Many of these lessons have been learned the hard way, and I hope that I can help founders and startup executives avoid some of the most common (and painful) mistakes. It's the kind of friendly but real advice you might get talking over beer or coffee at The Great Startup Bar & Grill, if there was such a place. 

Feel free to let me know questions you have or topics you'd like to see covered. Shoot me email (I'm easy to find) or add a comment below.  These posts are also available on Substack.