Zero-based budgeting [TEMPLATE]

Assessing spend allocation as you scale your team

DEAR STAGE 2: We raised our Series A in late 2021, and are now reflecting on our current team and the investments we are making. How can we balance long-term optionality with short/mid-term investments in building our team to drive growth initiatives? Would love any guidance on benchmarks on team make up and how founders are handling this scenario planning! ~ASSESSING OUR BUDGET

DEAR ASSESSING OUR BUDGET: Regardless of “why” you start down this path, scenario planning is incredibly important for any company. Most do this annually and tend to approach the exercise through a top down lens (“we are trying to hit 8M ARR, what assumptions get us there”). Strong operators add another dimension and build a bottoms up plan (“we know our current demand gen, head count and conversion rates, what can we reasonably attain with  certain assumptions”). These approaches help you build a financial model and operating plan, but both (almost always) assume you roll forward current investments.

But what you are describing is a bit more nuanced than annual planning. You are rethinking your long-term business strategy and debating if “what got you here, can get you there.” This is where we like a zero-based budget — an exercise where you assume nothing and allocate the entire company budget from scratch.

At Stage 2, we have a pod model with two partners working together on each deal/portfolio company. A question like this was a great time to call on my partner, Dan Heck, to share his thoughts.

Here’s what we know about you…

You started this business X years ago. You built a team from scratch. You bought software, layered in systems and processes, and scaled up your operations. And over those years, you have learned a ton about the business, how it works, and how different functions contribute to the value of the company. 

And here’s why we love this question…

The goal of the exercise is to take those learnings, put them into a budget with constraints, and see how you would allocate certain levels of capital/resources knowing what you know now. Then, you can see how that "build from a blank slate" approach compares to the current allocation of spend. 

Dan recommends building a spend plan for 4 different scenarios, based on your current business (aka actuals from the last 6-12 months):

1. Profitable: How would you allocate resources if you started from scratch and needed to be profitable?

2. Half net burn: How would you do it if you cut today's net burn in half?

3. Current net burn: How would you do it at today's burn (but doesn't have to be today's allocation)?

4. Double net burn: How would you do it if you could double today's burn?

Here’s an example to illustrate using a business with the following characteristics:

• Annualized run rate: $5M 

• Gross Margin: 80% 

• These two together give you ~$4M of gross profit to offset expenses against

• Average net burn: $150K/mo or 

With this information we can back into the expenses available in each of our 4 plans. You can grab the calculator here (tab 1)  and plug in your own numbers! 

Now that you have your available budget(s), it’s time to rebuild your team — from scratch. For the purposes of this exercise, we’re going to focus on employees/salaries because this is the largest budget line item for most startups. Of course, you can incorporate non-salary costs into this exercise and reduce the available budget accordingly. 

Start out with the very first role you need: that's probably a CEO. Current CEO cost is X. Now, you have (starting budget - X) left to spend. Then, what's the second-most critical role? Say that costs Y. Now you have (Starting budget - X - Y). 

The end result is a ranked list of roles, and salary expenses (make sure to include benefits as well, so it's a fully-baked salary cost), that fulfill the respective budget plans (tab 2 in the template):

Dan emphasizes that you are explicitly *not* thinking about who is on the team, or any individuals when you do this exercise. Rather, it's just ‘we need this role and this is what it would cost,’ filled by a faceless, competent person.

Finally, you can see how your current company’s org structure/spend compare to your various budgets and to what the "average" company looks like (credit: Carta):

Hopefully this exercise will help shed light on how you've allocated spend. If there is a mismatch between your current org structure and how you would build it from scratch, it’s a great time for reflection, and potentially action. 

Until next week!