Start-Up Business Plan: Cost Per Employee and Reducing Burn
There are, in all likelihood, dozens of better discussions on this topic from smarter people available all over the internet. I was simply inspired to write this because I have explained it twice in the last 72 hours to two vastly different people for very different reasons.
There’s a saying that sportscasters repeat over and over and over again on NFL broadcasts, “The NFL is a copycat league.”
What they mean is that if “Team A” had success last year by running a certain defensive scheme, this year 5 more teams will do the same thing, for example.
Well, the web-startup industry has been a copycat league as long as I have been aware of it. Someone creates a new web-based service, it gains some popularity and someone else takes that idea, puts their own spin on it and voilà!
Of course, this has been going on the entire history of man. But I digress.
If you are aware of good start-up plans, templates for web-based businesses out there, let me know. I’ve searched, but most business plans freely available on the web that I’ve found (hey, I haven’t looked very hard!) are geared towards more traditional business models. You know, trucks and yellow page ads. Yes, still.
But back to my original point, even though the web-based application start-up culture is a copy-cat league, I haven’t seen a plethora of good business plan templates. So you’ll have to make your own.
To me, one of the most essential things to capture when modelling a business is the cost to operate the new company. Both in the beginning and as the company (ideally) grows.
Over time I’ll detail a lot of this, but I want to focus on staffing and monthly burn for now. Rent, utilities, legal and accounting expenses will be another topic.
When you calculate the cost of each required initial resource, factor in the following:
- Annual Salary - then divide by 12 (actual monthly cost will be based on the payroll date. If you have 26 payroll dates in the fiscal year some months will be higher, others lower. But for our purposes we just want an average).
- Payroll Taxes - this depends on the country and state/province
- Hardware/Software - We replace operating systems, desktops, laptops and upgrade software on staff machines every few years. Factor this in and average the cost over 24, 36 or 48 months and calculate the per month cost.
- Office Supplies
Now, it’s quite common for a start-up to offer equity or options as a recruiting tool, especially if the entity does not have the capital to burn (it costs more money to run than revenue brought in) as it builds out its products or services and adds customers.
If the employee wants a near market or market equivalent compensation, they won’t get much in the way or equity or options. But if they take less salary, they might get some equity.
This is one way to bring down the cost to run the business (if - as most web-based startups experience - the employee salary cost is the greatest operating expense) and control burn.
Remember though, that in its simplest form you’re dealing with a pie. If there are 100 shares, and your investor takes 20, the founders take 30 each (and there are 2 founders) there are only 20 shares left.
And you might need to add or recruit more staff as they business grows. Executives generally demand more shares than developers, so you can’t allocate the entire pool of shares that remain. As your company grow you will need to add experienced management.
To keep it really simple, when I calculate the cost of the typical experienced employee in a large North American city, I generally factor between 6k and 10k per month. If equity or options come in to play, the cost per month goes down.
Note that if the company has already received funding, in my mind the value of the options or equity is even higher.
So we want to hire Steve. Steve is a application developer with a decade of experience and a great attitude. We want Steve.
Steve wants 70k, 2 weeks of vacation, benefits, a screaming fast computer. But Steve also sees value in the company vision, and wants to own a piece.
So maybe Steve would be ok with 60k, vacation, benefits and 1% of the company. Now, instead of $7,300 per month, Steve will only cost us $6,250.
How did I get here? Well, I simplified, so I could quickly try to prove my business model:
Steve’s Compensation Scenario 1
Steve’s Salary Monthly Cost: ($70,000 annually) $5833.34
Vacation, Benefits, Payroll Taxes, Workstation, Software: (25% of salary) $1458.34
Total monthly cost for Steve: $7,2916.67
Steve’s Compensation Scenario 2
Steve’s Salary Monthly Cost: ($60,000 annually) $5000
Vacation, Benefits, Payroll Taxes, Workstation, Software: (25% of salary) $1250
Total monthly cost for Steve: $6,250
By offering Steve 1% of the company, the initial monthly burn to get the company off the ground is reduced by $1,041.67 per month.
If you believe that Steve is critical to getting your business to success, consider equity.
If you are asking yourself, “but what is 1% really worth?”
Depends on the market cap of the company and a bunch of other factors. And probably 99% of tech start-ups fail.
But if Steve wanted a greater percentage, he’d have to factor in that he is receiving a salary, and in all likelihood the founders are not. At least, they didn’t until they got the business to a point where it could attract investment.
Obviously, as is typical for this blog I’m vastly over-simplifying this topic.
And, keep in mind that this post is only relevant to a start-up. Existing companies and public companies are a totally different game.