START UP SPENDING – WHERE TO SPEND ?
“How to efficiently deploy start-up capital such that it efficiently works?”
Defining “early-stage start-up”
To get started, we’ll need to agree on how to define an “early-stage start-up.” For the purposes of this series, I’m going to define an early-stage start-up as a company that can fall into any of the following buckets:
Where early-stage start-ups need to spend money
The following are areas where early-stage start-ups need to spend money in the early days. The underlying thesis is that these are not areas where you can afford to do things on the cheap. You may find other, free ways to do things in these categories, but, based on my experience, eventually, you’ll come around and wish you had spent a little bit more upfront to avoid a headache later on.
Your database is probably going to be the most expensive part of your infrastructure. It also has the potential to be the thing that increases in cost the quickest before your revenue catches up. If you have someone on your team with strong technical skills in this area, you’re probably best off running your own database in the beginning, but your mileage here will vary — big time.
Learning #1 – Do Not Be Blinded By The Idea or the Product
And what I can say is what we learned along the way is two golden rules, in my opinion. The first one is not to be blinded by the love of the product or the idea. I mean, we need to keep an eye on the market. We need to keep a very keen ear and listen to what the market is telling us. We need to pivot to adapt or whatever to whatever the market is telling us. If you’re too obsessed with your own product and idea and you don’t listen to what the market is telling you, you’re not going to survive because your idea is yours. It’s great, but it’s not necessarily what people are willing to buy and pay for. So that’s kind of the first thing we learned.
Learning #2 – Don’t Go Cheap With Your Talent, Good People are What Builds Great Companies
The second one that we learned is that we’re not rich enough to be cheap. By that I mean hire people by talent, don’t hire by cost. You know, a top-notch system architect for example is going to cost you a couple of hundred thousand dollars a year. You can technically go cheap and take somebody else for less for example – but for savings of tens of thousands of dollars, you’re going to pay twice because the product is going to be way more buggy and the time to market is going to be way longer and the issues along the way are going to be way harder to solve.
So when you don’t have a lot of startup capital, don’t be cheap because you’re going to end up paying twice.
Running a business isn’t easy. More than 90% of the businesses set up each year go bankrupt within the first three years. Less than 10% continue to live over the years. The number one reason for start-ups going bankrupt is the lack of cash. This brings us to the question, how do start-ups spend their cash? Do they have a way to prioritize spending?
Startups are largely dependent on the employees that work in them. As a result, they want to incentivize talented employees to leave their cushy well-paying jobs at multinational corporations. In their bid to do so, they often go overboard. Founders tend to spend an inordinate amount of money trying to have the coolest office in town. It may be necessary to provide employees with a safe and secure environment. However, it is not necessary to provide them with unlimited snacks and drinks. It is true that companies like Google have such offices. However, it would be better for a startup to first build a robust business model and only then splurge on an expensive office.
This is another area where a lot of start-ups tend to throw good money after bad. Recently companies have started a trend of acquiring market share before they become profitable. This often leads startups to give their products or services at throwaway prices. In most of these cases, the organization makes a loss from these sales and is better off not selling. However, it is often stated that this loss should be considered an investment in customer acquisition. The idea is that customers will get hooked on a product and will eventually start paying for it.
Many startups have learned the hard way that this is not always true. In most cases, such policies only attract freeloaders. These customers are quick to desert the company once they are asked to pay for the product or service. Startups should, therefore, focus their attention on getting genuine customers rather than discounting their products to freeloaders.
Startups often want to compete with corporate giants. Hence they tend to buy the same tools that these giants do. For many startups, this may not be a financially viable strategy. It would not be prudent to invest hard-earned cash in obtaining licenses for email and calendaring software. Similarly, companies tend to spend an inordinate amount of money on accounting and payment processing software. This is where startups need to leverage the benefits of modern technology. A lot of these services are available in the cloud. They can be obtained by paying a fraction of what big service providers like Google and Microsoft would demand. Startups must first acknowledge that their operations are small and hence the tools used by mega-corporations may just be expensive and economically unviable as far as their business is concerned.
Founders tend to have an emotional attachment to the companies that they work for. Often they have a burning desire to grow this organization into the next big corporation. The headcount of an organization is an important indicator of its growth. It is for this reason that many startups tend to scale up faster on the headcount that they ideally should. Employees are a permanent expense that many startup companies simply cannot afford. Instead, they should first outsource some of this work to other companies. Only once their revenues have grown robust should permanent employees be included on the team. Also, the process of recruiting new people on the team should be scrutinized to ensure that only employees that will add value to the firm should be included on the team
Branding is for big businesses. This is because branding leads to a lot of investment in the earlier stages. The benefits of branding are not really measurable at the early stages. By definition, branding is a long-term game. The problem with startups is that they are not sure whether they will survive the long term or not. Hence spending money on printing logos on hats, t-shirts, and pamphlets is not really a justified expense. These expenses would run counter to the lean business model that startups are expected to follow.
It is essential that startups must have access to strong legal advice. This is the number one expense that gets ignored. Legal advice is not as glamorous as marketing. However, it is definitely every bit as important as marketing is. Startup companies enter into a lot of unchartered territories during their early years. It is possible that the company may run into legal trouble sometimes. It is therefore important for the companies to seek legal advice and avoid these traps. Lawsuits can be expensive even for big firms. As far as startups are concerned, one nasty lawsuit can end the life of a very promising startup.