Thinking About Thinking

2010 Is A Tough Year To Budget

Posted in Venture Capital by larrycheng on January 4, 2010

In my 12 years of investing in private technology companies, I’m finding that 2010 is a uniquely difficult year to budget for our portfolio companies.  In many ways 2009 was an easy year to budget.  If you rewind to Q408, the global economy was on a precipice of collapse.  That made conservatism the principal theme for 2009 budgeting.  Everyone got conservative on operating expenses and top line growth.  The question wasn’t should we be conservative – the question was how conservative should we be?  In some ways, that made budgeting easy.

Now we look ahead to 2010.  The economy is not exactly in dire straights, but it’s not exactly healthy either.  The capital markets aren’t exactly frozen, nor are they robust.  There is some spending going on, but people are still cautious.  Should companies put their stake in the ground and say this is a great year to invest and really push top line growth?  The risk to that is you spend more, the top line doesn’t materialize and you burn more cash than anticipated.  Or should companies be conservative and measured in any incremental operating expense and top line growth projections?  The risk to that is you’re sitting on the sidelines and insufficiently aggressive as market growth returns.  This is a tough year to budget. 

Obviously, budgeting is a case by case exercise, but I’m seeing some common practices have emerge.  Note that these are common themes for several of our portfolio companies, a vast majority of which are between $10 million to $50 million in revenue. 

  1. Set a conservative maximum monthly opex.  Many companies get aspirational on the top line target which gives them budgeting freedom to increase operating expenses while only showing only a moderate burn rate.  Management and board are like-minded that their intent will be to lower expenses if revenue doesn’t materialize.  In reality – it’s never that simple.  It’s always harder in practice to lower expenses in the future than to simply wait and increase expenses in the future if business performance warrants further investment.  My suggestion is to set the monthly opex presuming conservative top line performance relative to historical norms.
  2. Commit to a minimum cash balance.  At the end of the day, cash is king.  Many of our companies are committing to a minimum cash balance for the year – i.e. we won’t go below $X million of cash in the bank.  As part of board approval of that budget, the Board and management agree to a re-budget if the company goes below that threshold cash balance.
  3. Set a top line growth goal that is realistic, but calls the company to perform.  With #1 and #2 in place, I personally think the top line goal should presume high performance by the people in the company.  If you don’t plan for and expect high performance, you’re less likely to get it.  Again, a stretch top line goal shouldn’t be used to increase underlying operating expense, but it should be used to challenge the company to peak performance.
  4. Set the key performance metrics.  Every company has the 3–6 metrics that determine the health of the business.  Agree in advance on what those metrics are and what numbers suggest different levels of performance.  Review those metrics every month to decide if the company is on the right track or not.  If appropriate, agree on what performance should point towards additional investment and what performance should suggest more conservatism on expenses. 
  5. Plan annually, revisit quarterly.  This is one year where it’s necessary to have an annual budget, but prudent to think about the budget quarterly to see if there is any new information that has entered into the equation that calls the company to be more aggressive of conservative.

A final point is not to put form over substance in the budgeting exercise.  The end goal is to build great companies and create shareholder value.  The budget should be used as a tool to achieve those goals not to distract from those goals. 

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4 Responses

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  1. Shawn Van Dalfsen said, on January 4, 2010 at 11:04 pm

    This is so very important for companies planning a recovery in 2010, thanks for sharing.

    In marketing, we’ve all experienced that third quarter pull-back (or sheer panic.) Cancel the campaign. Cut key staff that maintain the website. Pull the retainer (and therefore the strategy and the PR.)

    A more moderate, conservative approach as you suggest would allow marketers to follow through on every important project. Meeting topline revenue goals for growth? Metrics on track? Reinvest in that particularly effective campaign. Or take on that contingent project that got cut at the last minute during the budgeting and planning process.

    • larrycheng said, on January 8, 2010 at 11:47 pm

      Shawn – I love it when marketing execs that own the revenue number, same as the sales guys. Sounds like you’re of that ilk.

      Larry

  2. Umang said, on January 5, 2010 at 4:57 pm

    Given the reasons you mention about 2010 being a tough year to budget, I would expect that #3 (in the common practices) would be difficult too.

    If one can predict what will be “realistic” there is no difficulty with budgeting, is there? :)

    • larrycheng said, on January 8, 2010 at 11:48 pm

      Umang, there’s truth to that. I think I define realistic as something that is defensible given historical growth patterns.

      Larry


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