Back of the Envelope Calculations for Every Early Stage Startup
You don’t have time to build a fancy financial plan, nor do you need one if you’re trying to follow Lean Startup principles when starting a company. Figuring out your early finances can be pretty easy, if you just follow some simple steps and always keep unit economics in mind. Here’s an easy calculation for early growth:
1) Start at the End- You’re just starting the company or are working on it on the side. What is your goal for the business? Is it to quit your day job and focus on the business full time? Get into an accelerator? Just make a certain dollar amount with a certain subset of hours? Make sure to figure out what your goal is, and be on the same page with any other founders. I would go so far as to write the goal down in a visible place so you are always focused on one thing.
2) Figure Out How Much You Need to Make - Now, you have to take the goal your team decided on and turn it into numbers. How much money do you need to make in order to reach your goal? If your goal is to focus on the business full time, figure out how much profit (not revenue, but profit) you need to make in order to live. For example, can you go on a spouse’s health insurance, or will you need to pay for your own? Often, healthcare costs can be one of the most prohibitive personal costs at a startup. Make sure your cofounders do the same, and do some simple math to come up with the Magic Number. Now that you have a number, you can do some calculations of how to get there.
3) How Much Are Your Customers Worth?- This is the easiest way to explain the customer’s lifetime value (LTV), a metric crucial to your business. For example, if you have a subscription company where customers pay $30/month and stay for an average of 12 months, your CLTV is $360. You can make some assumptions regarding how long your customers will stay (here’s a great article on how Netflix uses this data). If you don’t have a subscription business, it may take a few customers to get good data on what their average spend is, but you should be able to figure it out fairly quickly. If not, make the best assumption you can using other data sources.
4) How Much Does It Cost to Get A Customer?- Your customer acquisition cost (CAC) will be another key metric as it informs you exactly how much it will cost to acquire any number of customers you need. How do you figure this number out? There are several good strategies, one of them focused on SEM. You can run a test to see exactly how many AdWords dollars you need to spend before you get a customer to convert. Or, if you have partnerships, you would count what you pay partners for leads. This can be a complicated number to figure out, but again, just make some assumptions and use data. (Here’s another good resource)
5) Do Some Math- Now comes the fun part: take all of this data and make it work for you. Let’s say you and your business partner decide your goal is to be able to generate enough revenue to work on the business full time. You both calculate that you need $5,000/month (rent, healthcare, etc) to do this. That means, at a minimum, the business needs to make $10,000 (we won’t consider tax right now since this is back of the envelope). Now, you’ve figured out your customers are worth $100 over one month. Your CAC is $150.
Well damn, you are out of business. Time to pivot.
Let’s try this again: same goal, same CAC, but now you redo the business model and your LTV becomes $300. Now we’re talking. To reach your goal, you’ll need to get $10,000/($300-$150)=67. In English, that means that to quit your job and focus on the business full time, your business needs to generate 67 customers/month. Play around with the numbers to see what scenarios permit you to achieve your goals.
6) Reality Check- Now it’s time to do a gut check on those numbers. How realistic is getting 67 customers? What have you learned so far with your current customer acquisition efforts? Only you know the answer to these questions.
This is a useful framework for analyzing different business ideas, although, it would be good to gather data on each metric as you run the numbers. If you haven’t decided on a business, talk to owners who run similar enterprises and try to understand the unit economics. In my next post, I’ll follow up with what to do once you figure out the number in step 6.