Written by Part 2 of 4
Congrats on the successful Series C funding of $100M! (or if you are Nile, even more ).
As the CFO, the focus now shifts to responsible spending, maximizing cash utilization, and collaboratively crafting an operational budget that aligns with our strategic initiatives and secures the Board’s approval. This 12-month plan is designed to ensure our financial stability while extending cash flow to the last six quarters, allowing room for flexibility and cushioning. The investor deck was great but now it’s about the operating budget and getting all the details into a financial model with the right metrics.
Strategic Allocation of Series C Funds
At this stage, we have surpassed the product/market fit and are experiencing significant revenue growth (ARR) while expanding our customer base. The financial model now shows a path towards long-term profitability, making it essential to allocate capital correctly and prudently to align with the company’s objectives and operational metrics. Investors gave us money to grow the business so the umbrella metric to keep in mind is money in to get ARR out.
There are four budgeting methods we can consider, and we’ll focus on growing the business with improved efficiency.
Growing the Business & Maintaining Efficiency
A few years ago when the capital was flowing it was all about stepping on the gas (more like a pedal to the metal) these days investors want to see growth with improving efficiency. It’s assumed by this point also that Sales and marketing teams are performing well, existing customers are satisfied and a good number of them are helping to drive ARR expansion. To guide the organization, we target Net Dollar Retention, aiming for a rate above 120%, with 135% considered excellent. So bookings growth and quality of bookings (or billings) is the top line focus.
Expanding Sales Team and Product Enhancements
A big chunk of the budget will be allocated to expanding the sales team and enhancing product offerings to get customers excited. The assumption is that you have a balanced sales force with some AEs exceeding the quota, and others hitting the numbers while improvements are being made for those that are either taking too long to ramp or will not make the cut.
Properly sizing the sales team with an appropriate ratio of Account Executives and Sales Engineers is important because I have seen a lot of frustration with AEs signing deals but is unable to get customers up and running successfully.
With respect to Marketing, at this stage, the company has moved past branding and new channel discovery to a focus on qualified leads and top-of-funnel coverage, while demonstrating improved metrics like return on ad spend, growth in marketing-qualified leads, sales-qualified leads, and conversion rates by marketing channels.
Customer Success and Support
Customer satisfaction, as measured by Net Promoter Score (NPS) or ranking, is critical to retaining existing customers and optimising marketing spending. A high NPS ensures we don’t invest heavily in acquiring new customers when existing ones are dissatisfied. Churn is so painful and it’s worse when they have cancellation clauses in their contract (ouch!)
Operational Efficiency
The budget will prioritize enhancing operational efficiency to achieve profitability, with key metrics centred around operating expense categories as a percentage of revenue, including gross margins, S&M, R&D, and G&A expenses.
Here’s a summary of other key metrics to dial into your operational model and make sure things make sense.
- ARR Growth: Track and forecast ARR growth. Make sure your pipeline and coverage make sense, there is a factor rate assumed for your AEs and you don’t necessarily count those big any-day-now deals that have been sitting in Salesforce for two years. We look at New Business ARR, expansion ARR, Churn and Downgrade (if any) while also forecasting annual and multi-year bookings.
- Customer Retention and Churn Rate: High retention rates and low churn demonstrate a strong product-market fit and long-term customer loyalty. We have seen startups where the quarter closes with negative ARR because the Net business was low, expansion was limited, and churn was high. That would not be good so dont get overconfident that your customers will automatically renew.
- Gross Margin and Net Profitability: A financially healthy company is essential to attract potential investors for Series D finance and accounting. For software companies, gross margins should be in the low 80%. GMs near 70% should be ok if there is some hardware or cloud costs that is coming down but if your gross margins start with “60%”, it will catch people’s attention.
- Sales Team Performance: The performance of AEs against sales targets is an instrumental KPI and we track that closely. The last thing you want to do is double your sales count when existing teams are not hitting their numbers. Meeting or exceeding sales goals indicates an efficient sales process so work closely with the CEO and the Chief revenue officer to dial that in.
- Market Penetration and Expansion: To extend its market reach, you can examine its current market penetration and assess opportunities for expansion into new markets or geographies. Does it make sense to have people in 12 countries at this stage? It depends but remember the PEO costs, the channel support costs, the travel, all those things that can impact your metrics.
Getting Board Approval for the Operational Budget
Data-Driven Decision Making
Our budget proposal to the Board will be backed by data and detailed financial planning. Be prepared to discuss AE growth plans (the linearity by quarter for the year), the burn ratio, and any metrics specific to individual Board members’ preferences. Some board members will keep asking about the cash to ARR while others will demand that the magic number doesn’t fall below a certain threshold.
To ensure alignment, the operational budget will be presented alongside clear milestones and objectives tied to specific KPIs. The performance of our company will be benchmarked against other startups in the VC’s portfolio. At the Series C level, you will inevitably be compared to other companies in that group, some of which will be growing faster while maintaining better metrics. Have an answer ready when asked why you can’t do better or what the timeframe is to get to better metrics.
Scenario Analysis and Risk Assessment
The budget proposal will include scenario analysis to showcase different growth trajectories and associated risks. We’ll be prepared to handle various outcomes, such as exceeding or missing sales targets, prolonged fundraising, and market uncertainties, instilling confidence in our financial planning.
What if you can’t raise money as the climate deteriorates, can you make the cash last 6 months longer? All these “what ifs” should be dialled into a scenario tab in your model. By demonstrating preparedness for various outcomes, you can instil confidence in its financial planning.
In Part 3 we dive deeper into ways to accelerate the GTM and leverage Channel partners to force multiply the top line.