Entrepreneurship Series – Keeping Your Cost Low

Dennis Goh, Entrepreneurship, Entrepreneur, forest, valley, start-up

I stated earlier that in going through entrepreneurship, it is vital to keep your cost low and explained why

So, how do you keep your cost low, Mr Entrepreneur?

FOUNDER SALARIES 

Peter Thiel famously stated in 2008 that a low founder CEO salary was the best predictor of start-up success. This is so critical to him, that he stated “If you only ask one question, ask that”. It is quite obvious why. High founders’ salaries burn precious cash that could otherwise be used for marketing and increasing the odds of success going to market. Founders’ salaries also set the benchmark for the entire company. If founders exercise salary discipline, the rest of the company will too.

Nextweb recently did a study on founders salaries, and the results are interesting. 

2 key charts that stand out for me from the article

1) The average founder salary is around US$40,000 annually from Concept to Functional Product (Limited Users) stage. Of course, this assumes that the start-up has raised funds, given there is no revenue at the beginning. Even when the product hits High Growth and Mature stage, it does not exceed US$70,000 a year.

Founder-salary-by-product-phase

2) By funding level, the statistics show a similar picture. For start-ups that have raised up to US$5 million, the average founder’s salary also hovers around US$40,000 annually. After US$5 million, it ranges from US$62,000 to US$82,000 a year. In all the funding ranges, it is consistent that the founders do not pay themselves a salary level that cripples the start-up. More crucially, this is the best way of showing the VCs/investors that the founders are seriously aiming high for that big payoff from growing the product and subsequently an exit/IPO, rather than a big payoff from salaries

 Founder-salary-by-funding-level

What is significant is that these salaries are indicative of Silicon Valley itself, as the article notes. In the land of 10x engineers (who can earn a lot more working for Google, Facebook etc as employees), it is highly significant that many of them are working on minimum salaries as founders to push their products out to market and allocate the majority of funds raised to growing the product globally.

If we start-ups know this, you can bet that the VCs/investors all know this as well. Before they dish out funds, the first question they will ask is: “How much are you paying yourself, Mr Founder?” – this issue will affect your success in raising funds besides the usual growth metrics VCs look at

I would however add that I do not advocate founders working for free forever. The reason is also quite simple: Founders’ morale will be destroyed over time, if they do not see a tangible return for their efforts and seeing some bills paid, however small that return might be. Entrepreneurship is meant to be enjoyable, not turn you into a suicide case 😕

Hence, the moment your start-up starts to generate some funds or you raise your seed round, you must pay yourself a small token, however small that is. It will go a long way in helping you last the distance. At the very least, you have something to live on – that is a tremendous morale booster

GET A FREE PROGRAMMER

Bet the headline gotcha!

Clearly, this is not a problem if you are a programmer. But many people are not, and they ask me “Can I do a technology start-up if I am an Arts student” – Yes, you can! But make sure you get a co-founder who can code well. So that it becomes easier to scale as you grow (you control your own code from Day 1), and you lower your cost dramatically – Remember….Founders always work for free in their own companies…..for a long time! 😉

In summary, 2 key advantages to having a programmer as your co-founder:

1. Good programmers are tough to find these days. 10x engineers (Rock star programmers) even tougher. To hire them is very expensive. Roping them in as co-founders dramatically lowers your cost (and risk). There is however the issue of teamwork – read my future post on “The Right Team”

2. Your company 100% owns the IP. No worries about future lawsuits when you are a billion dollar company whereby past programmers that you outsource work to say they own this or that etc. In addition, higher odds of continuity. It is tremendously disruptive and expensive when you change programmers (or outsource companies). Frequently, there is changing of code or frameworks, because it is a known fact that programmers do not like to work with other programmers’ code base, unless it is some rock star who programmed it – yes, programmers have egos too 🙂 There is also the simpler explanation that some programmers just might not understand the logic flow of the former programmer.  Regardless, it is unnecessary additional cost and time to always be changing programmers. And believe me – programmers come and go like crazy

But what happens if I cannot find a good programmer as my co-founder? Then I think your cost will go up. My own experience indicates that start-ups that outsource programming work (right from the start) bear a very high risk of going to market really slowly and bug changes going through a longer cycle. And you are paying salaries (yourself and the team) – the more delays you encounter, the more costs you incur. If you have zero cost, then ignore this point (although there will always be your opportunity costs).

Imagine this – assume your platform costs anywhere from S$10,ooo to S$50,000 to build. Unless you do your specs really clearly (very tough) and your outsourced team understands you 100% first time round (very rare), you will spend a lot more time getting your technology platform off the ground, asking many questions along the way such as “Why did you code this way” and “Why is that feature here” or “How come the flow is like that?”, and finally “We need to redo this again!”.

The problem arises because technology platforms are usually complex to build, while the outsourced team will never be by your side 24 hours a day. The risk of miscommunication is very high, and the coordination for rapid roll-out is near-impossible compared to having programming co-founders working on this 24 hours a day.

Worse, there is always the possibility that your outsourced team is working on 10 other projects at the same time – these 10 other clients are higher paying clients compared to you, and they do not have enough manpower to handle every project 100%. Guess whose project they will de-prioritise? 😉

Fixing bugs will also take a much longer time. Building a platform quickly is one thing. Building one bug-free is another. Frequently, you will encounter many bugs. And after a platform is delivered to you, follow up “customer service” from the outsourced house  might not necessarily be smooth. It is almost like embarking on an entire new project to get the bugs fixed, and they might charge you more if you take up too much of their time (i.e. way beyond the time cost they projected for your project).

The costs all start to add up over time, way more than if you had your own programmer co-founder (best), or hire trusted full-time programmers (2nd best) – your initial S$10-50K platform cost might end up becoming S$20-100K

Summary – Unless your cost is zero (all founders working part-time elsewhere to support themselves), not having a programming co-founder dramatically increases your cost of doing a start-up over time. And it makes your technology entrepreneurship journey extremely frustrating

TEAM SALARIES 

After getting a free programmer, it is now time to manage the rest of the team. At the beginning, keep your team really, really lean. If possible, just comprising of the co-founders. Hence, having a technical co-founder really helps. No need to pay salaries at all, which means your salary costs stay zero until you start to generate revenue.

But if you need to build a bigger team from the beginning, then attract only the really passionate people to join you. You can identify these people clearly – Almost 100% of the time, they will be taking a pay cut (from the corporate world or market rates) to join you. In return, offer them direct equity or share options. You really need to ensure that everyone in the core team joining you from the start is running full-on with you in your start-up rather than just working to take a paycheck home. The internal motivations are entirely different, even if the stated intention is the same (i.e. I want to get experience working in a start-up…..BUT I do not want to align myself to the outcome of this start-up journey).

This is actually the far more difficult path to take. Convincing a talent to join you at a reduced pay and taking equity that has high odds of becoming worthless – are you crazy? But trust me – this is part of being a visionary (see my future post on “Be a Visionary”). An inspiring leader who can convince talents to leave what they are doing, believe in a bigger vision, and rally around the cause.

You must understand that entrepreneurship and starting a company is not a sprint – it is a marathon. If you try to attract/retain your core talent via purely just salary, you are going to face higher costs and a normal turnover rate. You can never out-pay large MNCs with the larger salaries and employee perks they offer. And a normal turnover rate is risky for a start-up. Worse, once your talent (if working for just the paycheck) becomes experienced, he/she will be tempted to leave for a much higher paying job even if they join you now. I always believe that in start-ups, we are giving everyone very valuable hands-on experience that would translate into better career prospects later. So it is necessary to get the right people and align everyone from the beginning – everyone needs to have skin in the game.

Note that this does not guarantee 100% that your turnover rate will be zero. But if you set the foundation correctly from the beginning, you are less likely to run into disruption on the talent front just when you are about to scale up big time and you badly need all hands on deck rather than worry about filling key gaps

There is however one downside to giving too many people share options and equity – what happens should they leave halfway, and the company subsequently after many years has an exit/IPO? It is potentially very complicated. So you do need solid lawyer advice on how to manage this scenario. Scope this one very carefully – I mean it

Ok – now you tried hard, but still cannot attract the core talent required with equity? Then no choice – just have to make do with pure salaried team members. But make it very clear to them that this is a start-up – it is inherently risky, they cannot expect the perks offered by big MNCs and they have to fight/struggle/cry with you in this battle. It does not guarantee they will stay when the going gets tough – but at least you should scare them big time before they join….if they still join after you scare them, there is some chance they might stick with you all the way 😉

Even if you have the funds to attract sufficient talent, constantly be on the lookout for future talent that could play key roles in your start-up. You would need them when you scale, or when some of your salaried no equity team members leave. Trust me – that would happen

KEEP YOUR INVESTMENTS/SPENDING VERY FOCUSED  

The temptation to spend like crazy does not come at the beginning when you are bootstrapping.

It only comes when you start to internally generate lots of funds or when you have raised your Series A. This is when you might make a mistake by spending in a non-focused way

I define focus as asking yourself: What service or product are you providing that changes the world? That one service or product. And every time you spend – How is that investment going to increase the value you are bringing to the users consuming your service/product. My benchmark is that if your spending is going to take up at least 30% of your available funds, you better take a long, hard look at what the payoff (define the metrics) from that investment is. Is there a better way to do it, without incurring this heavy cost? If not, what is the downside from risking this investment? And what is the Plan B, if this investment does not pen out based on the metrics being monitored.

In this regard, it does pay to take a leaf from Warren Buffet on how he defines return on investment over the long term. It is simply every $1 re-invested into the company (retained earnings) generating more than $1 increase in company valuation over time. For a technology start-up, if your investment succeeds in getting your metrics up (anything from user engagement, to increased MAUs, DAUs, to increased revenue etc), does it increase your company valuation by proportionately more than the investment?

To understand this, you have to see the market, look at some of the benchmarks, understand where it is headed towards, and then take a calculated bet. The worst thing you can do is to start spending on what every other start-up is spending on, just because “everyone is doing it” or “this is what I read from a previous success story”. I made this mistake at the beginning of my start-up journey believing everything that Harvard Business Review and McKinsey stated about running businesses and what to spend on – at that time, Techcrunch was still a baby and technology advice online was still in its infancy. So it was difficult to find other start-ups at the same growth stage openly sharing how they used their funds wisely to grow their business. Unless you have a mentor

What I have learnt very clearly since then, is that every spending decision facing a start-up is different at various stages of growth, and you have to use some kind of common sense/gut instinct/experience to drive your decision-making process. This applies across the board, be it spending on marketing, expanding the team, opening a new office overseas or building a new revenue product or user feature.

If you hit a mental roadblock, then just email me on your spending dilemma. I might be able to help you.

Next up – “Revenue Model”

3 comments on “Entrepreneurship Series – Keeping Your Cost Low

  1. Pingback: Entrepreneurship Series Overview I | Dennis GohDennis Goh

  2. Awesome post. Can’t wait to read your thoughts on the “The Right Team”. You are so right about programmers! It is extremely difficult and expensive to hire rock star programmers these days as you can see in this article about 10x Engineers in Silicon Valley (http://www.reuters.com/article/2013/10/13/net-us-siliconvalley-engineers-twitter-idUSBRE99C03R20131013) – The great ones are either working for a top company in the valley that can pay big dollars or are co-founders of startups (co-founding means sacrifice in the early days with low pay or having a day job to pay the bills, high odds of failure – but huge rewards if successful). Digital products are TECHNICAL products – and most great success stories always start with rock star engineers: Mark Zuckerberg (Facebook), Jack Dorsey (Twitter), Mike Krieger (Instagram), Matt Mullenweg (WordPress), David Karp (Tumblr), Larry Page and Sergei Brin (Google) – or people like Steve Jobs that always treasured top quality people by building A teams wherever he went. If EQUITY is the formula so be it – It is a huge red flag to me when I see “entrepreneurs” hiring B-C-D level players as it shows a real lack of understanding of HOW and WHAT IT TAKES TO GET products built. We love to talk about Silicon Valley and how great it is…. They are what they are because they treasure talent. And if they can’t find local talent, they import them regardless of how difficult the US government makes the process be.

  3. Way cool that you think its awesome!

    I completely agree. Good technical people certainly play a critical part in a digital start-up success – So find them early on, have an aligned vision with them on changing the world, and then run together

    I think ultimately what we are all getting at is: Talent + Passion + Teamwork (can work well together / cover each other’s weakness / bring out each other’s strengths) + Aligned vision (very important) = The Right Team = higher odds of success

    I will elaborate more on “The Right Team” as part of this entrepreneurship series, so stay tuned!

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