Startup & Operational Costs

Introduction

Data from reputable organizations like the U.S. Chamber of Commerce and Kaufman Foundation reveal a sobering truth: a significant number of businesses falter and fail within their first few years. One of the critical reasons behind this high failure rate is an inadequate understanding of startup and operating costs. Businesses often stumble due to undercapitalization, inefficient budgeting, and unrealistic financial planning, directly linked to a lack of comprehensive startup and operational cost analysis.

By offering a detailed exploration of startup and operating costs, we aim to equip you with the knowledge and tools necessary for accurate financial assessment and planning. This step is about fostering a deep understanding of the financial framework your business operates within. 

With this comprehensive guide, you’ll gain the insight needed to make informed decisions, set realistic budgets, and price your products or services appropriately. Ultimately, this understanding can be the difference between a business that merely survives and one that thrives. As we move forward on this detailed roadmap, prepare to arm yourself with knowledge that will crucially impact the longevity and success of your venture.

Pro Tip: 

Review ‘Operations in Detail’: If you haven’t thoroughly examined the ‘Operations in Detail’ step or need a refresher, it’s essential to revisit this step. Understanding the operational aspects of your business is critical before you can accurately assess the financial implications.

Understanding Costs

Challenges in Startup Finance

Navigating the financial aspects of starting a business is a complex task, often riddled with challenges that can significantly impact the success and sustainability of the venture. In this step, we address some of the most common financial hurdles entrepreneurs face and provide guidance on how to overcome them.

Key Takeaways: Financial Hurdles

• Undercapitalization: Many startups underestimate the capital required to launch and sustain their business until it becomes profitable. This oversight can lead to a cash flow crisis, with the business running out of money prematurely.
• Inadequate Budgeting: A clear understanding of cost structures and operating expenses is vital. Without it, creating an accurate budget is challenging, often leading to over or underspending in critical areas.
• Pricing Issues: Properly setting prices for products or services is crucial. Misjudging costs can result in uncompetitive pricing or, worse, selling at a loss.
• Poor Financial Planning: Comprehensive knowledge of startup and operating costs is essential for realistic financial projections, crucial for effective decision-making and strategic planning.
• Difficulty in Securing Funding: Detailed financial plans and cost analyses are typically required by investors and lenders. Inability to provide this information can make securing necessary funding challenging or, more likely, impossible.
• Operational Inefficiencies: Without a clear grasp of operating costs, identifying areas for cost reduction or efficiency improvements can be difficult, leading to wasteful practices.
• Risk of Business Failure: Ultimately, a lack of understanding of the full financial picture significantly raises the risk of business failure, particularly in the crucial early stages of operation.

Categories of Startup Costs

Your startup costs is the capital you spend before you open your doors to customers and can be broadly categorized into assets, expenses, and working capital, each with its own set of subcategories. It’s crucial to consider various aspects like lease vs. buy decisions, supply ordering strategies, and staffing choices. The following gives an overview of of startup assets, expenses, and working capital: 

Assets

Startup assets for a pre-revenue startup are the tangible and intangible resources acquired to create a foundation for the business’s operations and growth. These assets include physical items like equipment and inventory, as well as intellectual properties and digital assets, which provide long-term value and contribute to the startup’s capability, unlike startup expenses that are consumed or depleted through the initial setup. Subcategories for startup assets often include: 

Tangible Assets

1. Real Estate: Land and buildings.
2. Equipment: Machinery, computers, office equipment.
3. Vehicles: Cars, trucks, or vans used for business purposes.
4. Furniture and Fixtures: Desks, chairs, lighting, shelving.
5. Inventory: Stock of products for sale.
6. Equipment: Computers, tablets, servers, displays, phones, printers.
7. Safety and Security Equipment: Surveillance cameras, alarms.

Intangible Assets

1. Brand and Intellectual Property: Trademarks, patents, copyrights.
2. Software and Technology: Custom software, tech tools, digital assets.
3. Goodwill: Value attributed to acquiring a brand, its reputation, and its customer relationships.
4. Non-Standard Licenses and Permits: Specific industry-related licenses where the license has a value if the business was sold (e.g., liquor license, cannabis license).

Other Assets

1. Refundable Deposits: Security deposits for utilities or rent.

Expenses: 

Startup expenses for a pre-revenue startup are the initial outlays necessary to establish and prepare the business for operation, including legal and administrative setup, securing a location, initial marketing, and workforce preparation. Unlike startup assets, which are tangible and intangible items of value the business owns, these expenses are one-time costs primarily aimed at setting up the business infrastructure and operational framework, without residual value or future liquidity. Examples of common startup expense subcategories include: 

Legal and Administrative Expenses

1. Legal Fees: Costs for legal advice, company registration, incorporation, patents, and trademarks.
2. Licenses and Permits: Fees for obtaining necessary legal permissions to operate.
3. Business Planning: Expenses for developing business strategy, model, and plans.
4. Consultancy Fees: Expenses for professional services like business consultants, accountants.

Location and Infrastructure Setup

1. Broker Fees: Initial payments and fees for securing a business location.
2. Utility Set-Up Fees: Initial fees for setting up essential utilities like electricity, water, and internet.

Insurance and Risk Management

1. Insurance Deposits: Initial deposits for various business insurance policies.
2. Business Insurance Premiums for First Term: Initial premium payments for business-related insurance policies.

Marketing and Branding

1. Branding: Costs for creating brand identity, including logo design.
2. Initial Marketing and Public Relations: Costs for establishing initial market presence and public relations efforts.
3. Website Development: Expenses for website creation, hosting, and pre-launch maintenance.
4. Advertising for Launch: Pre-launch marketing and promotional activities.

Human Resources

1. Training Period Salaries and Wages: Compensation for employees during training before business operation begins.
2. Pre-Launch Employee Recruitment and Training Costs: Expenses related to hiring and training the initial workforce.

Research and Development

1. Market Research: Costs for analyzing market trends, customer preferences, and competition.
2. Prototype Development: Costs associated with creating prototypes or initial service models.

Miscellaneous Preparation Costs

1. Software and Subscriptions: Pre-operational expenses for business software and service subscriptions.
2. Travel and Survey Expenses: Costs associated with market surveys, business location visits, and other pre-operating travel.

Working Capital: 

Working capital for a pre-revenue startup refers to the allocation of cash reserves to cover estimated monthly operating expenses (burn-rate components) and short-term liabilities, along with a buffer for contingencies. This capital is essential to support the startup’s operations through to the point of break-even or until it secures the next round of financing, such as moving from seed to Series A funding, with the amount and duration varying significantly based on the business type and strategy. Common examples of working capital allocations include: 

Cash Reserves

1. Initial Funding: Seed capital or initial investment funds obtained through investors, personal savings, loans, or grants.
2. Emergency Fund: Additional reserve funds to cover unforeseen expenses or delays in reaching revenue-generating stages.

Monthly Operating Expenses (Burn Rate Components)

1. Salaries and Wages: Monthly payroll for employees, including founders and early staff.
2. Office Rent and Utilities: Monthly costs for office space, electricity, internet, and other utilities.
3. Software and Subscription Services: Regular expenses for essential software, cloud services, and subscriptions necessary for operation.
4. Marketing and Advertising: Monthly costs for marketing activities to build brand presence and customer awareness.
5. Insurance Premiums: Regular payments for necessary business insurance policies.
6. Professional Services: Fees for legal, accounting, and consulting services.
7. Research and Development: Ongoing costs for product development, testing, and improvement.

Short-Term Liabilities

1. Accounts Payable: Short-term debts or obligations to vendors and service providers.
2. Accrued Expenses: Incurred expenses that are recorded but not yet paid.

Buffer for Contingencies

1. Contingency Buffer: An additional percentage of the total working capital estimated to cover unexpected costs or delays.

We have developed worksheets for hundreds of common Core Offerings to assist in brainstorming these costs. Download our Startup Cost Worksheet to get started.

Key to Building a Solid Foundation

Feeling Overwhelmed?

If you find yourself overwhelmed at this step of estimating startup and operating costs, it might be a sign to revisit earlier steps of the Pre-Planning Process. A thorough and well-executed Business Model Development and Operations in Detail step can significantly ease the burden of this step.

• Revisit Business Model Development: Ensure you have a clear and comprehensive understanding of your business model. This step provides a blueprint that guides your financial planning.
• Review Operations in Detail: A detailed analysis of Key Activities, Key Resources, and Key Partners is crucial. If this step is thoroughly executed, estimating costs becomes a more straightforward research task.

Accurate Cost Analysis

Once you have identified the operational components, research becomes your primary tool. 

Practical Steps in Research:

• For HR costs, utilize platforms like salary.com and Indeed to understand local pay scales and employment benefits.
• Contact vendors and partners for quotes and cost structures.
• Utilize online resources for fixed costs like cloud storage, utilities, and office supplies.

Pre-Planning is a Discipline

• Importance of Granularity: This step demands granularity. Each cost, no matter how small, should be accounted for to build a realistic financial picture.
• Avoiding Premature Adaptations: Remember, this is the Pre-Planning phase. The goal here is not to adapt or make operational decisions based on things you cannot know but to create a solid foundation for your business plan or pitch. Changes and adaptations come later, once you start considering funding methods and adapting to sales, market, or operational realities.

By approaching this step with diligence and attention to detail, you lay the groundwork for a strong and realistic financial plan. This foundation is crucial not only for the initial launch but also for the long-term sustainability and success of your business.

Adjusting for Business Type and Stage

Understanding the distinction between traditional and innovative or new market business ventures is critical when planning startup costs. Each type demands a different approach and perspective on financial planning.

• Traditional Businesses: These are established business models with predictable patterns and well-understood markets. For example, a daycare center needs to consider costs for licensing, facility rental, child care supplies, and staff training. A legal firm has to budget for office space, legal databases, and professional staff. These businesses must think through all elements necessary to become fully operational from the start, aiming for rapid achievement of break-even status.

• Innovative or New Market Ventures: Contrasting with traditional models, these ventures often break new ground or create entirely new markets. For instance, a tech startup developing a unique app may initially focus on costs related to software development, securing intellectual property rights, and market testing. Their startup costs might be leaner if they concentrate on developing a minimum viable product (MVP) and reaching early adopters. The goal is often to demonstrate potential and secure further funding, following milestones like user growth or feature development.

Traditional businesses typically require a comprehensive, all-encompassing financial plan upfront. In contrast, innovative ventures may operate on a more performance-based approach, aligning their financial planning with specific milestones and funding stages like pre-seed or seed rounds.

Recognizing which category your business falls into and planning accordingly can significantly impact the efficiency and effectiveness of your financial strategy.

Tools and Resources for Startup and Operating Cost Attribution

Get Your Startup and Operating Cost Worksheet

Efficiently navigate the complexities of startup and operating costs with our comprehensive worksheet, designed to streamline your financial planning process. Available in both MS Excel and Google Sheets formats, this versatile tool offers a structured approach to categorize and calculate various costs.

Download Startup and Operating Cost Worksheet

Analyzing Operating Costs

Day-to-Day Business Expenses

Operating costs form a substantial part of any business’s financial structure. These are the recurring costs necessary for the day-to-day functioning of the business and can be broadly classified into fixed and variable expenses. Additionally, entrepreneurs must account for elements like depreciation, payroll taxes and benefits, and potential interest expenses.

Categorization of Operating Costs

• Fixed Expenses: These are costs that remain constant regardless of business performance, such as rent, salaries (to an extent), and insurance.
• Variable Expenses: Costs that fluctuate based on the level of business activity. Examples include utilities, raw material costs, and commission-based salaries.
• Additional Considerations: Depreciation of assets, payroll-related taxes and benefits, and interest expenses, which may become relevant in cases of debt financing.

Estimation: Implications and Accuracy

• Striving for Granularity: While it’s challenging to perfectly estimate operating costs, aiming for 85% accuracy can significantly reduce financial risks. Many business failures are linked to imprecise cost estimations, leading to the issues highlighted previously. If you aim to get a solid B+ here and have allocated a portion of your working capital for emergency funds and contingencies, you’ll be in a much better position to handle what actually happens in the market. 
• Importance of Detailed Planning: We provide worksheets based on common Core Offerings to assist in thinking through various Cost Structure categories. Access our Operating Cost Worksheets to facilitate thorough planning.

Strategies and Considerations

• Early-stage Cost Considerations: In the initial phases, certain expenses might be higher. For instance, hiring competent employees from the outset often means paying higher salaries. Similarly, ordering smaller quantities of supplies or products can result in higher per-unit costs.
• Industry Averages as Reference Points: While comparing costs with industry averages can be insightful, it’s important to remember that these may not always be applicable, especially for startups or innovative ventures where the cost dynamics can be quite different.

Special Note: Innovative or New Market Ventures:

• Lean Approach to Fixed and Variable Costs: These businesses often plan operating costs with a lean approach, focusing only on the essentials necessary to reach the next phase of development.
• Understanding Burn Rate Schedules: Particularly in pre-seed or seed rounds, understanding and managing the burn rate – the rate at which a company is spending its capital – is crucial. This schedule helps startups plan how long they can operate before needing additional funding, ensuring that they remain solvent while pursuing growth or development milestones.

A thorough and detailed approach to outlining operating costs not only lays a solid foundation for current operations but also prepares the business for future financial strategies and funding phases. This step is about outlining costs with precision and foresight, setting the stage for sustainable growth and successful funding endeavors.