Top Four FInancial Tips for Pre-Seed/ Pre-Revenue Companies

Founders frequently seek financial tips for pre-seed/pre-revenue companies. In this blog, we’ll explore four key areas:

1. Developing your initial bootstrapped budget
2. Ensuring that your unit economics are sound
3. Determining the number of customers needed to cover operating costs
4. Calculating the sales and marketing budget necessary to achieve your sales targets

Bootstrapping typically means relying on personal savings or minimal external funding, like grants or friends & family money. Every dollar counts, so it’s essential to estimate all costs as accurately as possible so that you can allocate resources efficiently and avoid unnecessary expenditures.

Here are five main cost categories:

1. Product and Software Development: Expenses related to developing a Minimum Viable Product (MVP).
2. Legal Costs: Fees for establishing a legal foundation, including Founders Agreements, Incorporation, Intellectual Property (IP) protection, Confidentiality Agreements, Employment Contracts, and Terms and Conditions.
3. Website Development and Branding: Costs for building your website, designing branding materials, and graphic design.
4. Customer Research: Expenses for understanding your target market and gathering customer insights.
5. Living Expenses: Personal costs necessary for sustaining yourself while focusing on your startup.

Unit economics refers to the direct revenues and costs associated with a particular business model, typically analyzed on a per-unit basis.

Understanding and ensuring that your unit economics are sound is crucial because it directly impacts your startup’s long-term viability. If each unit you sell costs more to produce than it earns, or if the cost to acquire a customer exceeds the revenue they generate, your business will struggle to stay afloat. By focusing on unit economics, you can make informed decisions about pricing, marketing, and scaling, ensuring that every sale contributes positively to your overall financial health. In simple terms, solid unit economics means your business is set up to make money rather than lose it.

Key Components of Unit Economics

1. Revenue per Unit: How much money the company earns from each unit sold or each customer acquired.
2. Cost per Unit: The cost associated with producing, delivering, or servicing one unit. This includes direct costs like materials and labor, and sometimes indirect costs like marketing and overhead.
3. Contribution Margin: The difference between the revenue per unit and the cost per unit. It indicates how much profit each unit contributes towards covering fixed costs and generating profit.
4. Customer Acquisition Cost (CAC): The cost of acquiring a new customer. This should be compared to the revenue generated from that customer over their lifetime (Customer Lifetime Value or CLV).
5. Customer Lifetime Value (CLV): The total revenue expected from a customer over the entire duration of their relationship with the company.

Example: 

“Coolest T-shirt Ever” sells its T-shirts for $20 each. With manufacturing, packaging, shipping, and credit card fees totaling $10 per shirt, the contribution margin is $10. This positive margin indicates that the business is profitable on a per-unit basis.

Suppose that last month, you spent $1,000 on marketing and acquired 50 customers, making your customer acquisition cost (CAC) $20 each. If customers are unlikely to make repeat purchases, your business is unprofitable, as the CAC exceeds the contribution margin per T-shirt.

However, if customers are expected to buy one T-shirt per month, each customer would generate $120 in revenue over a year. In this scenario, you would break even on your CAC after 2 months and begin to see profit from each customer thereafter.

Unit economics refers to the direct revenues and costs associated with a particular business model, typically analyzed on a per-unit basis.

Understanding and ensuring that your unit economics are sound is crucial because it directly impacts your startup’s long-term viability. If each unit you sell costs more to produce than it earns, or if the cost to acquire a customer exceeds the revenue they generate, your business will struggle to stay afloat. By focusing on unit economics, you can make informed decisions about pricing, marketing, and scaling, ensuring that every sale contributes positively to your overall financial health. In simple terms, solid unit economics means your business is set up to make money rather than lose it.

Key Components of Unit Economics

1. Revenue per Unit: How much money the company earns from each unit sold or each customer acquired.
2. Cost per Unit: The cost associated with producing, delivering, or servicing one unit. This includes direct costs like materials and labor, and sometimes indirect costs like marketing and overhead.
3. Contribution Margin: The difference between the revenue per unit and the cost per unit. It indicates how much profit each unit contributes towards covering fixed costs and generating profit.
4. Customer Acquisition Cost (CAC): The cost of acquiring a new customer. This should be compared to the revenue generated from that customer over their lifetime (Customer Lifetime Value or CLV).
5. Customer Lifetime Value (CLV): The total revenue expected from a customer over the entire duration of their relationship with the company.

Example: 

“Coolest T-shirt Ever” sells its T-shirts for $20 each. With manufacturing, packaging, shipping, and credit card fees totaling $10 per shirt, the contribution margin is $10. This positive margin indicates that the business is profitable on a per-unit basis.

Suppose that last month, you spent $1,000 on marketing and acquired 50 customers, making your customer acquisition cost (CAC) $20 each. If customers are unlikely to make repeat purchases, your business is unprofitable, as the CAC exceeds the contribution margin per T-shirt.

However, if customers are expected to buy one T-shirt per month, each customer would generate $120 in revenue over a year. In this scenario, you would break even on your CAC after 2 months and begin to see profit from each customer thereafter.

One of the most important financial analyses is a break-even analysis for a startup determining the number of customers needed to cover fixed and variable expenses. Here’s how you can perform a break-even analysis focusing on the number of customers:

Key Concepts

1. Fixed Costs (FC): Costs that do not change with the number of units sold, such as rent, salaries, marketing budget, and insurance.
2. Variable Costs per Unit (VC): Costs that vary with each unit sold, such as manufacturing, packaging, and shipping.
3. Selling Price per Unit (SP): The price at which you sell each unit.
4. Contribution Margin (CM): The difference between the selling price and variable costs per unit (CM = SP – VC).

Steps to Calculate the Break-Even Point in Customers

1. Calculate Contribution Margin per Unit
   • Contribution Margin (CM) = Selling Price per Unit (SP) – Variable Costs per Unit (VC)
2. Determine the Break-Even Point in Units
   • Break-Even Point (Units) = Fixed Costs (FC) / Contribution Margin (CM)
3. Calculate the Number of Customers Needed
   • If each customer purchases only one unit: The break-even number of customers is the same as the break-even point in units.
   • If each customer purchases multiple units: Divide the break-even point in units by the average number of units purchased per customer.

Example

“Coolest T-shirt Ever” sells T-shirts for $20 each, with variable costs of $10 per T-shirt. This results in a contribution margin of $10 per shirt. Let’s assume that the company’s monthly operating costs are $10,000 and it uses a print-on-demand model with no upfront inventory costs. Let’s further assume that each customer only purchases one T-shirt. Then the break-even number of customers is calculated as follows:

Break-Even Number of Customers = $10,000 / $10 = 1,000 customers

This analysis reveals that the company needs 1,000 customers, each purchasing one T-shirt, to cover its monthly costs. Understanding this helps determine how many customers are necessary for financial viability and highlights how customer purchasing behavior affects overall profitability.

Another important question you should answer is what marketing budget you need to generate enough sales to cover your operating expenses.

Here’s a step-by-step process to figure this out:

1. Calculate the Gross Profit Margin

• Gross Profit Margin (CM) = (Selling Price per Unit (SP) – Variable Costs per Unit (VC)) / SP

2. Determine the Required Sales Revenue

• Required Sales Revenue = Fixed Costs (FC) / Gross Profit Margin

3. Estimate Customer Acquisition Cost (CAC)

• CAC: The cost to acquire one customer through marketing efforts. Use online research to estimate it for a specific marketing channel if you don’t have any company data.

4. Number of Customers Required = Required Sales Revenue/ Average Order Value

• Average Order Value = Selling Price per Unit * Average # Units per Order 

5. Calculate the Marketing Budget = Required Number of Customers * CAC

To cover fixed costs through sales, you need to generate enough revenue to cover those costs. The marketing budget should be aligned with your CAC and the number of customers needed to generate that revenue.

Example: 

“Coolest T-shirt Ever” sells its T-shirts for $20 each. With manufacturing, packaging, shipping, and credit card fees totaling $10 per shirt, the contribution margin is $10, resulting in a gross profit margin of 50% ($10/$20).

Last month, you spent $1,000 on marketing to acquire 50 customers, making your customer acquisition cost (CAC) $20 per customer. Let’s assume that each customer usually buys one T-shirt, so the average order value is $20. Given your monthly operating expenses of $10,000, you need to generate $20,000 in sales revenue to cover these costs, calculated as follows:

• Required Sales Revenue = $10,000 / 50% = $20,000
• Required Number of Customers = $20,000 / $20 = 1,000

To acquire 1,000 customers with a CAC of $20 each, your marketing budget would need to be:

• Marketing Budget = 1,000 × $20 = $20,000

This marketing budget exceeds your monthly operating expenses, indicating that the current model is not sustainable.

If you increase the selling price to $40 while maintaining the 50% gross profit margin, the calculations would be:

• Contribution Margin = $40 – ($40 × 50%) = $20
• Required Sales Revenue = $10,000 / 50% = $20,000
• Required Number of Customers = $20,000 / $40 = 500
• Marketing Budget = 500 × $20 = $10,000

In this adjusted scenario, the marketing budget aligns with your monthly operating expenses, suggesting a break-even point. However, this assumes that the entire operating budget is allocated to marketing, and further refinements may be needed to fully optimize the model.

Have questions about making your business model financially viable? Book a free 30-minute consultation with The Startup Station for personalized advice and tips HERE. Set your startup up for success—schedule your session today!