People are the greatest asset of every company. They’re the lifeblood of the product, they shape the strategy and breathe life into it, and they steer the company through good and bad times. For every team, it’s essential to be able to perform as efficiently as possible. But as the business starts to scale, this task becomes ever trickier. Since investors are well aware of this stumbling block, they usually want to make sure your startup has a solid plan for both current and future talent acquisition.
As personnel-related costs make up a large chunk of your total expenses, it’s extremely important to provide sufficient detail in your forecast so that the amount you raise will cover your business needs as the company starts to scale.
Payroll calculations – most common startup mistakes
From our regular observations, many startups underestimate personnel cost calculations in their model. They frequently bunch them up within just a handful of rows – hidden somewhere in one of the final tabs. Not only are they often difficult to find, but they’re also hard to decipher – failing to reflect the exact positions included in the team, how quickly the number of people for every function will grow, and what other sundry personnel-related expenses have been accounted for. All these are major red flags for any investor, sending a clear message that the founder has no idea how to scale the team.
Let’s go through some of the most common mistakes made by our clients when treating payroll in their financial model and share key tips on how to avoid them.
No future team growth
You may not need a large team with 100+ people in the beginning, but incremental scaling implies corresponding increases in the number of employees or contractors hired. Likewise, boosting your sales & marketing efforts and your product development activities over time requires additional team players. And finally, don’t underestimate your G&A hires. Add new admin people if you plan to open new offices.
Another important point is your client-facing staff which should grow in line with the number of customers, otherwise you risk having angry, underserved, or simply lost clients.
Total expenses only include salaries
This is the #1 mistake we see in the financial models submitted for our review. Everyone includes salaries and the occasional payroll taxes, but two categories don’t make for a solid set of personnel expenses. What about recruitment agencies? At some point, you’ll end up using them and their fees can be gigantic (sometimes up to 100% of the newly onboarded hire’s salary).
Remember also to reward employees. Staff motivation can fluctuate, so you’ll need to reflect that through a bonus and commission structure. You won’t find many sales representatives these days willing to work without commissions, so be realistic with your commissions.
You also need to consider items like training expenses, social security taxes, pension fund contributions, and health insurance. Given differences in jurisdiction, these need to be quite detailed. You can imagine that these will mount up, so be really careful and ensure they’re comprehensive. You really don’t want to risk missing out some costs in your forecast and then having to confront them later in reality.
No salary growth
This sounds like a strange oversight, but it occurs quite often. Don’t just include your pay increases. Factor in annual inflation too.
Unrealistic ramp up times
This point is missed in almost all of the models we see, especially with newly onboarded, client-facing team members such as sales representatives. Remember that every new employee needs some time to ramp up and there’s just no way they can work as efficiently as their embedded colleagues. So, bear that in mind when calculating your personnel efficiency assumptions such as the number of clients per employee.
Salaries that are either too low or too high are a no-go. You’ll either end up running out of money much faster due to unrealistically low salaries (first case) or you’ll erode trust with investors who’ll conclude they’re too much for a startup given all the other important expenses (second case).
To avoid both situations, include benchmark statistics. Check tax rates and salaries for specific countries and jurisdictions and ensure bonuses and commission rates for particular positions in your region/country are at acceptable standards.
Standard assumptions across different geographies
This mistake can often cause a flurry of investor questions and render your model really questionable. Obviously, salaries, rates, and other expenses are going to vary across different countries, so if you haven’t considered this fact at the outset, it’s going to be extremely difficult to make your investment case. If this part of the model is full of holes, it’s likely the investor will conclude that you’ve treated your other assumptions in just the same way.
Make sure you included these elements in your projections
We’re the first to recognize that a key founder issue is time, given everything else on their plate. It can be so easy to miss something or simply skip over important details when working under tight deadlines. To make this process easier for you, Waveup analysts have prepared a list of the key elements for you to include in your ‘personnel’ tab to ensure your model is defendable.
Include BOTH employees & contractors
If your team includes employees and contractors, that’s fine. But just make sure it’s clear in your forecast and you provide a clear team breakdown by role or area of expertise.
Also, make sure you don’t double count or omit anything. For example, contractors don’t need a payroll tax provision, so don’t include them. Similarly, some employee or contractor salaries and commissions are calculated as part of the cost of revenue as is the case for support agents. In such a case, not only will you need to include them in the total headcount and calculate all the related personnel expenses but you’ll also need to account for the costs as a part of the cost of revenue.
Provide a clear breakdown by departments and position
It’s always tempting to bunch all the positions together. But investors want to see how you allocate your payroll among different functions – especially in the first years. Many startups for example tend to forget to categorize their payroll by department. Consequently, there’s no quick way to gain an overview of your R&D or sales and marketing spend, either in numerical or percentage terms.
Total number of employees
This may surprise you, but many models will often lack a complete breakdown by number of employees or show a generalized total of salaries by department or position.
For example, a Marketing Manager might have an allocation of $5,000 in September, $10,000 in October, and $15,000 in January. What this doesn’t mean is that the same person has two salary raises in a row, but that the company plans to employ an additional Marketing Manager in October and another employee in January. On the one hand, it’s clear. But on the other hand, it’s not so obvious. And when you have more than ten rows with different positions in your payroll sheet, it can be really difficult for the person seeing your model for the first time to understand that these total salaries actually mean new hires. And any attempt to reflect your monthly and annual hiring plans remains very murky.
So, to show that your model is robust and reasonable, make sure you split out the number of employees by position/function from the actual salaries so that your model makes it easy to see how fast your team will grow.
Any realistic forecast must include a growth rate for all your salaries, factoring in both regular salary increases as well as inflation assumptions.
Commissions and bonuses
If you’re not already aware, always check what positions require both salary and commission, and reflect that in the model. This applies mostly to client-facing positions such as Sales Development Representatives, Business Development Managers, Account Executives, and other employees working in client-facing roles.
Of course, it’s often difficult to predict the precise number of clients onboarded or the revenue generated per employee/sales rep, but you’ll still need to factor these expenses into your projections by at least taking an average percentage of total salaries for all of the employees or for a particular position. And remember to check benchmark commission rates for your jurisdiction/industry.
Include taxes and contributions for all employeess
Ensure you have covered all taxes, other contributions, and related fees. If you work with employees from different countries, check thoroughly that these accurately reflect local rates.
Recruitment fees and other personnel expenses
Recruitment fees are considered one of the most important hiring expenses. If you don’t have a HR manager and recruit via an external agency, then reflect these fees in your model. Recruitment fees can often make up a large chunk of recruitment costs, with fees for certain roles being up to 100% of the salary of a new hire.
As for other expenses such as education, training, health, travel, and software, make sure you have included them and they’re detailed. They may not be as large as other categories of expenses, but they mount up and will still have an impact on your monthly cash burn rate.
It can be quite common for startups to neglect expenses such as recruitment fees, commissions, bonuses, and training costs. And then, when they hit the road, they end up facing the harsh reality of a deluge of costs they initially hadn’t accounted for and realizing their financial model was not robust enough to meet all the company’s strategic needs. When this happens, it can be very difficult to continue hiring and scaling a team that will achieve the projected hockey stick growth you promised to investors. All too often, we hear the sad stories of investors declining to invest, simply because the financial model contained unrealistic or flaky personnel numbers.
How to check whether hiring rate is too slow or too fast
Here’s a question we get to hear often: “Is it possible to check whether my hiring plan is realistic or if my hiring rate is too slow or too fast?”. It’s a great question and an important one at that. And yes, it is possible.
Here is a quick sanity check for your payroll tab, showing how you can compare your annual revenue per employee with certain benchmarks.
This method allows us to understand how many people you need to hire each year and follows a simple logic: simply take the total revenue for the year and divide it by the number of employees at the end of the year.
The number you arrive at will then need to be compared to certain benchmarks which can be easily found in different resources on the web. When comparing these benchmarks, make sure you look at companies with similar revenue level to yours and who are at the same development stage as you.
Hopefully, this provides you with a clear picture of what it takes to ensure the personnel/hiring section of your financial model is robust. Remember that the beginning and the end of each company is the team. You don’t want to sign your company’s death warrant because you haven’t properly factored in all your management and employee costs. That’s why your model is such a powerful tool for convincing the investor you won’t meet such a tragic end.
As always, our team of Waveupers have already helped cool businesses from 50+ countries around the world to make their fundraising materials investor-ready. If you need help with yours, please don’t hesitate to contact us.