Financial Planning for Startup Founders

Financial Planning for Startup Founders

If you are planning to build a startup, the usual financial advice that you get from the media and from popular books is not going to help you.

Books generally preach investing in stocks, real estate, and other channels that will help protect your "savings" against inflation so that one day, someday, you will have a million dollars saved up.

Let's say you are making 1,00,000 INR/month ($1300 approx) as your monthly salary. And let's say your personal expenses out of this is around 50,000 INR/month to sustain your lifestyle. You have an extra 50,000 to save and invest.

Most people will end up investing their extra money into real estate (at least in India). Homeownership in India is over-rated and people end up signing up for 10-year loan terms, sometimes 15.

The usual narrative goes like this... "Why pay rent which is usually wasted, instead of somehow making a downpayment and then paying the EMI every month."

I wouldn't go into the disadvantages of home ownership right now because it might turn into a rant. But the top 3 reasons why you shouldn't buy a home right now are

  • You might move cities and need to stay light on asset ownership. Place of stay has a major impact on our lives and we don't want to get tied down to a single place for a very long time.
  • Rental yield in India is usually 2-3% per year of the home's value, and that's extremely low (or cheap if you are renting). You will not be able to liquidate your real estate easily if you need cash to invest in your startup.
  • You might move to a much better and bigger house as you make more money in the near future (as a startup founder) and you don't want to be stuck in your old house just because you bought it and got attached to it.

Anyone who is already in a job and making some money that is more than what they need for personal expenses ends up investing in real estate and locking up the liquidity for a long time. Sometimes they will invest in mutual funds or the stock market.

If you invest in the stock market, your portfolio will go up, go down, go sideways and it will tire you out. The cash that you have right now is extremely important for building your startup. You will lose money if you withdraw when the market goes down (and you won't feel like selling at a loss).

Though stocks are liquid and can be sold in tranches, it is still not a good investment, unless you are ready to hold them for 5-10 years and dollar cost average your way into it. This is not suitable for startup founders.

Remember, the best channel of wealth you have for yourself is your startup. If you have decided that you are going to startup, then don't try to make wealth by investing in other's companies. Invest in your own company. Invest in yourself.

How do you invest in yourself?

Save the money as fixed deposits. (Why? explained in the latter part of this article.)

Fixed deposits will give you a very low yield in the short term and the long term. I would be surprised if any bank gives more than 6% in interest. Many people advise against it. Real estate and stocks will give you a 10-20% yield at the minimum.

However, we are not looking for a 10-20% yield. If you have $100,000 to invest, it will take 10 years for it to become $450,000 at 15%. That's not even a million dollars and 10 years down the line inflation will make it look like chump change.

If you grow it at 20% per year you will have a bit more than $700,000, but it is not easy to get 20% unless you are investing a lot of time and effort in researching the market and making the right calls (which most people can't). And $700k is still not a lot of money.

If you invest $100k for 20 years at 20% growth, then you will have $5m at the end of 20 years but what will you do until then? And what will you do with $5m after 20 years anyway?

In 20 years you will burn out working for someone else, trying to go from paycheck to paycheck meeting the demands of personal expenses. As you get married (and have kids maybe), your expenses are only going to go up and there is a very high likely chance that you might end up disturbing the compounding that is taking place with your initial capital. Life never goes as expected. There will be wants, desires, and emergencies.

Remember, as a founder, your best chance of striking it rich is your own startup. Unless you are starting out with a very big capital (like $1m) and have the time and patience to look for the right investment channels, place your bet on building your own startup.

The few ways for young people to have a lot of money are:

  • Inherit a huge amount of wealth (most of us probably can't)
  • Marry into wealth (not recommended, but most can't do it anyway)
  • Win the lottery (forget it)

If you are less than 30 years of age (or around that), the best chance for you to start making money is through a job (and/or freelancing work). The only thing that you have to sell is your skill and your time. You don't want to remain in a job forever, and you also don't have a huge capital to start with if you want to start investing.

What should you do?

Sell your skills and time to make money, and use that money to buy yourself some time, and invest that time into building your startup.

When you start up something new, you will not be able to make enough revenue and profits to pay yourself for a few years. Usually, for one year, there is absolutely no way you can pay yourself. Sometimes it takes 2-3 years before your business generates enough profits so that you can pay yourself a salary that is at least as much as you would be making with jobs/freelancing.

If you run a startup for 5 years, there is a very good chance that you will get to a stage where the amount of money you would be making from your startup would be the same as you staying for 5 years in a job. But the problem here is that you wouldn't last for 5 years with your startup unless you have planned your finances properly, which is what this blog post is all about.

The general narrative in the ecosystem is that 90% of the startups die within a few years. But why? If you are building a startup, there is no way it can die, unless you quit. And you will quit only when you have run out of money.

My general advice for people who want to startup is not to go for a brand new idea that might or might not work. I recommend people to focus on products, services, or training. These are proven business systems and what you need to choose is your niche.

Once you understand your niche, your offer, and your audience deeply, you can become a category leader in your niche (and in your region) and aim for maintaining that category leadership. What business to do and how to do it is a topic for another day, let's get back to the point of finances.

Let's say your income right now (in a job/freelance career) is 1,00,000 INR per month. Your personal expenses are 50k/month. You can save 50k per month. Your personal numbers might be different, less than this or more than this, but this example will illustrate how to think.

Now instead of investing the 50k extra, you make every month into something that's illiquid (like real state), or something that is volatile (like stocks and crypto), you just save this money as fixed deposits.

Initially, keep your monthly expenses low and do not do the mistake of upgrading your lifestyle. Lifestyle will come later, I promise.

If you work for 1 year, you would've earned 12 Lakhs (at 1L/month). You would've spent 6 lakhs and saved 6 lakhs. Now, this saved up to 6 lakhs can help you survive for another 12 months (1 year) without a job.

If you want to quit your job and start a business, you can "invest yourself" into your business for 1 year without having to make a profit in your business and pay yourself for the first year. Remember, a baby human takes 20 years to grow up and start making money. How can you expect a new business to start making money within 6 months or a year?

However, in most cases, one year of a startup is not going to take you to a place where you can start paying yourself a salary. I would recommend 2-3 years. If you target a time span of 3 years to invest yourself in a startup, then you need 18 Lakhs to pay yourself 50,000 a month for 36 months.

You don't need to raise money to run a startup. But startups need initial investment. You invest yourself, as a one-man startup to start with, for as long as it takes to get traction in the market.

Once you start making revenue, you can use that revenue to hire some people to slowly expand your revenue. In 2-3 years, in most cases, you will be able to make enough money with your startup that you can start withdrawing your salary (at least 50,000 a month) so that you don't need to dip into your savings.

Please note that I am being pessimistic here. Making 50,000 a month with your startup after 3 years is extremely pessimistic and not so motivating. There is a good chance that you will do much better than this. But I am trying to convey a point here. The point is that startups take time. But they can have a much higher growth rate than any other channel of investment. (Especially if you follow my advice on building your startup).

Look at this sheet...

Let's say in the first three years you don't make much money with your startup.

You don't withdraw any salary and you make 5 Lakhs, 10 and 15 in the first three years. The actual numbers might be much more than this for you, but I am showing you a pessimistic figure because I want you to see how good the numbers become with time even when you start with small revenue numbers.

It's hard to do this because it would require some conviction in yourself about what you are building and you have to battle the constant self-doubt that you might have. But remember, this is the way. This is what it takes.

After 3 years, let's say you grow at 30% a year and after 10 years, you grow at 20% a year. And from year 4 you aim for a 20% profit margin with your business.

In 10 years, you will be able to make around 20 lakhs a year in profit with your business (at 1 crore per year in revenue). And if you pay that profit for yourself, that's 1.5 Lakhs a month. At least. In reality, it can be much more than that depending on your focus (and some luck).

If you make more than a 20% profit margin, reinvest those profits in your business to make sure that you keep growing.

A growing business that makes 1 crore a year in revenue is usually valued at at least 5x of the revenue (if not 10x or more). That means that you have built an asset that is worth 5 crores. If you are the only founder of your company, you have a net worth of $650,000.

In the next 10 years, even at a nominal growth rate of 20% a year on average, you will be making more than 1 crore a year in profits (take home a salary of 10 lakhs a month), and your business will be making 6 crores a year in revenue. The value of your business will be 30 crores. That's a $3.8 million in total value.

And there is nothing stopping you from growing this startup for 30 years or even 40 years. You will more than meet your financial goals taking this route of wealth building and most importantly you will be doing what you love and not looking for an exit. Building your startup will become a part of your life and lifestyle.

Building a startup will change your identity, make you a positive person overall and you will stay away from office politics and toxicity in the workplace. You get to choose who to hire and when to take a break and you will be able to choose chaotic productivity over forced productivity.

Most important of all, you will be creating way more value for the world around you than what you could do by investing or working somewhere else. The money that you make would be a side effect of the value you are creating.

Ideally, a 10x possibility from the numbers I have shown you is possible, if you keep your focus tight, be disciplined, and have the patience. Imagine owning a startup that is worth 300 crores (around $40 million) in 20 years. If you are 25 right now, by 45 you will be able to reach that goal. You will be in the top 1% of the top 1%.

Remember, the numbers I have shown you here are indicative and can vary widely from person to person. But the point I want to drive home is that your financial planning needs to be completely different from your friends, family (and enemies), if you want to build a startup and truly believe that you have a calling to build one.

If you have a high conviction that your business will be your lifestyle, your wealth creation machine, your purpose, and your value creation machine for the world, then save money for the short term.

Save enough money so that you need not strain your business' finances for the first few years, and put the sweat equity into your business.

Your time into your business is the startup capital your business needs. Not external investment. And even if your business scales down at some point, even if you are the only person employed in your business, your business can never fail, as long as you don't run out of money.

For the first 5 years, be frugal, keep your personal expenses low, and have enough money to last you for 3-5 years. Don't lock up your precious capital into real estate or volatile instruments that will pay your personal bills. That's how you invest in yourself so that "you" can invest the time, the energy, and the effort into your startup.

Quit your job, reduce your time commitment to freelance projects and start investing time in building your startup. Sell products, services, or training. Grow the revenue and keep working on it until it starts taking shape.

The silver lining here is that if you are a digital freelancer (working remotely for a few clients), you will be able to run your startup and earn some money with part-time freelancing while you are at it. (It would be almost impossible to build a startup while you are in a job). That's why I give so much importance to freelancing for young professionals. It is the best way to transition from a job to a startup, effortlessly.

For you, me, and everyone else like us, there is no other way to have a shot at becoming a multi-millionaire (and a happy healthy one at that) in this lifetime.

If you go down this path, success will find you sooner than you think.

Good luck.

Deepak Kanakaraju