Why you need an operating model
As first-time founder and CEO my relationship with an operating model has gone through many iterations. Early advice I got after spending time building out my first model was, “All you need is an idea to raise money. You’re wasting time on the model because it’s going to be wrong anyway.” Part of that statement is true, but it was terrible advice.
My first operating model was indeed wrong, but it’s a critical first step to really owning the financial future of the company. I found building a financial model from scratch helped me understand the mechanics of growth that were particular to my business. For example, we had to go through a year-long audit process with an industry regulator that cost us time and money before we could start selling to our target audience. Showing these costs in the model helped my early investors see that I had a point of view and was planning for this stuff. But there were some fundamentals that were missing, such as the relationship between investing in sales and marketing and revenue growth.
You might be using Quickbooks or Xero or other accounting software. The model is not intended to replace these. Both the accounting software and the operating model play an important role in managing your business. You’ll want to keep BOTH up-to-date as part of your monthly financial close process.
Questions, answers and considerations
A model will help you answer questions, model different financing scenarios and generally understand your business more clearly.
How much money should I raise? The amount of capital raised matters. Raise too much too soon and dilute yourself unnecessarily. Raise too little and you run the risk of running out of money. So you must take time to consider how long it will take your team to reach the milestones you want to reach before going out for the next funding round. Let’s say you’re considering a seed round and want you want to get to $2m run rate before you raise your Series A. You must figure out how much you’re going to spend before you reach that milestone and raise enough to get you there with some cushion. It nearly always will take longer and be more expensive than you’re able to anticipate.
Should I be conservative or aggressive? You’re going to need to show up to different conversations with different points of view and a flexible model will help you understand what levers you can pull to grow faster or slow down your burn rate. Investors will likely trim your revenue projections by 20%–40% when considering an investment. As a result, when selling the idea many founders like to be more aggressive when showing how the company could grow. But once you’re working with a board and using your model to set company goals and quotas for your sales team, you’ve got to think carefully about what you’re committing to. The model alone won’t determine how many activities each sales person can do in a day and how many sales are actually achievable each month. One of my favorite sales leaders Loren Padelford of Shopify has a great talk on this part of building sales models with Bowery Capital.
How fast will we be able to grow? If you’re raising a Seed round your primary mission is to quickly find product-market-fit for and then scale. If you’re raising a Series A you’ve already found product-market-fit and you’re focusing more on building the organization in preparation for the growth ahead. After product-market-fit is established, how fast you are able to grow depends a lot on how much capital you have available. A model like the one we’ve shared here will help you understand some of the key relationships between growth and costs.
Who do I need to hire and when? One of the most important parts of the operating model is the hiring plan. Personnel will likely be the largest part of your operating expense. Being thoughtful about the WHEN and WHY of hiring is critical for controlling your burn rate and planning your company’s growth. A good model will help you understand if your ideas about who to hire and when make sense and will help you explain your thinking to your prospective investors and/or your board.