Note: This is a guest post from Adam Hoeksema, Co-Founder of ProjectionHub. ProjectionHub is a web-based tool that helps small business owners create financial projections without the need to have a PhD in spreadsheet modeling.Hiring even just one employee is a major investment for a small business. Because of that, many business owners delay hiring far too long to the point that it hurts the success of their business, while other entrepreneurs hire way too soon.
In order to make a financially sound hiring decision you need to run some numbers to determine what it would take for the new hire to provide a positive return on investment for the company. There are at least 3 ways to quantify the return on investment for a new hire that will ultimately help you determine whether or not you should take out a loan to hire an employee.
Maybe you want to hire a salesperson, but in order to find a quality salesperson you need to provide a base salary and benefits to go along with sales commissions. Typically it will take some time for the sales person to start generating new sales, so you will have thousands of dollars in payroll expenses before you ever see the first dollar in new sales. This can be a great scenario for a small loan, but you will need to run some numbers to make sure you borrow enough to give your salesperson enough time to start paying for themselves with new sales. Here is an example of what that analysis might look like:
So let’s assume you offer a $20,000 base salary, and you will spend an additional $10,000 on taxes and benefits per year.
Your monthly cost would be $2,500.
Then assuming a 15% sales commission you can see what your investment looks like for the first 12 months. We are assuming it will take a couple months before they make the first sale, so you will need to pay the entire $2,500 monthly expense out of your loan proceeds.
Then as sales kick in month 3 you can see how the new sales start to chip away at the cost of the employee.
In this model the salesperson breaks even in month 9 and starts to contribute back to the company.
Of course every company will be different, but you can see that in this particular situation you will need to borrow just over $11,000 in order to cover the new hire expenses.
In many cases this is an excellent investment because by year 2 a successful salesperson will cover all of their expenses, have repaid the initial loan, and continue to add sales to grow the company.
If you crunch the numbers and it will take 3 years for the employee to breakeven, then it is probably a bad investment.
You might also hire in order to free up your time so that you can focus on sales. The model on this would look slightly different. You might want to estimate a dollar amount you can generate in sales for each hour your focus on sales. Once you have that number, the rest is easy.
If you can generate $50 per hour in gross profit, then you should hire someone else to do everything you currently do that costs less than $50 per hour. For example, you might do the bookkeeping, but you could hire someone else to do the bookkeeping for $20 an hour. This is an obvious decision. You are immediately more profitable when you exchange $50 in gross profit for $20 in bookkeeping expenses.
Of course, you may need to take out a small loan in this type of situation because there is training involved when you hire a new employee. You might need to continue to spend time training and helping with the accounting which would take away from your sales. If the new employee is a quick learner, a very small loan should take care of your shortfall until the new employee starts to pay off.
The last situation where you might need to consider taking out a loan in order to hire a new person is bringing in house an activity that you outsourced in the past. For example, large companies have in-house counsel, in-house accountants, an in-house marketing team, etc. Eventually you will hit a point where it is more cost effective for you to hire an employee to do a job rather than outsourcing the job to another company.
Again, this is an easy model to figure out. Are you paying your marketing firm $50,000 per year to work on your business 10 hours per week? If so, you could bring in an expert marketer on staff for $50,000 per year who will work 40 hours per week.
In this type of situation you may save money right off the bat, and have no need for a loan to fund the transition.
There are ways to finance the hiring of new employees. Don’t wait so long that you hinder the growth of your business, but make sure to actually look at the numbers. Understand exactly when the new employee will begin to provide a return on your investment? This will help you determine right loan amount to request, and will set your company up for future growth.