Saturday, October 10, 2009

New Startup: Sizing & Funding It

I've been working in stealth mode for the past two and a half months on new software that I hope will really help people. The closed beta starts sometime next week. I'll announce the software here and hope you'll give it  a try.

A question I've been pondering is something familiar to founders: should I raise money, how much should I raise, and what on what terms?

After starting three technology companies, two music companies, and a consulting business, I'm working on creating a worksheet to evaluate a number of things about how I'll build this one.

Like Chilisoft, I won't have co-founders, but will have a very small team that can get things done as I try to evangelize the products. I haven't thought too much about team composition, except that there will at least three developers, focused on three different parts.

A five-member team feels about right, and more than seven feels like too many moving parts. I will need some help with marketing tasks, so it's likely I'll hire a generalist with some site building skills, and I'll outsource and automate all admin, accounting, and HR stuff.

But I might not need to; it's very possible I'll stick with freelancers until there's a need to do otherwise. Employees can be helpful, but until you know you have a steady stream of sustainable revenue or sufficient investment, you're better off waiting.

So, a topic on my mind is fundraising. I've raised a lot of money, and have a lot of opinions about it, but here I want to focus on one question: how much is enough? If you're pre-revenue, pre-release, it's tough to raise from VCs, so you're likely raising from angels, friends, and family.

I'm not very liquid at the moment, so I'm likely to raise something. I have two significant successes under my belt--ChiliSoft and Mission Research (9,000 customers, profitable and growing), so doors are open to me that aren't open to first-time founders.

But the question is how much? For me, I just want to have enough to fund the path to product completion, tiny launch, and my own salary, which I'll keep at maybe Sr Developer level--enough to get by and rebuild the buffer. But for how long?

I've developed a few business models for it, most of which depend on adoption. I think 12 months from release is enough to know whether you can get adoption and whether there's a business there. I'm about 2 months from full release, so I'll need about 14 months of funding, but I'll base my calculations and number on 12 months because I have some sweat equity in it.

During that time, I'll need about 1 full-time developer, and 1 full-time utility person--the generalist. The generalist is really key for startups, but has trouble fitting in down the road as a company specializes more. I'm a generalist, but have not needed to specialize because I've always stayed in leadership roles.

So I'm going to make the guess that if I want to have a full-time focused effort on this project, I'll need 14 months of salary, plus ops costs, hosting, a little marketing, and etc. In Mission Research, I didn't get paid for 5 years, then was paid decently for one year, and well for one year. This time around, I can't afford to not get paid, because I'm not liquid.

So let's say I can convince my cohorts to take $60k, and i'll take the same. That's $180k, to which I'll add 30% overhead, so $240k, and then ops and marketing at maybe $5k/month. $300k to find out if there's a there there.

So in this little exercise, I nailed the number pretty easily, based on the assumption that I can get cohorts at $60k. If I can't get them for say less than $80k, then we add $60k to that number, or shorten the path by $60k. I won't take less than the cohorts--I've been there and I can tell you that I'm willing to be the hero when needed but not by default. I have some specific cases in the past where I just ended up getting burned, and I won't do it again.

So now the number is, well, let's call it $360k. That's if I want fulltime focus. Time to market is important, quality is crucial, timing is important. I can make this happen as a part-time thing, but without any guarantee for success. So I'd rather fund it.

So a pre-revenue company with a repeat successful founder might be able to get a pre-month valuation of around $1 million if the model is clear and some opportunities are already lined up. Without a track record, you might get between $500k and $750k. Even with a track record, that might be the range.

So if I'm crisp, maybe we'll raise $300k at 900 pre, 1.2 post, for 25% of the company. To me that's worth it, but if I could avoid that, I will.

The critical question is this: can I build a company worth more than the amount invested by the time the money runs out, and sell it or create sustainable revenue?

The answer is yes.

But if I can get it to revenue a lot faster, than the capital requirement goes down. So, what does it take to get it to sustainability?

1) Cut the costs. If I keep my expenses down, investment can be lower, % lost can be lower, and amount of revenue to get to sustainability is lower.

2) Get to revenue faster. Sell more faster. At $360k/year, we need to get to $30k/month. Now, I can get to $30k a month just selling consulting services. But building company revenue that requires adoption is tough, when the biggest obstacle to adoption is price. This is a free product, supported by sales of derivative products.

3) pursue multiple sources of revenue early on until adoption. Here are some ideas I'm kicking around:

  • freemium--free plus premium. The free part is easy. Defining the line between free and paid features is a challenge.

  • Heroes Subscription--basically ask super users to support you with a monthly subscription that entitles them to direct interaction, early news, lifelong benefits of some sort, and a list of satisfying benefits. I'm not good at defining those, so I have some research there. But I like the idea, and know people who would do this. At $20/month, it would take 1500 subscribers to float us. Doesn't feel realistic, but I think the product will inspire that kind of support. I hope.

  • Data Exclusivity for 1 year. The primary model will likely be selling data, reports, analysis, etc. It's possible to enlist a large company that cares about the kind of data we'll be generating to fund it as a research project;i.e. have your customers fund you.

  • etc


If the post-money valuation is $1.2 million (optimistic or not), then one percent is $12,000. So for each $12,000 of revenue we can generate or cost we can cut, we get 1% less dilution. Sell the company for 20 times the first round, and you've left $240,000 per 1% on the table. If that' s not incentive to cut costs and generate revenue...

The place you don't want to get to is running out of money while the opportunity is still green and growing but not producing. Been there, too, many times, and it sucks for everyone.

I'll keep thinking about this out loud here as I get closer to deciding on my path.

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