If you count Mom and Pop shops, the average entrepreneurial venture requires about $25k in startup cash. Talking to Web 2.0 guys, it seems like everyone is out to raise a couple million to put their plans into action and pay their salaries during early stage growth. I was particularly struck by this article and Nivi’s responses which state you should raise “As much as possible“. I’ve also been advised more than once that I should look to add people to our advisory board who can introduce us to sources of possible funding (in other words: VCs and Angels). For better or worse, we’re bootstrapping for now.
A couple of things have led us to this decision and an understanding of when we’re going to have to change our minds.
Don’t Need It
First off, we’re not doing anything that’s capital intensive right now. That will certainly change when we have good product / market fit and needs to invest heavily in marketing, but right now it makes no sense to spend a lot of cash trying to scale until we’ve got a product that we know will reach the scale we have in mind. So until our theories are backed up by hard evidence, there’s no need for cash and we’re all happy to put in sweat equity instead of demanding a salary. That’s one of the many benefits of working for a few years before starting your own business, not to mention you’ll need the experience. Also, being able to cut back on the 3 digit sushi dinners definitely helps to control your burn rate.
Cash Flow is King
We’re buoyed in this approach by a short sales cycle. In a B2B market you might have a sales cycle anywhere from 6-12 months (as with my last company Secude). This means you need minimum 6 months cash on hand to pay salaries in the meantime. Depending on how large of a sales and marketing staff you have, that could be a serious amount of cash.
The simple math: Imagine you’ve got two cheap enterprise sales guys costing you $5k a month each, a sales cycle of 6 months, and you expect to be able to make at least one sale a month for $10k thus covering your costs. Guess what? Unless you’ve got $60k in the bank on day one you’ll go bust before you get your first sale. That’s not even a realistic example talking about fixed costs or including inventory holding costs. Even software companies with no inventories and sometimes a very low COGS (because the CEO is also the lead programmer) can have serious cash flow issues which kill it before it gets going, all due to a simple math problem. When it comes down to it, no one cares if your balance sheet is pretty if you’re not cash flow positive.
Keep Your Sales Cycle Short
With startupSQUARE.com, we’re looking at a consumer sales cycle which can be measured not in months, but in clicks. That means if we have sufficient data on user behavior for a high confidence statistical sample, we can finance our growth with debt alone. This means taking out loans from banks and paying it back every month. This has the additional advantage of building up your credibility with financial institutions quickly as you show you can manage your finances and pay back your debts on a monthly basis. So long as our revenue per user is higher than our cost of debt and we retain a short sales cycle, we can scale our growth via debt indefinitely. Our only limit is our ability to borrow, which should increase quickly based on demonstrable milestones.
(note: This does not help us with our long range plans which is to eliminate any short term revenue from entrepreneurs in favor of earning our money from financial institutions, but hey…gotta start somewhere.)
It goes without saying that a great additional advantage of not raising capital is retaining the ownership of your company to a greater degree. Of course, there is a trade off. First, you take all of the risk yourself. That’s a bit obvious. Less obvious perhaps is the possibility that you’ll just wind up giving the same amount of equity away to your partners instead of VC. After all, they’re taking on just as much risk as you. With startupSQUARE, we don’t consider this an issue as we’d all prefer to have a deeply invested partner rather than a hired gun we have to pay with VC cash.
Standing on Killing Ground
There is something to be said about Sun Tzu’s advice regarding desperation.
Ground in which the army survives only if it fights with the courage of
desperation is called ‘*death*’. … In death ground I could make it
evident that there is no chance of survival. For it is the nature of
soldiers to resist when surrounded; to fight to the death when there is no
alternative, and when desperate to follow commands implicitly.
With no big pile of money to back up, there’s a lot of emphasis on doing it right. It is a motivator, even for yourself. That said, I think Nivi’s suggestion to this is quite valid:
I know a serial entrepreneur who raises as much as he can, then puts a lot of the money into a separate bank account that requires board approval to access. It helps you act like you don’t have a lot of money. It also helps with your second concern above.
When to Change Your Mind
My biggest takeaway from our decision is that we have to be fluid and understand the limitations of our understanding. Based on customer feedback, we may be propelled into a model with a longer sales cycle or into a completely different market. To paraphrase Rumsfeld (’cause he can even make something brilliant some downright ridiculous): We don’t know what we don’t know. There may come a time when we need funding and we need to be prepared for that.
We’ve asked a lot of advice on fund raising and there’s a ton more available on-line. We’ve come to the conclusion that if we need to go for an angel round, we’re certain we can do it with 3-6 months of lead time. Based on that, we know when we need to go out and raise funds so the coffers never run dry. Especially since the terms of any deal will get worse the needier we are. So we need to negotiate from a position of strength, with cash in the back, solid customer metrics, and a great list of friends and mentors ready to help us out.
And yes…that 3-6 months is essentially another sales cycle which we need to account for in our WCS (Worst Case Scenario) cash flow planning.
Here’s hoping you never need funding, but find it when you need it,