Jessica Mah is the founder and CEO of InDinero, a San Francisco startup that makes Web-based financial tracking tools for small businesses. A version of this article first appeared in her blog, Jessica Mah Meets World.
Over the past few weeks, I've noticed that companies known for raising absurd amounts of money are often founded by entrepreneurs who have succeeded multiple times before.
Off the top of my head, there's Color ($41 million), Flipboard (a $10 series A round and a $50 million follow-on) and AdKeeper (an $8 million first round and $35 million more four months later). Plenty of others raised $5 million or more before even launching.
At first I thought this was crazy, but now I finally understand. Building a good software firm is far more expensive than people think. Sure, you can start with five guys sitting in a living room coding, and that costs virtually nothing. That's how my company, InDinero, was just a year ago. We figured that everyone raising more than $1 million pre-launch was crazy.
Boy were we wrong. Turns out it costs a lot of money to build a real business. You have office expenses, server costs, and employees who would rather not live off ramen-level salaries. Building features takes 3X longer when you're no longer incubating -- because you care about testing and reliability, you're dividing your time between building features and assisting existing customers, and you now care about writing maintainable code.
When I first went out to raise InDinero's angel round, we were looking for $250,000 to $500,000. But since we got a lot of competition from investors for our deal, we decided we'd raise more. Before we knew it, we were up to $1 million in commitments -- more cash than we knew what to do with.
Twelve months later, we've realized this was the best thing that could have happened for us. As one of our angel investors put it: "Given favorable terms, raise as much money as possible." His reasoning: 1) the bubble won't last forever, and 2) startups cost more money and require more time than the founder ever predicts.
First-time entrepreneurs frequently ask, "How much should I raise?" Most investors respond, "Enough to get you to the next inflection point, which should be 12 to18 months out."
From a practical perspective, it's alluring to raise money in small chunks only on an as-needed basis. But that's a flawed approach, I learned. In order to do a successful fundraising, the entrepreneur has to drop everything they're doing, create competition and hype for their investment round, hope that the market doesn't dry up in the middle of it, and gamble that the amount they raised lasts until their next "inflection point." The concept of raising money in small batches no longer seems feasible.
If I had to do it over again, here's how I'd think about the "how much to raise" question:
1) Create a budget for 18 months of runway. In the San Francisco area, factor in $5,000 a month for rent, Internet, electricity, etc. Throw in $100,000 a year for servers, marketing experiments, conferences, travel, and other expenses.
Budget at least $80,000 per employee for payroll, benefits, insurance, and miscellaneous costs. You'll have to budget more if you plan on hiring experienced talent. We've been able to pay less than market rate because we offer more in equity, but there have been potential employees with higher financial requirements who we haven't been able to consider because of our budget restraints.
2) Multiply that number by 2, because it'll take twice as long as you expect to execute on the product roadmap.
3) Increase the total runway by another 12 months in case the financing markets dry up. I believe this is likely to happen.
4) Assume that you'll be talking to investors when you have six to eight months of runway remaining -- which means that so-called "inflection point" actually needs to happen way sooner than you think.
The amount you need raise obviously depends on how expensive your engineers are and how much revenue you're generating. But if you run this exercise against your original prediction of how much you "need" to raise, you'll find that your intuition is probably off.
InDinero's original plan to raise no more than $500,000 ended up netting us $1 million -- and though I couldn't understand at the time why we needed that much, it ended up being the right thing to do. My only regret is not raising even more.
|Yahoo buys Tumblr, promises to not 'screw it up'|
|Amateur investors tap 401(k)s to buy homes|
|Tesla's fight with America's car dealers|
|Yahoo's $1.1 billion acqui-hire of David Karp|
|Death cross brewing in bond market|