Tag Archives: starting costs

How Much Money Do I Need for My Startup?

Angel investment, Business Planning, Starting a Business, Venture Capital, , , ,

It’s an obvious question. And if you’re looking for startup investors you’d better be able to answer it well, and quickly too. No wandering eyes. No doubt. If you’re doing a pitch, have a slide for it. And be specific.

I liked this from Ben Yoskovitz’s Instigator Blog on Use of Funds:

…most descriptions of “use of funds” are incredibly generic and standard, typically involving the following: hire key personnel, product development, sales & marketing. Hhhm…the phrase, “No shit Sherlock…” comes to mind.

And on the other hand, there’s this about that, from Perfecting Your Pitch, by Guy Kawasaki’s Garage.com Ventures:

It should be clear from your financials what your capital requirements will be. On this slide you should outline how you plan to take in funding—how big each round will be, and the timing of each—and map the funding against your key near-term and medium-term milestones. You should also include your key achievements to date. These milestones should tie to the key metrics in your financial projections, and they should provide a clear, crisp picture of your product introduction and market expansion roadmap. In essence, this is your operating plan for the funds you are raising. Do not spend time presenting a “use of funds” table. Investors want to see measures of accomplishment, not measures of activity.

So go figure. There are two opposite points of view from two good sources.

I’m amazed, meanwhile, how often I see people pitch startups to investors without having a good answer to that question. I expect an instant answer, without hesitation, and if it’s a slide deck there should be a slide.

And that doesn’t mean that anybody necessarily believes what you say. It’s all educated guessing. But details add credibility. And if you can’t answer that question, what do you think your audience is thinking?

There is a standard way to calculate starting costs.

  1. Make a list of the stuff you need to purchase before you start. Include expenses like early salaries, cleaning up the location, developing the website, packaging if relevant, prototypes … it’s a collection of educated guesses, of course. It’s just guessing, but how can you not do it?
  2. Do your projected first year cash flow. Estimate sales, costs, expenses, and payment lags from business customers, your own lags paying your vendors, plus what you need in inventory. If this isn’t a cash deficit, recalculate. In real startups it almost always is.
  3. Add those startup costs with the deficit spending, and that’s what you need from investors.
  4. Reality check: if that calculated amount is way too much, investors will laugh at you, go back and change your plan. Spend less. Look for the startup sweet spot.
  5. Double reality check: if you can spend less, maybe you can do it without investors. There are other ways to get money. But even in that case, don’t you want to have a good idea of what it takes?
  6. Triple reality check: if you’ve got a high-end high-tech startup, looking for serious angel or VC investors, give them a break and show spending the money on things that make for growth, excitement, virality, sizzle. If you don’t know what that is, rethink your plan.

(Image: mgkaya/istockphoto.com)

3 Steps to the Startup Sweet Spot

Angel investment, Starting a Business, Venture Capital,

Every startup has its own natural level of startup costs. It’s built into the circumstances, like strategy, location, and resources. Call it the natural startup level; or maybe the sweet spot.

1. The Plan

For example, Mabel’s Thai restaurant in San Francisco is going to need about $950,000, while Ralph’s new catering business needs only about $50,000. Sweet Spot The level is determined by factors like strategy, scope, founders’ objectives, location, and so forth. Let’s call it its natural level. That natural startup level is built into the nature of the business, something like DNA.

Startup cost estimates have three parts: a list of expenses, a list of assets needed, and an initial cash number calculated to cover the company through the early months when most startups are still too young to generate sufficient revenue to cover their monthly costs.

It’s not just a matter of industry type or best practices; strategy, resources, and location make huge differences. The fact that it’s a Vietnamese restaurant or a graphic arts business or a retail shoe store doesn’t determine the natural startup level, by itself. A lot depends on where, by whom, with what strategy, and what resources.

While we don’t know it for sure ever — because even after we count the actual costs, we can always second-guess our actual spending — I do believe we can understand something like natural levels, somehow related to the nature of the specific startup.

Marketing strategy, just as an example, might make a huge difference. The company planning to buy Web traffic will naturally spend much more in its early months than the company planning to depend on viral word of mouth. It’s in the plan.

So too with location, product development strategy, management team and compensation, lots of different factors. They’re all in the plan. They result in our natural startup level.

2. Funding or Not Funding

There’s an obvious relationship between the amount of money needed and whether or not there’s funding, and where and how you seek that funding. It’s not random, it’s related to the plan itself. Here again is the idea of a natural level, of a fit between the nature of the business startup, and its funding strategy.

It seems that you start with your own resources, and if that’s enough, you stop there too. You look at what you can borrow. And you deal with realities of friends and family (limited for most people), angel investment (for more money, but also limited by realities of investor needs, payoffs, etc.), and venture capital (available for only a few very high-end plans, with good teams, defensible markets, scalability, etc.).

3. Launch or Revise

Somewhere in this process is a sense of scale and reality. If the natural startup cost is $2 million but you don’t have a proven team and a strong plan, then you don’t just raise less money, and you don’t just make do with less. No — and this is important — at that point, you have to revise your plan. You don’t just go blindly on spending money (and probably dumping it down the drain) if the money raised, or the money raisable, doesn’t match the amount the plan requires.

Revise the plan. Lower your sites. Narrow your market. Slow your projected growth rate.

Bring in a stronger team. New partners? More experienced people? Maybe a different ownership structure will help.

What’s really important is you have to jump out of a flawed assumption set and revise the plan. I’ve seen this too often: you do the plan, set the amounts, fail the funding, and then just keep going, but without the needed funding.

And that’s just not likely to work. And, more important, it is likely to cause you to fail, and lose money while you’re doing it.

Repetition for emphasis: you revise the plan to give it a different natural need level. You don’t just make do with less. You also do less.