Over the past few weeks, I’ve come to notice that companies known for raising absurds amount of money are often founded by entrepreneurs who’ve succeeded multiple times before. Off the top of my head, there’s Color ($42M), Flipboard ($10M A-round, $50M follow-on), Adkeeper ($8M A, $35M follow-on 4 months later), and plenty others that raised $5M-$10M before even launching.
At first I thought this was crazy, but I think I finally understand. Building a good software firm is far more expensive than people may think — yes, you could have 5 guys sitting in a living room coding, and that costs virtually nothing. This is how inDinero was just a year ago, and we figured that everyone raising more than $1M pre-launch was crazy. Boy were we wrong…
Ends up that 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 reliablity, you’re dividing your time between building features and assisting existing customers, and you now care about writing maintanable code. All your fundraising budgets were based around time to develop functionality, and now they’re completely wrong. Before you know it, you’re raising 2X-3X the original amount you sought to raise.
When I first went out to raise inDinero’s angel round, we were looking to raise between $250k-$500k. But since we were getting a lot of competition for our deal, we thought we’d raise more. Before we knew it, we were up to $1M in commitments, and thought we had more cash than we ever knew what to do with. 12 months later, we’ve realized that this was the best thing to happen to us. As one of our angel investors put it to us, “given favorable terms, raise as much money as possible.” His rationality was two-fold: 1) the bubble won’t last forever, and 2) startups cost more money and require more time than the entrepreneur ever predicts.
First-time entrepreneurs frequently ask “how much should I raise?”, to which most investors respond “enough to get you to the next inflection point, which should be 12-18 months.” From a practical perspective, you should raise money in small chunks only on an as-needed basis. But this is flawed thinking. In order to do a successful fundraise, 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 their raise, and hope that the amount they raise lasts them until their “next inflection point”. The concept of raising money in small batches no longer seems as feasible anymore.
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. Factor in $5k/month for rent, internet, electricity. Throw in $100k/year for servers, marketing experiments, conferences, travel, etc… Budget at least $80k/employee in payroll, benefits, insurance, and misc costs. (you’ll have to budget more if you plan on hiring more experienced talent) edit: we’ve been able to pay less than market rate purely because we offer more in equity. But there have been potential hires who have higher financial requirements who we haven’t been able to consider because of our budget restraints.
2 - Multiply this number by 2 because it’ll take twice as long to execute on 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 I’ll be talking to investors when I have 6-8 months of runway remaining, which means this so called “inflection point” actually needs to happen way sooner than you think.—-
The amount you’ll raise will obviously depend 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 $250k-$500k ended up being $1M, and though I couldn’t understand why we needed that much, it ended up being the right thing to do.
My only regret is not raising even more.