To raise or not to raise

If you follow startups at all, you’ll likely notice that there are precisely two camps when it comes to raising venture funding of any sort: those who trumpet each new round as if the company won the Super Bowl and those who believe bootstrapping is the only legitimate way to build a business. There are, of course, merits to both camps’ arguments, but, as with all things, reality tends to live somewhere in the middle. There are dozens of reasons why raising money could be a good idea and dozens of reasons why raising money might not be a good idea.

Whether or not to raise funding is an extremely complicated question with dozens of angles, numerous points of data, and, in the end, gut instinct and your emotions. Your company is a very personal topic. Don’t forget that, because your emotions will effect your business decisions.

I look at capital, whether it comes from an angel, a VC, or a traditional bank loan, as an accelerant. It’s like gas. Sometimes your fire is burning nice and bright. You’re warm and have plenty of heat so why pour more gas on the fire? Sometimes, however, you’d like to start another fire, or maybe you’d like to burn down a house, or, possibly, you’d like your little glowing embers to be a fire more quickly than is otherwise naturally possible. These are all great reasons to reach for the can of gas.

There are, literally, hundreds of reasons why you might consider raising money. The following is a small list of reasons that I think are in support of raising funding:

  • You’d like to create a product which requires you to build hardware, open storefronts, or otherwise produce something physical. Manufacturing is a capital intensive adventure. I doubt someone could easily bootstrap the Tesla or the Nest.
  • You’d like to focus all of your resources on getting the product to a new level. Sometimes your company’s bottom line isn’t growing quickly enough for your product’s needs. Do you think Steve Jobs would have hesitated to raise capital for Apple if they needed it to ship the iPhone? Investors call this an “inflection point” and love to invest in companies at these stages. Could you wait a year and save your pennies? Sure, but you could give up couple of points on a convertible note and be in a position to get there in a few months instead. And, in this industry, a year is a long time.
  • You’ve built a successful business, which you have no interest in selling, and would like to extract some liquidity. We’ve all seen this, but nobody ever talks about it. Some company raises $10’s of millions and people wonder why a company making that much money would need it. They don’t, but their founders are now multimillionaires and free to get back to building that 50-year business without wondering when the big payday will come.
  • Not everyone is in a position, financially, to pursue their dreams. There are a litany of reasons why this might be, but you’d have to be a gigantic asshole to pooh-pooh someone for raising capital for this reason. Kids, family, mortgages, salary requirements, and time constraints are all legitimate reasons to say, “I either hunker down at this giant corporation for the rest of my life or I raise some capital, mitigate my family’s risk, and chase my dream.”
  • It can, at times, make sense to raise capital simply to gain access. Many large corporations have investment arms that keep an eye out for promising young companies and products that could help the mother ship out. Raising capital from Verizon or Salesforce is a great way to gain access to lucrative partnerships, which, of course, you’ll parlay into partnerships with other companies.

That being said, there are legitimate pitfalls to raising capital. Luckily, there is a solid book, Venture Deals, that very clearly and plainly lays out your options, how such deals are structured, and what to look out for. If you are considering seeking capital, or even if you are not, this is a must-read book.

Venture Deals raises a number of concerns, though not directly, about raising capital for founders. For every reason to raise money there is likely a good reason to not raise money. Specifically, I’ll talk about reasons related to what investors call a “priced round”, rather than convertible notes, which I find to be spectacular vehicles for founders seeking to take investment. A few reasons you might want to second-guess your decision to raise capital:

  • Raising capital is an enormously distracting process. Your company, product, and sanity will absolutely take a hit throughout the process. If you’re in the middle of a major product push, or negotiating a big contract, do not think for a second you should be out looking for money – you’ve got more important work at the moment.
  • There is such a thing as raising too much capital. If you raise too much money in an early round, you’re likely going to get severely pinched in future rounds. It’s not fun to hit your Series B and realize that you only own 7% of your own company (Yes, I know founders who’ve been in that position. Yes, they were at companies you’ve heard of.).
  • There is such a thing as too high of a valuation. I’m going to tell you a dirty little secret – investors think valuations are bullshit too. The real issue, though, is raising at a valuation that takes other options off the table. Setting the bar too high in your Series A or Seed can take early exits off the table.
  • When you set up two classes of stock and structure your company the way VCs usually require them to be configured, you give up all control of your company. Yes, you’re on the board and, yes, you’re CEO, but that hasn’t stopped Sequoia from (proudly, no less) firing 45% of their founding CEOs within 18 months. Remember, you’re on a vesting schedule too, so you’ll lose all of the equity that’s unvested.
  • Investors can be a huge distraction. It takes time to keep them up-to-date, coordinate conversations, extract input and insights. Additionally, 99% of the investors you’ll work with haven’t built a product like yours (if they’ve even built one), worked at a company like yours, interacted with users like yours, etc. They’ll suggest things to you that are completely insane. Stay the course – nobody, including your investors, know your business, product, and customers like you do.
  • Investors play portfolio theory. If you’re one of the ones they think are going to strike it big, you’ll be showered with praise and attention. If you’re not, you’re in for a rough reality – you’re now competing for their attention with the dozens of other losers in their portfolio.

I don’t have any hard and fast rules when it comes to raising capital. I think every business, product, and team are unique with their own unique set of challenges. That being said, I do have a set of guidelines I like to follow when raising early stage capital, which are as follows:

  • Don’t raise money before you have a working prototype. If at all possible, wait until you’ve launched a private beta. Every line of code you write, every beta signup, will lead to better terms with any investor. The downside, of course, is that you might prove to yourself and potential investors that your idea is dumb.
  • Only raise money from people with their own money in play. With the advent of the “super angel”, we’re now seeing many angels who are not, in reality, investing their own money. Investors who invest their own money tend to be a lot more attentive.
  • Look for investors with a low “deal flow”. Do you honestly think the guy funding 20 startups a year is going to have a whole hell of a lot of time to help you out? I’d shoot for people that do 3-5 deals a year.
  • Whenever possible, take money from the former founder. I jokingly refer to being a founder as being a member of the Fraternal Order of Founders. You simply don’t know what it’s like until you’ve been there and tried it. Having an investor with the “founder context” is going to be hugely important when you hit rough waters.
  • Seek out investors who have skillsets that compliment your own. If you’re a coder and your cofounder is a designer, look for a guy who used to be VP of Business Development somewhere or find a former COO/CEO. Those skills are not the bullshit most makers would have you believe. The tricky part is finding someone who treats those trades as craft and science rather than pure hustle or vapor.

In the end, do what you feel is best for your product and business. No book or blog post (including this one) can replace your insight into your own business.

HOWTO: Spend your investors’ money

I’ve invested in two startups and advise, officially and unofficially, a dozen or so other startups. Recently, a company that I’m involved with, attachments.me, raised $500,000 from Foundry Group. Since their raise, the two cofounders, Ben and Jesse, have been on a tear adding features, solidifying the infrastructure, and ramping things up to a public beta.

Attachments.me is a unique consumer service in that a single user could have gigabytes of data to crawl across multiple accounts. As a result of this unique challenge, Ben has been spending a great deal of time working out how the underlying infrastructure is going to scale. This, of course, involves spinning up a decent amount of servers on AWS. In doing so, Ben was extremely worried about keeping costs down. I had to laugh as the numbers he was worrying about was less than 1% of the total amount raised or, as Chris Lea said, “Your investors didn’t give you the money so you could look at the large balance in your bank account.”

But, it’s a good question, and I get asked it often. How should you spend all that money your investors just gave you? How should you spend that 15% employee option pool? So I set up a Google Form and asked a dozen or so of my favorite investors what they thought. I got six responses from four seed stage investors and two Series A investors. Here’s what they had to say…

  • If you took total monthly burn and divided it by total number of employees, how much would you expect the per-employee burn be? The average response was $12,000 per employee with the majority saying $15,000 was expected. This means if you have 10 employees you should be comfortable with a total monthly burn of between $120,000 and $150,000 per month.
  • What percent of a given round of funding do you expect will be spent on personnel? The average response was 73% of the total round with the majority saying 80% This would indicate that my friends at attachments.me should feel comfortable spending $400,000 on building out the team.
  • What percent of a given round of funding do you expect will be spent on servers and infrastructure? The average response was 18% with the vast majority saying they expect a company to spend 15% of their total raise on servers and infrastructure. If you’re burning $150,000 a month, you should try to keep your AWS bills below $22,500 per month.
  • How much should rent be, roughly, per employee per month? The average response was $666 with the vast majority of investors saying $500. So a team of 10 shouldn’t be spending more than $5000/mo. on rent.
  • How much equity, on average, should early engineers get? Two investors recommended less than 0.5%, which seems extremely low for your first couple of engineers. One said 1.5% to 3%, which I think is fair for your first engineer, but on the high end for your third and fourth engineers. The other three said 0.5% to 1.5%, which seems to be the universal standard when I talk about this topic with other founders in Silicon Valley.
  • How much equity, on average, should an early executive hire get? The consensus, with four investors agreeing, was between 2% and 5% The other two investors thought 1% to 2% was appropriate. My personal recommendation, pre-Series A, would be 1% for a Director, 2-3% for VPs, and 6-9% for CEOs. This, of course, depends greatly on salary and other benefits offered. What I tell people is that I have two dials: salary and equity. Dial one up and the other gets dialed down.
  • How much, if any, of a premium would you expect there to be on burn for
    SaaS and PaaS companies?
    One investor said there should be no premium, one said 10%, one said 30%, and three said 20% The 20% number resonates with me as that’s about the premium SimpleGeo has spent on our per-employee burn. In other words, if an investor expects you to spend $15,000 per employee per month, they most likely will be okay with a platform company spending $18,000 per employee per month in total burn. The thinking here is that SaaS/PaaS companies require more infrastructure, better/higher quality infrastructure, more bandwidth, and more senior/seasoned engineers.

These are, of course, rules of thumb, but it should give you a good feeling of where you and your company stands. Your investors put money into your company under the expectation that it’s going to be spent so you shouldn’t feel bad about spending that money.

UPDATE: A lot of people have questioned the $12,000 per month, per employee number. Keep in mind that’s 100% of all burn for the entire company and not just their salary. This includes server costs, travel, rent, office supplies, etc. On average, an engineer in Silicon Valley will have a base salary of $100,000 a year. Add roughly 20% for benefits (healthcare, vacation, payroll taxes, etc.), $3k every two years for hardware, rent ($500/mo.), etc. and you’re at $10,800 per month just to pay for them to walk in the door. I doubt it’s too hard to imagine spending $1,200 per employee on travel, servers, office supplies, etc.

Why you should probably have an LLC for side projects

I recently posted an illustration I was getting made for a holding company I’m creating for my side projects. One of the comments asked me what the benefits were for creating a holding company for side projects. It’s a great question and I thought would make a good post for other nerds to think about.

I’m operating under two assumptions:

  1. You, the creator of said side projects, have assets you wish to protect. Houses, laptops, cars, bank accounts, other side projects, etc.
  2. You have side projects which are actually used by other people. A lot of people have side projects that only they use or a small group of friends engage with. For instance, my tweetimag.es project services over 10m Twitter avatars in a single day.

When I was in business school, one thing was hammered into my head: limit yourself to “exposure.” Exposure, is a business term that basically encompasses the things you do that could get you sued. Unfortunately, the US is a litigious country and any idiot can sue you for anything. Getting sued costs a lot of money; even if you’re totally innocent.

In the US, and I assume other countries, we have LLCs. LLC stands for Limited Liability Corporation. It’s what business people call a “passthrough” entity. This means that you don’t get double taxed like you do with corporations. In other words, it’s like a fake version of yourself as far as the IRS is concerne. It can also own property and enter into contracts on its own.

That last tidbit is what you should be most concerned about. If you create a side project that gets used by lots of people, you are at a risk for getting sued directly. If your LLC owned said side project, you are not personally at risk of anything. The LLC could get sued and all associated assets could be taken, but your car, house, etc. should be fine … unless they’re owned by the LLC.

And this, my friends, is why I’m creating an LLC for my side projects. I have assets, outside of tshirts featuring the word fuck, that I’d like to protect. By creating an LLC for my side projects, having the LLC engage consultants on its own, and having the LLC own all of the IP for said projects, I’m greatly limiting my personal exposure.

NOTE: I am not a lawyer or a tax advisor. I think having an LLC is a good thing for me personally, but it could be a really dumb idea for you. Everyone’s miles may vary.

UPDATE: Marco Tabini has a great followup noting that an LLC is not necessarily a silver bullet. A must read if you found this post interesting.

Fail fast and often

I’m saddened to hear the news that EventVue has closed up shop. It’s never fun watching other entrepreneurs have an exit like this knowing full well how much of themselves they put into it. The good news is the EventVue guys clearly have learned huge lessons and will be in a much better position to win in round two.

The one point they brought up as a lessoned learned was that they didn’t focus on learning and failing fast until it was too late, which reminded me of a quote from Joi Ito I recently heard at a conference.

“Want to increase innovation? Lower the cost of failure.” — Joi Ito

This is absolutely crucial. As a startup you need to fail and fail often. Not a lot of people know that SimpleGeo was, in fact, born of failure. Matt and I originally started the company as a location-based gaming company. Due to market realities (investors rarely invest in gaming companies in the seed stage), personnel realities (neither Matt nor I had built games), and other factors we had to have what I call our “come to Jesus” moment. Since then we’ve focused on small, quick iterations and quickly scrapping or moving on from our failures (or in many cases simply adjusting our assumptions).

Easy to say, but how are we doing it?

  1. We use a loose approach to Agile development with two week sprints. This means that, worst case scenario, we’ve wasted two weeks of effort in order to find out if a tweak, product, etc. is going to fail. I can’t emphasize how important this is. If you push your team 6 months and release a giant product only to find out users hate it or don’t use it, you’re screwed. 6 months is a lot of opportunity cost for a startup.
  2. We actively engage our user feedback. If users don’t like something we abandon it. If users are demanding something we move it up the priority list. For instance, we thought for sure that people wanted location-based search first and foremost after storage. Turns out, users actually wanted better tools for accessing and managing the data they’re sending us. So we’ve focused on churning out more SDKs and tools for managing data.
  3. We use Amazon EC2. Specifically, for testing and prototyping, we use spot instances. It’s an extremely cost efficient way to destroy servers during testing.
  4. We start small. Our current product offering is probably only 10% of what users expect from us long-term as far as pure number of features go. That being said, we picked the initial use-case and, I think, nailed it. The reality is 60% or more of the use cases for our users is simply storing millions of points and running radius queries on those points quickly. It’s also the foundation that all of our other products will be built on. So we’ve spent time focusing on building and iterating on that use-case. As a result, we’re multi-homed in three datacenters (actively serving data from all three), redundant across all three (meaning your data is stored in every datacenter), searches are extremely fast (under 50ms in some cases if you’re on EC2), and all points are backed up to S3 in YOUR account (it’s your data after all).

We’re not perfect by any means, but I think Matt and I realized early on that we need to be most efficient at recognizing and owning our failures and deficiencies. If you focus on minimally viable products, small iterations, and prioritizing user feedback you, too, can fail fast and often.

“Failure is useful.” — Larry Page