Starting the Company - When to Raise Money
I think I'll start off with some general thoughts on funding a startup and then after getting a few Introduction to Funding posts out of the way, then I can dive into more details later on term sheets from an entrepreneur's perspective. The first few posts here will be super basic, as I think there's a dearth of this kind of stuff out there in the wild.
There's been a lot of discussion the past couple years about the fact that Internet startups need less funding than they used to because hardware, software, and bandwidth costs have all come down. It's certainly true that you can successfully bootstrap a startup more easily now. 37 Signals and Bloglines are two good examples (one still private and one sold to Ask.com) of successful startups that got very far before or without raising money. There are plenty of other examples. FeedBurner investor Fred Wilson had some excellent thoughts on funding dynamics in the Web2.0 world.
The reality is that every company is different. YouTube was obviously going to be a capital intensive business with a huge bandwidth bill. Generally speaking, I would probably never spend more than 6-9 months working on a company without raising money, because I prefer to work on platforms that can be extensible to massive audiences, and if you want to build and develop extensible platforms, then at some point you're going to spend a lot of money on infrastructure. So, if you're just getting started, and you don't know much about funding or how much you're going to need or even who to talk to (angels?, VC's?, Friends and family??), what should you do? My strong suggestion is to start working on your idea without raising money and keep going until you've gotten your product or service to a state in which a) you have a good feel for whether you like its chances of success in the market (you might rephrase this to say "now that you're looking at something real, are you still as passionate or even more passionate about it?"), b) you have a very general feel for how much money you think you'll need in the next year. For the FeedBurner founders, this time period has been about 4-8 months in our last couple of startups.
There are a couple benefits with taking this initial bootstrap approach. First, once you have investors, you have some level of obligation to others than yourself and your employees. It gets significantly harder to just say "this isn't as exciting an idea as I thought it would be, I think I should focus on something else". Second, in most cases, particularly for a first time entrepreneur, it's going to be a lot easier to attract funding for a product or proof-of-concept that you can demonstrate to investors. The first two reasons for bootstrapping for a half a year or so are somewhat obvious, but there's a less obvious reason. In my opinion, you don't want to raise enough money to last you three years on your A round. The money that you raise costs you equity. Theoretically, you will increase the value of the company every week, month, year that you work on it. By raising 5 million dollars when you're only planning on burning 1.5mm the next 12 months, you are shortchanging your ability to raise the incremental 3.5 million at much more favorable terms ten months later. I mention all this because I've heard a few entrepreneurs talk about how much runway they've got, and I'm not sure that's necessarily a good thing. So, by waiting a few months before you raise money, you'll hopefully have a better feel for pace and potential burn rate and can raise an amount that comfortably gets you through the next phase of growth. The one caveat I'll mention here is that it's been my experience that even when you're capital efficient, you always spend money faster than you think you will in a startup, so make sure you raise enough to get you through the next phase of growth.
The other benefit to only raising as much as you need to get you through the next phase of growth is that companies (now speaking VERY generally!) tend to spend what they raise, unless you are particularly rigorous about being capital efficient. It's a lot easier to say "yes" to the monthly PR retainer from the high-falutin' pr firm with the great client list if you've got "extra" cash in the bank. It's a lot easier to say no if you're managing to a burn rate that's not cushioned with loads of extra cash.
The problem with advice like this is it invites comments like "but Google did one big 25mm dollar raise after their seed funding and look how well that worked". It's important to remember that you can't apply a one size fits all approach to thinking about these things. This is just a general framework for the way I like to think about getting started.
In the next post I'll talk about VC vs. angels vs. friends and family. Fortunately, I've done all three in different companies, so I there's a slight chance I will actually have some idea what I'm talking about. We'll see.