Anatomy of a vc funded startup

October 9, 2009

More insight into the Mint deal, and how the stages of financing and growth play out in a venture-backed model from Christine.net:

The straight shot: Why should you raise money, and how much?

  • Step 1: When you’re ready with an Idea: Raise $100K from friends and family, and use it to build a prototype.
  • Step 2: Once the prototype is done: Raise < $1M in seed capital, and get into market with an alpha launch.
  • Step 3: After that initial launch has traction: Raise $5-10M, and use it to prove/scale the model.

Garage Phase: What are the costs and milestones?

Here’s how MINT spend its $100K of garage money:

  • Founders: $30K/year living expenses
  • Engineering 1st hires: $30-50K/year
  • Office: $400/cube/month
  • Tech: $10K
  • Legal: Deferred payments for 0.50 – 0.75% of company

Roughly, 2 founders + 1 engineer/contractor = $150K/year burn. This gives you 6 – 9 months of runway before you need to raise a seed round.

In order to get that seed round, you’ll need to understand your competition, and come up with projections. Everyone knows this will change…but you need to show your thinking around it anyway. As an example, MINT originally projected $30/user/year for lead-gen and CPA. (Aaron noted that the company is pretty close to this today. But this is the exception rather than the rule.) Know how the business model works. People do X behavior and it turns into $Y income, add up those $Ys and it’s a $Z business. If you can walk people through these assumptions convincingly, you’ll get that seed round.

Seed Round: What are the next costs and milestones?

  • Salaries: $50 – 90K/year ($450K/year for 5 people)
  • Overhead: +20% ($100K/year)
  • Legal: $25K + $2K/month ($50K/year)

MINT.com raised $750K in its seed round to cover these expenses for 12 months, which is about how much time you’ll need to develop into the Series A stage.

What model do you build next in order to raise the Series A? Testing and learning from your seed model, show user growth, retention, COGS, revenue per sale/user, and profit. The accumulated loss is how much you need to raise, and a well-though funding strategy combined with an understanding of (hopefully good) business economics is what will speed the Series A process along.

Series A: Now what?

  • Salaries + Overhead: $200K/year/person
  • COGS: Varies, but even one-time expenses magically add up to $150K/month
  • Legal: $10-50K/month

Total burn for a 30-person team: $6M/year. Naturally you don’t start out burning this much, as it takes time to grow the team. However the numbers work out, your goals should be the same: Get profitable within 2 years. Raise the capital you need to do this without much distraction.

If you want to raise more after this in order to grow more aggressively or extend otherwise, your success in achieving those first two goals will speak for itself.


StartUp valuation 101

May 18, 2009

If you are raising capital, be prepared to tell investors your proposed deal terms. Terms can get very complicated, especially with venture capital investors, but I’ll stick to the basics in this chapter, since most of you will be raising capital from friends, family, and / or angel investors.

Whether or not to put deal terms in your pitch deck is a matter of style. I often prepare a backup slide with deal terms, and pull it out if the pitch is going well, or if the investors ask for it. The mechanics are as follows:

  1. How much is the company worth today? (“pre-money valuation”)
  2. How much money are you looking to raise? (typically enough to get your company through at least 12 months of operations)
  3. How much will the company be worth the day after you raise the investment? (a.k.a., post-money valuation)

Let’s try some simple round numbers. Let’s say the company is worth $1 million today, and you are raising $500,000, so the $1 million it’s worth now plus the $500,000 cash from the financing will make the company worth $1.5 million. That means the investors as a group will be putting in $500,000 of the $1.5 million post-money valuation, so they will be buying $500,000/$1,500,000, or 33% (a third) of the equity ownership in the company. 

cap table

The toughest part of this calculation is determining the pre-money valuation. I recently helped a client establish a valuation for his startup, and thought I’d discuss the topic a bit here. He hadn’t raised capital before, and his instinct was to value the startup based projections of future cash flows (i.e. Net Present Value analysis). That can work for a going concern, but startup valuations are typically derived by looking at comparables, meaning recent valuations of other startups being financed. 

As I write this, most seed-stage round valuations tend to range from $500,000 to $2.5 million. Factors that determine where a startup falls along this spectrum include:

  • Quality of the team. Have they founded successful businesses before, and made money for investors?
  • Stage of development. Is this an entrepreneur with a business plan and nothing more? Does she have a prototype developed? Paying customers? 
  • Size of the opportunity. Is this a company that could, in theory, become a $10 million business or does it have the potential to be $100 million business?
  • Sweat equity implications. If the valuation is too low in relation to the amount raised, the management team may own a very small stake. That’s bad for you as an entrepreneur, because you won’t have enough incentive to make the sacrifices necessary to build the company. It’s also bad for investors— they want you motivated to work hard to make the company valuable, so you both make money when the company is sold.

After considering these issues, my client and I came up with a target pre-money valuation. Our number was $1.5 million. His goal is to raise $500,000, so he’d be selling $500,000 / ($1,500,000 +$500,000), or 25% of his equity to the new investors.

Like any good entrepreneur, he was concerned about giving away too much equity, and thought he should try for a $3MM pre-money valuation. It took a bit of discussion, but I convinced him otherwise. Of course, I want the best for my clients. But if he walked into a meeting with a sophisticated investor with a valuation that’s out of line with what’s happening in the market, he could lose credibility, and blow the deal. If he were to convince an unsophisticated investor (e.g. a family member) to take the higher valuation, he could have a different problem… Down the road, if he took money from a venture capital firm, they might strike a tougher bargain, in which case (depending on terms) the unsophisticated investor could suffer significant dilution.


Valuation

April 29, 2009

I just helped a client establish a valuation for his startup, and thought I’d discuss the topic a bit here. He hadn’t raised capital before, and his instinct was to value the startup based projections of future cash flows (i.e. Net Present Value analysis). That can work for a going concern, but startup valuations are typically driven by comparables, meaning recent valuations of other startups being financed.

At the time of this post, most seed-stage round valuations are between $500K and $2MM. Factors that determine where a startup falls along this spectrum include:

  • Quality of the team. Have they founded successful businesses before, and made money for investors?
  • Stage of development. Is this an entrepreneur with a business plan and nothing more? Does she have a prototype developed? Paying customers?
  • Size of the opportunity. Is this a company that could, in theory, become a $10MM business or $100MM business?

After considering these issues, we came up with a valuation. To be more specific, a pre-money valuation, or the value of his company today. Our number was $1.5MM. His goal is to raise $500K. So how much do his investors get? The math is pretty simple. Take the value of the company before the investment ($1.5MM), add the amount of the investment ($500K), and you have a post-money valuation ($2MM). The investors get $500K divided by $2MM, or 25% of the equity.

Like any good entrepreneur, he was concerned about giving away too much equity, and thought he should try for a $3MM pre-money valuation. It took a bit of discussion, but I convinced him otherwise. Of course, I want the best for my clients. But if he walked into a meeting with a sophisticated angel investor with a valuation that’s out of line with what’s happening in the market, he could lose credibility, and blow the deal. If he were to convince an unsophisticated investor (e.g. a family member) to take the higher valuation, he could have a different problem… Down the road, if he took money from a venture capital firm, they might strike a tougher bargain, in which case (depending on terms) the unsophisticated investor could suffer significant dilution.

Have thoughts on valuations of early stage companies? Please share them below.