Depend upon it Sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.
– Samuel Johnson, in Boswell’s Life of Johnson
So you managed to build a prototype, you’ve gotten some traction, and some credulous soul now wants to write you a check to bankroll your startup. How long will it last? Napoleon said that an army marches on its stomach. Well, a startup marches on its bank account, so kiss your startup dreams goodbye the day a zero stares back at you from your bank statement. But forewarned is forearmed: I’ve collected below some observations from our experiences during the past six months running a funded seed-stage startup.
Salaries
Such is his majesty,
although his miseries are many,
and despite the taxman’s hegemony,
He loses not his quality,
but rather gives authority,
to the nobleman and the beggar,
and makes the foreigner a welcome native,
That powerful gentleman….Mr. Money– Francisco de Quevedo, Poderoso Caballero es Don Dinero (auth. translation)
One of the touchier questions faced at the beginning is that of salaries.
The reality is that, just as you had an uncomfortable conversation about the equity split, you will have a similarly awkward conversation about salaries once you have some money to dole out. Ideally, you will all agree to equal (or at least equitable) salaries and that’s that.
A more likely case is that you’ve raised just enough for a year of runway, every dollar counts, and you’ve got founders who need different amounts of money to get by. How to deal with the resource contention?
One approach is a Marxist, to-each-according-to-their-needs compensation scheme, granting every founder what amounts to a lifestyle subsistence wage. Like Marxism itself, this is an approach that sounds good in theory, but is impossible in practice. One man’s luxury is another man’s necessity, and having to communally decide what’s a reasonable life expense for every founder is fraught with peril. This is particularly problematic when the founders are at different points in their financial life trajectory, or have opted for different lifestyles (footloose bachelors and settled-down family men).
The best solution is to agree on a salary for all that will cover the most cash-hungry member of the team, and then allow each founder to tweak the relative admixture of equity vs. cash in their pay package. Each founder will then trade cash for equity until they reach their desired equilibrium between sure money and lifestyle quality now vs. a risky asset and potential payoff later. If the company is at any sort of decent valuation, the amount of equity differentially disbursed will be negligible in the scheme of things, and your equity ownership pecking order will be unchanged. But those who happen to have particularly cash lean lives aren’t screwed because they happen to live light, and the cash-hungry members of the team can still play the startup game even though their lives don’t really fit the risk profile.
As a broader point, the startup vs. regular job divide isn’t as binary as choosing between being an equity-rich founder or a journeyman1 employee. You can ‘titrate,’ to use Paul Graham’s term, your level of startup-ness by paying out varying quantities of cash vs. equity. You should probably offer every new hire the option to change cash for equity in his/her pay package. If you offer, be suspicious of anyone who doesn’t take the opportunity. They don’t have the startup attitude.
Taxes
One day, sir, you may tax it.
– Michael Faraday, responding to William Gladstone’s question about the usefulness of electricity
Unlike death, taxes have to be dealt with repeatedly throughout our lives. As a startup entrepreneur in California, probably in San Francisco, you’ve got three fat little piggies eating at your tax trough: federal, state, and (yes) the city.
Federal: corporate tax rates vary from 15% to 38%. There are a number of credits and deductions a tech startup is eligible for. I can almost guarantee you haven’t heard of most of them. Get tax planning advice. Good accountants should pay for themselves, so don’t hesitate.
State: If you’ve incorporated in Delaware as a C-corporation, as per startup usual, then you’ll be responsible for a minimum annual franchise tax of $400. Assuming you register as doing business in California (which you’ll likely need to do), you’ll be responsible for California state corporate tax as well. The first year is free, but the second is a $800 minimum (payable ahead of the tax year, for added insult!).
City: San Francisco has payroll tax of 1.5% on payrolls of greater than $250,000. What’s worse, income from options or equity is treated as common income, so, in theory, you owe 1.5% on that. The reality is nobody actually pays payroll tax on their options, but the city might crack down. The monumental stupidity of this tax need not be lingered on for too long. Companies like Twitter and Zynga are considering leaving SF as a result (read TechCrunch’s take on it here). In the meantime, it’s one more expense for a budding startup.
Healthcare
Ebenezer Scrooge: Who is that? The doctor?
Mrs. Dilber: No, the undertaker.
Ebenezer: You don’t believe in letting the grass grow under your feet, do you?
The Undertaker: Ours is a very competitive business, sir.– The 1951 BBC version of The Christmas Carol
In California, as of December 2010, a health plan will cost you between $250-$330/month for a reasonably healthy 20-30 year-old. Every additional member of the plan, assuming nominal health, will be another $300/month. Standard startup practice is to cover much or all of the employee’s healthcare bill, and a small percentage or none of the healthcare premium attributable to dependents. So, as a rough estimate, tack on $500/month for each employee for healthcare.
Legal fees
A lawyer with a briefcase can steal more than a thousand men with guns.
– Mario Puzo, The Godfather, through the mouth of Don Corleone
With the rise of open-source funding docs, the need to pay lawyers to do a funding round has decreased. The terms are becoming standardized (e.g. http://www.seriesseed.com/) and it’s not the cash hit it used to be.
Just to give you the painful numbers, top-shelf lawyers (WSGR, MoFo, Fenwick, etc.) bill at $600-$900/hr. Their associates and junior people bill out at more like $300-$400. That’s about what single-lawyer firms charge (i.e. where you’ll get referred after the pricey guy sees the four shades of pink you turned when he quoted his rate).
Whatever you use a lawyer for, most Silicon Valley lawyers will defer up to $30,000 in legal fees for a small bit of equity (say a quarter-percent). If the amount deferred is higher, they might be willing to do it if they like you, and you kick them a bit more equity.
Money that goes to lawyers’ fees is like energy lost to friction in a mechanical device: pure inefficiency, and pure loss. It goes without saying you should minimize it.
Marketing
Marketing in the future is like sex. Only the losers will have to pay for it.
– Jon Bond, founder of KBS+P, an ad agency
Most startups don’t have the cash to do real marketing campaigns, so entrepreneur, time to head to hills with a rifle, time for some guerrilla marketing.
Two blog posts early on (one on NY vs. SF, and another about my time at Goldman Sachs) went viral and were what first put us on the map. To this day, people stop me when I’m wearing an AdGrok shirt and ask if I’m the guy from the blog. We’ve gotten meetings with major companies who might otherwise not return emails because of those posts. Pick a fight. Pinch a nerve. Rattle the cage a bit. Remember, for a startup, no news is bad news. What do you have to lose?
More guerrilla-ness:
At our first industry conference2, we snuck a beer keg into the conference hall and broke it out at the end of the first day. We gave everyone a beer who would either tweet about us or listen to a demo. Nothing attracts a crowd like a crowd, and we had a full exhibition booth. That $80 keg drove more traffic than the immense carnivalesque contraptions costing thousands of dollars our deep-pocketed competitors brought to the conference.
The real masters of guerrilla marketing are the guys over at WePay. Read here about how they sabotaged the developer conference for PayPal, the 800-lbs. gorilla in their industry. For the price of a big block of ice, a pallet hoist, and a sprint around downtown San Francisco, WePay got mentioned in countless media outlets and essentially stole the spotlight from PayPal’s expensive pow-wow. That’s the way to play the game3.
Office space
When you grow up you’ll be put in a container called a cubicle. The bleak oppressiveness will warp your spine and destroy your capacity to feel joy. Luckily you’ll have a boss like me to motivate you with something called fear.
– The Pointy-haired Boss in Dilbert, said to a college student on Career Day
Right now the market price for a separate office in one of the startup spaces in SOMA is around $1500 a month. That’s typically a space around 12′x12′ which can comfortably fit three, and uncomfortably fit up to five. Rent-a-desk type places will sell you a dedicated desk for around $400, and just rights to sit at their space for around $200. The proliferation of startup spaces in SOMA has mimicked the rise in startup venture capital, and choices now abound (Wade Roush’s pretty definitive list of co-working spaces is here). Startup rent will probably be one of the smaller line-items on the budget. If you’ve got anything approaching real funding, you’ll be able to afford a pad of your own.
Show Me the Numbers
With four parameters I can fit an elephant, and with five I can make him wiggle his trunk.
– John von Neumann, on mathematical models
Let’s get down to brass tacks, shall we? Click here for the spreadsheet that was essentially our cash burn calculation when were deciding how much money to raise. The inputs are users, percent of users paying, monetization, per-employee cost, cost per server per number of users, and number of employees to support a given number of users (our model is nominally self-serve, but there’s a lot of hand-holding…user support load is a big factor for us).
The very bottom row is your remaining investment capital. The penultimate line is revenues net of expenses. Both are red if negative, and green if positive. You want a nice big green line at the bottom. Note the plot of your cash burn in time at the bottom. That’s the subject of the next section.
Run, entrepreneur, run
If everything seems under control, you’re just not going fast enough.
– Mario Andretti, only person to win the Indy 500, Daytona 500, and Formula One World Championships
My favorite cliché about startups is that it’s like jumping off a cliff and building an airplane on the way down.
The plot above, taken from the spreadsheet in the previous section, is the flightpath of your startup airplane.
If you play with the inputs, you’ll note that almost nothing makes the airplane recover before it craters into the ground than juicing your paid user growth rate. Not reducing employee salaries, not saving on your Amazon server costs, not getting a deal on healthcare. Paid user growth is your only savior, and it has to be crazy aggressive for that revenue to kick in in time.
For those startups without even the ghost of a revenue model, be aware you are building an airplane without wings, or so much as an engine. It will never fly, and you’d better find some way out of your freefall.
One alternative is raising a series A wherein a VC, like a
deus ex machina, gives you a term sheet and suddenly that cliff you jumped off is taller. That’s certainly a valid stalling tactic, although often all the new time does is convince the entrepreneur that he needs to build a 747 rather than a Cessna.
Another alternative is getting acquired. Suddenly, someone trades your half-built, untested plane for a parachute, and you land safely on the ground without ever even learning how to fly the thing. People who build companies to flip are essentially base jumping without a parachute.
So how much do I raise?
The guerrilla fighter eats whenever he can, and whatever he can.
– Ernesto “Che” Guevara, Argentine Marxist and Cuban Revolutionary figure, Diario del Che en Bolivia4
If you’ve got an investor offering you money, the terms are reasonable, and the investor doesn’t seem like an obnoxious pain-in-the-ass, the short answer is you should take the money.
Let’s take a numerical (toy) example: two co-founders, with equal equity stakes, raised their first angel investment of $500K at a $5MM cap. So far, they’ve essentially sold $500,000/($5,000,000 + $500,000) = 9% of the company. They each have 45.5% of the company.
A new investor walks in the door and offers them $250K on the same terms. That new investor is essentially buying $250,000/($5,500,000 + $250,000) = 4.3% of the company. The founders don’t know what to do.
Here’s one way to get an answer:
Let’s say their annual burn is $250,000. Without the money, they’ll last two years. With the money, they get an additional year. Assume (and this is obviously a crude assumption) that your chance of success scales linearly with your runway: in other words, your chances of either selling the company or getting enough traction to raise a series A, scale with the time you have to do it in. In that case this new money upped your chances of success by 50%. In order to do that, each co-founder had to sell 2% of their stake. That’s proportionally around 4% (i.e. 2/45) of their upside, for a 50% increase in chance of the upside happening. Conclusion: you should take the money5.
Dulce et decorum est pro startup mori6
Manning the purse strings at a startup is death by a thousand little (and not so little) bites. I recommend getting a decent accountant, buying QuickBooks, and reconciling your expenses monthly. Run a detailed cash flow report every month and stare at it hard. Get rid of random crap that’s living, like a pack of leeches, off of your startup’s lifeblood. Then forget about it for the rest of the month, build something people want, and get that user growth rate going. And hurry, because the ground is rising up to meet you faster every moment.
- Journeyman in the original, reductive sense of the word: someone paid a daily wage (from the French journée, the time span of one day). The original meaning is preserved in the related Spanish word jornalero, a day laborer . A white-collar employee working as an accountant or programmer at a large company is no different than an undocumented immigrant picking avocados in the Central Valley: they get a day’s wage for a day’s work, have no real equity in the business they’re helping, and are essentially interchangeable parts in a corporate machine. [↩]
- Speaking of conferences, a booth at a conference like AdTech or SMX will cost you $6K-$10K. Expect to pay another $1K (at least) kitting out the space, plus your travel and hotel costs. Whatever industry you’re in, there are probably a couple such conferences a year you’ll need to go to. Keep those costs in mind as well [↩]
- We, of course, do occasionally pay for it. Keeping a PR freelancer on retainer will cost you $2000-$3000 a month. A small(ish) media agency will run you $10,000 per month. Both will work email, plug the journalists, and find out every which way to get you exposure. The good ones deliver and are worth their cost. [↩]
- That your faithful correspondent, the son of Cuban political refugees who were hustled off to a long and uncertain exile in a panicked reaction to the atrocities committed by ‘el Che’ & Co., should sardonically quote him while shamelessly plugging a VC-backed startup, the very epitome of tooth-and-nail capitalism ‘el Che’ would have loathed, is of course irony with a capital ‘I’. Hasta la victoria siempre, compañeros. See you in La Habana in a few years, and save me one of those ’57 Chevy’s please. [↩]
- To the credit quants in the audience who are having déja-vu right now, a startup is essentially a credit-default swap, except where payoff happens on survival rather than default. The running coupon is also paid by someone else, your investors. I know what you’re thinking. Yes, that’s really the way it works. [↩]
- An assist for our more culture-challenged readers, like our CTO: this is a wordplay of a World-War I poem, meaning, “It is sweet and fitting to die for one’s … startup” [↩]