Once a month, on the second Friday of most months, a CTO networking group that I belong to meets. Each meeting starts with a speaker – speaker in the loose term because it is not a fixed format – and then leads to questions and answers by the members and to discussions. This Friday the speaker was an individual that transitioned from being a CTO to being part of a VC. The attendance was not very abundant. However, since it is the path my career is taking and/or wants to take, I was not about to miss the meeting. The presenter brought up some good points and topics of arguments. And, of course, we all engaged readily. One in particular that developed into a full conversation once the speaker left was the initial cost of starting a company.
What Sangam Pant mentioned in terms of cost is that today it is VERY easy to start a company. It only takes $1M. Now … everybody jumped at that except another member and I. First of all, Sangam was using $1M as a figurate amount. Or at least I think he meant it does not take millions upon millions to start a company. Second of all, it is true, it does not take much money. You can use any of many OpenSource projects that are more than adequate for an initial buildout without compromising too much the quality of the architecture and application. You can successfully build on them. Or, you can use a small local team complemented with an outsource team at a fourth of the cost. I prefer the second option. It allows me to add more value to the company by providing a proprietary code base and create opportunities for the future. Besides, I am more on the side of build than buy for core elements of the business.
The argument from the members was that if you are trying to build a $100M+ company , you need to start with adequate funding. $1M will just not do. My position is that you do not need to start with $10M or $20M. Or even $5M. What you need is to start. The initial problem of a start-up is two fold:
- You need a product that works. Not juts technically – which is exceedingly important – but also from a business concept point of view. Is there a need in the market? Can a need be developed? Is the market ready for a product like “this”? Can the market mood help a product like “this”? There are a series of market factors that can be put into the conceptual analysis of a product. And many of those factors will help define the product, its marketing strategy and how the market is approached.
- You need a business model. Now … this is the hard part. You need to devise a way to make money. It does not mean that you have revenues right away and it does not mean that you are profitable right away – although in a previous post I focused on the March To Profitability. Business models do not come by easily. Let’s restate this: An effective fully developed business model that matches the market mood and not only prevails, but gains traction, does not come by easily. A model like that takes time to develop and can only be developed by generating friction against the market.
How much does it take to start addressing these two questions? It changes from project to project, but does not need to be much. If the company is to get to $100M+ you will need growth investment; I absolutely agree that you will need more investment along the way. ALONG THE WAY. But first prove the “model”. Prove that there is a need in the market, or that the market will be somewhat receptive. And first begin to develop your business model and put it through some friction to see how it fairs. For the “first begin to” part of the project a “$1M” ought to be enough. Once you see a small light at the end of the tunnel and it is not an incoming train, the you can go ask for $5M, $10 or more.
There is also a financial argument to not “taking” in big rounds at first: Valuation and dilution. The more the above questions are answered, and they do get answered over time, the higher the valuation. The higher the valuation the less the dilution. To the cost of a startup you need to add the cost of getting funding. Often enough there are situations where the founders of a company loose control of the helm because they get too diluted to retain a majority; in many of those cases you get there by either poorly negotiating or by asking too much too early and since there was no tangible value but value of an idea, the percentage sold is too large. Either case can be mitigated by having a more robust offering. Even if you negotiated poorly, the odds are in your favor if you have a more developed project well beyond an idea. Thus, the cost of funding is less. And the upside at the end is much larger for all involved.
Going back to the meeting … I have to say that I did not agree with everything the speaker said, his positions and the reasons for them. I have to say that I did not agree with the speaker in every idea or vision that he has on the market and how the market will develop. But the balance of what I got from him is positive. He was not only well spoken, but eloquent in the way he presented his ideas. And whether I agree with him or not, it does not matter. It is whether I could derive value from his experiences, concepts and intelligence.
Sangam, thank you for your time on Friday.