Financial Modeling for Startups-- How Much Will It Really Cost?

I came across this blog entry from Christine Herron of First Round Capital detailing the costs of starting web wunderkind Mint.com (acquired by Intuit for a handsome $170M).

Christine does a great job of breaking out Mint's costs by "Garage Phase," "Seed Round" and "Series A," showing the cost structure of building the company at each step. 

We build about 10-15 startup financial models per year, and this post is right on the money (pun intended). The key element is in the thinking that goes into the model-- building out solid model logic and assumptions-- since everyone knows reality will be far different than the pro-forma.As Christine puts it:

"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. "

and she continues:

"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."

An interesting side note from a post on WSJ blog Venture Capital Dispatch is that Mint raised about $32 million from investors but only used about $12 million of that capital.

Naturally, it makes me wonder if founder Aaron Patzer now wishes he had raised a series of smaller rounds and retained more of his equity. But of course, this type of Monday-morning quarterbacking is easy to do with post-acquisition hindsight, and in this market most startups are wise to raise as much as they can, when they can.

Either way, it's an impressive success story and a good archetype to follow.

Positioning for a Startup Market Turnaround

It was around this time last year-- Summer of 2008 to be precise-- that a rash of VC firms and angel investors such as Ron Conway and Benchmark Capital issued highly publicized decrees to their portfolio companies to bunker down, cut costs, and prepare for a deep fund-raising freeze.

Now there are signs that things may be (slowly) starting to turn around. I've had a couple lunches with attorneys this week which were illuminating. I would posit that startup lawyers are the 'canaries in the coal mine'-- they work on deals well before the deals are publicly announced. So these data points, while not statistically significant, were nonetheless encouraging.

During a meal of excellent Osha Thai food in SF, one boutique attorney stated that he has worked on something like 25 early stage financings this summer, mostly involving web startups and angels or 'super angels' (i.e., folks with small seed funds like the aforementioned Ron Conway).

Indeed, angels have picked up the slack in the early stage funding market, as evidenced by an Under The Radar Strategy Series conference I attended in September. This 'fireside chat' was led by Rob Hayes of First Round Capital, Jeff Clavier of Softtech VC, and Aydin Senkut of Felicis Ventures, all of whom have been very active investors as of late. To wit: Hayes had six investments in the last quarter, Senkut had five with three follow-ons, and Clavier stated he had put down two term sheets that very day.

The other attorney I brunched with this week works in Silicon Valley at a large law firm. He stated that he has recently worked on several deals where large VC firms were making seed investments. This is unusual-- large venture firms, who are investing from funds that often top $200M or greater, generally seek to put substantial amounts of capital to work in each deal-- typically a minimum of $4 or $5M and up-- due simply to the fact that any given partner can effectively serve on only so many boards at once.

The attorney's thesis is that the large VCs are making such small bets to secure an 'option' to invest later-- basically, using the $500k or $1M seed round to guarantee a seat at the table for a future larger round, when things pick up again. (Indeed, there is some corroborating buzz around this trend; see this post, "Seed is the new Series A for VCs.") The sentiment he picked up was that follow-on rounds would start happening in Q4 of this year or Q1 of 2010.

It's certainly encouraging, as things have been fairly tepid for all but the hottest web and social gaming startups. August was among the slowest months we've had here at VentureArchetypes since 2002, when the funding market hit bottom in the last recession.

But these things always go in cycles, and we have been taking advantage of the downtime between clients to lay the foundation for the next upswing. It's actually rather nice to have some time to take care of all that is neglected when we're going 100 MPH-- website updates, marketing materials, etc.-- as well as the network. It is a luxury to have the time to reach out and catch up with contacts-- after all, this is a relationship-driven business.

We have also been laying the groundwork for a new service line, which we will debut shortly. It is called StartupPartnerships, and the focus will be on offering outsourced business development consulting to technology startups. It is a service we have been doing semi-formally with clients for many years, so it is a natural spin-off of our business plan and venture strategy work.

You can get a sneak peak at this new direction here: www.StartupPartnerships.com -- please let me know what you think, and how we can make the service as valuable as it can be to startups.

And finally--to end on a positive note-- I leave you with two more links showing encouraging signs regarding the startup market: Mark Suster's post on "The Big VC Thaw" and Bob Ackerman's post on how "M&A and IPOs are Restarting the Innovation Flywheel."

This may, in fact, be the best time to pursue your vision and finally launch that startup idea -- carpe diem!