Friday, September 24, 2010

Startup Financing Exposed Part I: Humble Beginnings

"Audentis Fortuna Iuvat" - Fortune favors the bold - Virgil, Aeneid X: 284

Today is the first of a series of essays examining startup financing in detail, from the entrepreneur's prospective, and also from the perspective of the small investor. Maybe you're thinking of starting a company, maybe you've started one and need more money to grow, or to survive. Maybe family, a friend, or a business contact is asking you for money to fund a startup, maybe they're coming back to ask you a second time.

In Part I, we are looking at the Humble Beginnings of your startup.  The first question is, how much money do you need, and where is it coming from?

The focus here is with the software and software services sector, because that's the only thing I know anything about. But it may be applicable outside to other fields, your mileage may vary.

The Entrepreneur's Side

Before you make the plunge and quit your job, or quit looking for a job, or quit doing the company you're running now, make a plan.  A business plan.  If you don't know what one is, don't sweat it, that's why we have Wikipedia.  It doesn't have to be longer than a page.  Just think about what you're going to do for the next year, where the money is going to come from, and how you're going to spend it.  Break it down, month by month, because timing of cash flow is very important.  You may not want to pay yourself, but unless you're independently wealthy or have a working spouse to support you, you'll need to eat.  Plan that money too.  Don't bother planning more than a year or two into the future because even the first year of planning is uncertain enough already. Look at the chart from Wikipedia concerning the startup financing cycle, which we'll be constantly referring to throughout this series. For now, just plan to break-even within the first two years or so.

Did you do your plan?  Good.  Now you know how much money you need.  Perhaps you are thinking to yourself, I take the estimated revenue, subtract the estimated expenses, and that's my estimated profit, so if it's negative I need some money to tide me over. Also I need working capital as a cushion depending on payment timing, and initial capital for outlays like desks and computers.  That's also good.  But probably you can ignore the revenue side, at least for six months, because you're not going to make any revenue right away if you're in the software business.  Consulting maybe you'll do better, but you've still maybe got a few months before the payment cycle goes in your favor.  You don't want your business to end before it begins, so be realistic.

Be Cheap: An Interlude

Also, and I can't emphasize this enough, be cheap.  Until the point that you're meeting customers regularly, avoid spending unnecessary money.  Even better, avoid spending money at all.  Don't rent an office when you can work from your home or apartment or parent's garage or basement.  Don't buy a desk when you can bring an old one from your storage room that you haven't used in years.  Don't get a new laptop that you "need" for development when your current one will do just fine.  Don't launch an expensive advertising campaign before you have exhausted free word-of-mouth, blogging and social network lead generation. Don't get an accountant to handle your books when you can do it yourself by hand or with Quicken.  Don't pay someone to open a company for you when you can file the form yourself, in fact don't open a company at all until you are ready to take some big checks from investors.

Business Plan

Here's a business plan of an actual proposed software startup company in the iPad game / social media space. I've included it here so you can see what one actually looks like. It's a small, one-man, or one-woman, operation seeking to raise only a small amount. You can use this as a template for your own company, if you'd like. For the first funding round, keep it short and to the point, with a minimum of fluff. Hit the basics, toss in some financial projections, and end with a plea for funds. We add a disclaimer on the end just for safety. Naturally, if you want to raise several hundred thousand, or even more, you're going to need to provide a lot more detail, management bios, an experienced board, a lawyer's review, and all that. But for the humble beginnings, at the early stage, consider the plan below.

TreasureSys Business Plan

The Problem

Scavenger hunting is a popular recreational activity found throughout the world. It is popular in many online forums, at many colleges, and celebrated with reality shows. However it is currently difficult to setup and conduct a scavenger hunt in the connected world of the internet and social media. Old-fashion pen-and-paper is the most common approach with its associated clumsiness. There is no way to update and track initiation of the hunt, progress, and achievements in real-time with in-the-field information collection. This presents a missed opportunity and a market gap which can be exploited.

The Solution

The era of the tablet computer has arrived, with the iPad and emerging Android platform, offering an unprecedented venue with which to conduct scavenger hunts. The tablet provides a method to link together in-field maps, location updates, and hunt progress with other users and their associated social media networks. Along with this capability comes the potential for revenue from downloads of the application, downloads of add-on packs, and advertising on sites tracking of hunt progress, awards and real-time updates.

Strategic Plan

We aim to be the premier provider of real-world interaction social tablet games. Our primary revenue generator will at first be the TreasureHunter application, a scavenger-hunt type game for the iPad, later for the Android Tablet platform. It will be linked to friends via social media networks including Twitter and Facebook. We plan to start as a low-overhead one-person startup until after the second year, when with ramping revenue we will hire a full-time developer to pursue ancillary revenue with add-on package downloads and ad-supported web interfaces. We continue after the fourth year with an additional hire to further explore the add-on space and a social-media tie-in, and also to allow the founder to shift focus to consumer marketing and partnerships.

Project Timeline

In Year 1, we begin initial development of the iPad TreasureHunter application, with initial release within 3 months and full release within 6 months. The product will be exclusively marketed through the iTunes AppStore with no-cost social media, blog, network sites and press releases. Further enhancements are made through the end of Year 1, with research on an Android tablet simultaneously conducted. In Year 2, we begin development of the Android Tablet version of TreasureHunter, with a 6 month target release, while simultaneously supporting the installed base of iPad applications. Towards the end of Year 2 we also begin investigating ancillary revenue through TreasureHunter add-ons such as downloadable hunts and merchandising. In Year 3 with our primary products gaining steam we hire a full-time developer to focus on maintaining the existing applications and exploiting the ancillary revenue space. In Year 4 we begin to transition to growth in marketing our application with bringing on another developer at the end of the year to take over primary application programming from the founder. Year 5 is dedicated to expanding the market particularly around tie-ins to social network gaming.

Pro-Forma Projections

Year 1 Year 2 Year 3 Year 4 Year 5
AppStore Downloads 1,000 3,000 6,000 10,000 20,000
Android Downloads 0 1,000 4,000 10,000 20,000
Total Downloads 1,000 4,000 10,000 20,000 40,000
Avg Price $3 $3 $4 $4 $5
Download Revenue $3,000 $12,000 $40,000 $80,000 $200,000
Ancillary Pct 0% 10% 20% 30% 40%
Ancillary Revenue $0 $1,000 $8,000 $24,000 $80,000
Total Revenue $3,000 $13,000 $48,000 $104,000 $280,000
Headcount 1 1 1.5 2 3
Expenses $24,000 $24,000 $48,000 $72,000 $120,000
Net Profit -$21,000 -$11,000 $0 $32,000 $160,000
Accumulated Profit -$21,000 -$32,000 -$32,000 $0 $160,000
Market Value (4x Sales) $12,000 $52,000 $192,000 $416,000 $1,120,000

Funding Raise

We are seeking $50,000 to fund company operations and working capital until break-even is reached in Year 3. Our financing offer is an 8% per-annum note convertible to 25% of the common shares with payback estimated in Year 5. According to projections, market value at the end of Year 5 of the notes, when converted, would be worth $280,000 which is over a 5x, or 40% annual compounded return.


The information contained in this Plan is strictly confidential and is supplied on the understanding that it will be held in confidence and not disclosed to third parties without the prior written consent of TreasureSys. The Plan is to be used solely for the purposes of evaluating TreasureSys' business. Any reproduction of this Plan, in whole or in part, without the prior written consent of TreasureSys is prohibited.

In addition, this Business Plan contains certain "forward‐looking statements" that may be identified by the use of forward‐looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," or "anticipates" or comparable terminology. Although TreasureSys believes the assumptions underlying the forward‐looking statements contained in this Business Plan are reasonable, any one or more of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward‐looking statements will prove to be accurate. The inclusion of such information should not be regarded as a representation that TreasureSys' objectives and plans will be achieved. TreasureSys also shall have no obligation to provide updates of any changes in this Business Plan or the underlying assumptions or projections.

This Plan, in and of itself, is not an offer to sell or a solicitation to buy any securities of TreasureSys. Any such offer shall be made only through a definitive confidential Private Placement Memorandum, which, among other things, will describe in detail the risks involved in investing in any such securities. This Plan shall not be part of or be deemed to be included in any such offering material, unless such offering material incorporates this Business Plan into such offering material.

It's All About the Benjamins

Now you should know about what you're going to need for the business. We're talking cash. You need cash, where are you going to get it? You might have savings. You might do some consulting "on the side" to survive. You might go around begging friends, family, colleagues, anyone who will listen. Unless you're rich enough not to need to read this anyway, you're probably going to be raising money in $1,000, $5,000, $10,000, $25,000 chunks, small to the big-time VCs but big for many individuals. And you need to be clear with people what they are getting for their money. Shares? A percentage of revenues? A loan? A convertible note?

We'll talk more about specifics of raising the money in Part II, namely what the investment looks like financially and what forms you might need in order to actually close the investment round. See ya there!


  1. Looking forward to part II.


  2. Excellent pieces. Keep posting such kind of information on your blog. I really impressed by your blog.
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