How much money should you raise for your start-up?

• Internet start-ups should budget for salaries and human capital, not marketing and R&D
• Raise enough funds to carry you through the next stage; at least 18 months of runway

WHEN going out to raise money, you need to figure out how much money you need to grow your company over the next 18-24 months.  This article is intended for Internet start-ups (web, mobile, SaaS, etc.) going out for a Seed Round.

Before your Seed Round: Validate your idea

In the valley, most start-ups are ‘bootstrapped’ for the first few months. This means no funding and no salary while you build an early version of the product or service and test it in the market.  During this time, you may raise money from friends and family in order to cover expenses of the founding team.

Thankfully for an internet start-up, the costs related to hosting and marketing are quite low for your first year of development.  Most of your company's expenses will be put towards human capital – which is why ‘sweat equity’ is so popular in the Valley.  People work unsalaried in exchange for equity in a company, for a product or service they are truly passionate about and believe in.

Product roadmap

Before you can budget expenses, you first need to start with a product roadmap which will help you plan what needs to be built, so you can budget who you need to hire and when.  When prioritizing your roadmap, it’s helpful to consider if a feature will help attract new users or re-engage existing users through retention techniques.

For example, SEO (search engine optimization), blogging, and social media strategies can help with attracting new users, while emails, mobile notifications, and onsite community can help with retention.

Your product roadmap will change.  Investors understand that it’s impossible to accurately forecast market needs or features essential to the growth of your company. Investors ask you to do this planning to get a better understanding of your assumptions and approach.
 
Much like a game of chess, there is value in thinking deeply through possible scenarios, playing the best move, then re-evaluating at the next stage.

A product roadmap can start as a simple text file that gives a high-level outline of what features you plan to build out.  You can then put that into a Google spreadsheet to budget what can be built over the next six quarters (planned with your CTO).

Financial budget

From your high-level 18-month product roadmap, you should plan a hiring schedule (developers, marketing, customer support, etc.).
 
Typically the founders will be paid minimal salaries but have the most equity -- be realistic and conservative.  If you’re not sure what to estimate for a monthly salary, talk to people (other entrepreneurs, developer friends, etc.). Put your findings into a spreadsheet and waterfall out your expenses for 18+ months.

You want to raise enough money to carry your company to the next stage, but not so much that you’re giving away too large a chunk of your company.
 
I’ve seen marketing budgets that are half a company’s expenses and, as an investor, I think they’re crazy.  You shouldn’t be budgeting for expensive advertising campaigns or costly promotions. Those will not translate into Internet users during your early ‘high-growth’ stage.  Google Adwords and Facebook Ads are great marketing channels that can be utilized very cost effectively, often for less than RM900 a month.

As an entrepreneur, you’ll need to get creative on how to market your product without a marketing budget.  Everything from handling your own public relations and writing guest blog posts can keep your budget at $0.  Business development through partnerships and distribution deals are another great way to get free marketing.

I’ve also seen budgets that include research and development (R&D) -- this is too vague. Investors want to see detail and that you’ve already done the bulk of R&D before reaching out to them.  The majority of your financing should go solely towards human capital (salaries).

You’ll want to break out at least the following expenses into rows on a spreadsheet.  Columns should represent expenses for each month.

• Salaries (CEO, CTO, co-founding team, early employees, developers, marketing person, accounting, customer service, etc.)\
  • Hiring freelance contractors to start is a great way to save costs.  Tools like 99designs help you find freelance designers.  Elance and Odesk are great tools to find developers, marketing talent, and customer service hires.

• Operational expenses (rent, utilities, etc.)

• Marketing (minimal budget), Google Ads, Facebook Ads, etc.

• Travel (should be kept minimal)

• Legal (there will be costs around closing a financing round, you should use a lawyer very familiar with the process)

• Hardware/ software/ SaaS (laptops, LCD panels, Amazon AWS, Sendgrid, Mixpanel, etc.)

Once you tally up all your expenses, add at least a 20% buffer and voilà! This is the amount you’re looking to raise!

Valuation

In the Valley, most ‘seed’ or ‘angel’ rounds are invested without a valuation, using a ‘Convertible Note’.  However, this is not yet common practice in South-East Asia. Most investors will look to place a valuation on your company so they know how much equity they will own with an investment.

For your first round of considerable financing (more than RM500,000), you should expect to give up anywhere from 20%-35% of equity from the company.  A venture-minded investor does not want to own a majority stake as they expect you to have multiple rounds of future financing due to high growth.
 
Your company's valuation will depend on a mix of the market potential, your team’s capabilities, competitive landscape, and customer traction. Another driver of valuation is market interest -- it’s a free market and if lots of investors are interested in your company, you can negotiate a higher valuation :-)

Ideally when fundraising, you want to show a few months of traction from a small but growing user-base. Investors want to see your idea validated in the market and to see week-over-week growth.  Flat lines with big spikes are not impressive but we always love a good solid up-and-to-the-right growth curve.

Vinnie Lauria is a founding partner of Golden Gate Ventures, a Silicon Valley-based VC firm focused on South-East Asia. As a Kauffman fellow he’s well plugged into the world of venture capital. A former repeat-entrepreneur, he has raised funds for two Silicon Valley companies; his last company, Lefora Forum Hosting, was acquired by CrowdGather in 2010. He can be reached at @vlauria.
 
Previous Installments:

Sustainable social start-ups and the ecosystem

Counterpoint: The case for angels and VCs
 
Related Stories:

Start-ups and deals, Malaysian style
 
Raising money IS supposed to be hard!
 

For more technology news and the latest updates, follow @dnewsasia on Twitter or Like us on Facebook.