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Powerpoint Financing

Posted on Thursday, Nov 9th 2006

Here’s an article from today’s New York Times on how entrepreneurs are shunning venture capital, and choosing to bootstrap their companies. While that is a very good strategy for web 2.0 plays where very little money is needed, and a 12-18 month exit is in the cards, is it necessarily the right strategy for all startups?

Let’s take the example of an idea-stage internet deal that, at first glance, looks extremely capital efficient. It will probably only take $5 Million to get to profitability in 3 years. Let’s assume, also, that it is not a built-to-flip, but rather, a built-to-build.

Beyond the 3 years, raising capital will become very easy for such a company. So the real question is, what is the right financing strategy for the seed and series A?

Here are the options:

(a) Bootstrap for at least 6-12 months, build up traffic, then raise a $5 Million Series A at a decent valuation ($6-7 Million). This may be all the capital the company ever raises, which
makes it a good deal for the entrepreneurs, who can possibly retain 47-50% of the company. It will, however, be a slower ramp than what a bit of capital infusion early can achieve.

(b) CRV Quickstart or equivalent – Take $250k debt, and raise Series A at a higher valuation of $5-$10 Million. If you can push valuation up to $9-10 Million in Series A, then you conceivably could get to keep over 55% ownership.

(c) Take a $1 Million seed round. Pre-money valuation will be around $2 Million, and hence the dilution ratio is very significant for little money. However, if you assume a $9 Million pre-money on Series A, where you raise $4 Million, the Founders still get to keep 40% of the company.

(d) A third option is open only to more experienced entrepreneurs. Raise $2-$5 Million.

(e) And finally, strategic investors are offering money right now as well, which fetches somewhat more attractive valuation numbers, although, may have strings attached.

Which is the right strategy? That decision is based on a number of qualitative factors, especially, who brings what to the table besides money, time-to-market, apetite for bootstrapping, etc.

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