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Wednesday, December 2, 2009
Startups learn to stretch their finances
By Jill Gambon, Special to Mass High Tech
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With capital markets still tight, many entrepreneurs in the technology sector are spending more time than ever hunting for financing and stretching every dollar to support their fledgling businesses. It is taking them longer to raise smaller amounts of money, while at the same time investors have tightened their financing requirements. So, when money finally does come through, the entrepreneurs have to make it last longer than ever. They also are finding that their investors are keeping a closer eye on how they spend the money, and how they run their business.
“We are expecting firms to go much farther on a short dollar,” said Elon Boms, managing director of LaunchCapital LLC, a Boston-based investment firm that provides early-stage capital to startups and small businesses.
Companies seeking funding must be “capital efficient,” said Larry Naughton, a partner at Choate Hall & Stewart LLP in Boston. While it used to take six to nine months to close a round of funding, in the current economic climate startups should now expect to spend at least a year raising money, Naughton said.
“We tell clients they have to have a keen sense of what their burn rate is going to be so they can conserve money,” said Ben Hron of VC Ready Law Group, a Cambridge firm that focuses on startups. More than ever before, entrepreneurs need to carefully map out plans for how they will spend the cash they raise and meet the goals set for each stage of growth. “It’s imperative that companies use their money wisely if they want to raise more.”
According to the Center for Venture Research at the University of New Hampshire, total funding from angel investors dropped 27 percent during the first half of this year compared to the first half of 2008. But while the total amount of financing was down, the number of deals was up, according to the center’s analysis, indicating that angel investors still willing to invest in deals, but for smaller amounts per investment.
Before the recession hit, angels would typically invest anywhere from $20,000 to $100,000 in a startup, but now deals for as little as $5,000 are common, said Connie Wright, managing director at Accounting Management Solutions, a Waltham-based provider of finance and management outsourcing services.
With retirement accounts wiped out and home equity dried up, the usual early-stage cash source of friends and family is out of reach for many entrepreneurs, Wright said. Gone are the days when ideas sketched on the back of a Starbuck’s napkin or a business existing only as a PowerPoint presentation could woo investors. Venture capital investors now expect thorough business plans, revenue forecasts and even an early version of the product or service with paying customers before they’ll write a check. “Back in the go-go ’90s, VCs would fund an idea. Now investors are pickier. They want to know that you’ve thought through your business,” Wright said.
As they’ve become more selective, many investors are spending more time vetting ideas, listening to early-stage startups and helping them hone their business plans, according to several entrepreneurs and investors. Ryan Damico, founder and CEO of WebNotes Inc., a Cambridge-based startup that has developed online research tools, said his company began meeting with potential investors several months before it was officially ready to seek venture financing. The company has incorporated the investors’ feedback into its plans, he said. “To really succeed in a large-scale fundraising effort takes a lot of time,” Damico said. “It’s all about relationship-building.”
Many early-stage startups are also turning to outside advisors for guidance. “That sound advice is causing them to hit fewer dead ends. That can help them preserve their cash,” said Wright. Damico said his 2-year-old company has benefited greatly from the guidance it’s gotten from its advisory board and through MIT’s Venture Mentoring Service. WebNotes, which has been financed largely through friends and family thus far, is seeking venture funding to expand its sales and marketing efforts. Damico hopes to close a deal, which he estimated will be under $1 million, before year’s end.
To preserve cash, some startups are contracting out software or web development work, rather than hiring employees. Some pay contractors by the project or for reaching a milestone instead of hourly wages. LaunchCapital has stressed the need to keep head count down with the firms it funds. “You don’t know when the next round of financing will come,” Boms said.
Deferring salaries, especially for founders is another way to keep costs down, he said. Naughton, of Choate, advises companies that are scaling up operations to have a plan for outsourcing work to countries where labor costs are lower.
For Dan Sullivan, a Boston-based entrepreneur who bootstrapped Appswell, a startup launched in October that uses crowdsourcing to develop iPhone applications, being self-funded gave him the flexibility he needed to get a product on the market quickly. “We tried to keep this fairly lean,” he said.
He worked with the web development firm Bit Group and contracted for legal and public relations services. With a first product out the door, Sullivan is now starting to think about approaching angel investors. “My advice is to find a cheap way to show the product works. And a key is to have a clear path to revenue,” he said.
Jill Gambon is a freelance writer in West Newbury.
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