Venture Funding – Less is More

November 1, 2006 at 6:26 pm 3 comments

Charles River Ventures just launched a program to fund companies with small loans of $250,000 instead of through equity investment. I thought I would weigh in with my two cents from the perspective of an entrepreneur. 

There are two main stages companies go through, product development and business execution. 

Product development is not capital intensive. We started with a development team in the Ukraine, a freelance designer in Romania and a research team in
India. The software and hardware we needed to launch were cheap. Getting our prototype to the market was inexpensive.
 

Business execution in most cases is capital intensive. You need US based resources to handle Marketing, Sales, Business Development, Financials, and these don’t come cheap. You need to lease an office. You need to have scalable infrastructure. You need money. 

The issue many entrepreneurs face is that taking VC money during the product development cycle makes little sense, because 2-3 million dollars is about 10x more than is needed. This completely dilutes the founder’s equity position and does little to actually help the company. Further adding conflict to the situation, many web-based products are being bought as features by the internet heavyweights. This makes it even harder to justify giving up more equity for more cash than is needed. 

On the other hand, if entrepreneurs don’t take the money during product development they end up having to beg, borrow and starve to launch their businesses. 

So getting back the Charles River Ventures program, I really like it. It allows entrepreneurs to take money and build a product without diluting their equity. No reason to take 3mill if only 250k is needed. If the company is acquired before they raise venture money they still maintain 100% of the equity. If they do raise money later, CRV only asks for a small discount on the terms they negotiate with the lead investor.  

From the VC’s perspective it works equally as well, letting them get in on the ground floor with a minimal investment, but with the right to take a significant equity percentage if the company does decide it needs to raise money. 

 

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Entry filed under: Start-up.

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3 Comments Add your own

  • 1. Ben  |  November 1, 2006 at 10:07 pm

    excellent insight here and i think you are dead on. entreprenuers shouldnt jump at money, nor make it the focus of their launch. but strategically planning the right moment to target funds is paramount.

    good post.

    Reply
  • 2. Hasan Luongo  |  December 12, 2006 at 7:49 pm

    Hello,

    Lots of news lately around the CRV quick start program, and I really appreciate your insight.

    I have a question about your early stage Product Development costs. We are developing a web app (promoterforce.com/product)
    and are negotiating an engineering/dev for equity deal with a US based web dev partner. They are very skilled, very interested in the project, and will add a ton of value to the project. However I don’t want to give up too much equity off the bat.

    You posts states that product development is cheap in regards to market development. Can you give me a ratio of your costs in each area, and any advice on what you might offer to an early stage web dev partner in terms of equity.

    thanks!

    Reply
  • 3. EP  |  December 13, 2006 at 2:36 am

    Ben,

    Thanks for your comment, there is always a sense of urgency when it comes to taking money because one doesn’t know when they will see another term sheet, but going through with a bad deal is significantly worse than missing out on a great deal.

    Hasan,

    Thank you for reading. In today’s environment developing a fairly sophisticated proof-of-concept web application should not cost more than $50,000. I would venture to say that it can be done for significantly less if you find talent outside of the US.

    At the same time, if you can find a good development company that is willing to do it for equity, it could make sense. I would think you would need to give a fair amount of equity though, as at that point all you have is an idea so they would be “getting-in” at a very low valuation.

    In terms of a breakdown of cost of development vs. cost of marketing, it varies significantly by industry and product/service, but I can tell you it is significantly weighted towards marketing.

    Hope this helps and good luck with your business.

    Eli

    Reply

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About

Exactly one year ago I set off on the most exciting journey of my life; I started Emerging Demographics Inc (the parent company of HireWorkers.com).

Along the way I was selected as one of the top 20 young entrepreneurs by BusinessWeek.com and the 21st coolest young entrepreneur by Inc. magazine. I have also appeared in ABC7, Telemundo, NPR, and been quoted in StaffingIndustry.com, WorkforceManagment.com, Entrepreneur Magazine, and various other publications.

Over the next few months I will recount some of the stories and lessons learned from building, developing and creating a business from scratch.

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