A big dilemma many entrepreneurs encounter, is whether to raise seed money or continue developing the product until it’s ready for a bigger A round. Another related dilemma is whether to raise capital at all, or just bootstrap the company. There are many parameters to consider in these dilemmas. In this post, I want to address one parameter that is commonly overlooked or underestimated – the costs of fundraising.
Some costs, like traveling costs, are very trivial. If you live at a place like Silicon Valley, then it’s not a real issue. But if you don’t live near a Venture Capital hub, you might need to spend a few thousands of dollars just on traveling costs. Legal cost can also become very significant. Although there are many free resources for Seed and Round A legal documents, customizing them to meet your specific needs can easily cost $10,000.
However, the biggest cost of fundraising is the amount of time and energy you’ll need to spend on it. Fundraising is one of the toughest tasks you’ll have to deal with as an entrepreneur. First, you’ll need to prepare your elevator pitch, executive summary and investment deck. Although it doesn’t seem that much of work, it can take weeks of endless discussions and iterations to achieve a satisfying result.
Once all your materials are ready, it’s about time to start pitching your idea. Most entrepreneur find this phase emotionally exhausting. There is a lot of stress before every meeting and it’s really tough to overcome many negative answers. You’ll find yourself analyzing every meeting (which you should) and constantly iterating to improve your pitch and fundraising materials. In average, it takes around 3-4 months until you get a termsheet, if at all. Why so long? Because it takes time to build a strong enough relationship that can lead to an investment.
Assuming you got a termsheet, you now get into the negotiating phase, and it’s neither simple nor pleasant. You should plan for about 1-3 weeks to negotiate the termsheet, and another 3-5 weeks to let the lawyers negotiate the final phrasing of the full documents.
So how is this long fundraising process relevant to the costs of fundraising? The problem is that the lack of focus and stress demolish any chance for creative work. Therefore, it’s almost impossible to build your product and raise capital at the same time.
Since in average it takes 4-6 months to close a seed round, you should add the team’s living costs to the overall fundraising costs. For example, if you are a team of 2 co-founders and need about $1,000 per month each, then you should add at least $12,000 (= $1,000 X 6 months X 2 team members). To be on the safe side, I would actually assume $18,000.
When you sum all these costs, you can easily get to $20,000 – $40,000. Since there is no promise that you’ll succeed raising seed money at such an early stage, you should consider the option of spending this money on developing your product until it’s ready for a bigger A round or even better – generate some revenues. If we take the middle range of $30,000 and use them just to cover your living expenses, than you have more than a year to focus on developing your product. That’s usually enough time to see whether you really have a something substantial in your hands.
If you have something substantial, then you’d probably find it much easier to raise money (and even get a higher valuation). If you’re lucky, you might generate enough revenues to bootstrap your company and avoid all the fundraising hassle. On the other hand, if you realize that your project isn’t as good as you thought, then at least you had fun building your product, and can confidently move on to the next thing.
To conclude, think thoroughly whether you should spend time, energy and money on raising capital. There are cases where it makes more sense to skip the seed round and just try to bring your product to the market.