panelarrow

The Chenope Blog

We bring more things to light

The Starting Up Divide: that initial $30,000 is only the tip of the iceberg

| 2 Comments

A recent Kauffman foundation study showed that the average cost of starting a start-up was $30,000, noting that this money usually comes from a combination of personal savings, friends and family – also known in Silicon Valley as “friends, family, and fools.” The takeaway is clearly intended to be that the idea of anyone with a good idea can start a start-up is something of a myth.

But this number is in fact deceiving and misses the point.

Back in 1992 when John Nesheim first wrote the book “High Tech Startup” the original how-to book for starting a startup, he clearly noted that one shouldn’t think about starting a startup until one had achieved a real VP-level position in a real company with everything that that entails – significant management and business experience, a high degree of domain knowledge in a given market, an excellent reputation in that market, and a certain amount of just overall life experience.

Obviously things are much different now – as the latest versions of the same book reflect. Most start-up founders these days are in their early to mid 20’s and so have none of the above attributes.  Which may not matter so much: few truly have the expectation of building a sustainable business that could someday perhaps go public. Rather the goal is to sell quickly to a company like Google, Yahoo, or Facebook for a grossly inflated price; such companies will often pay an irresponsible premium simply to acquire promising young engineers with the right pedigrees.  By “quickly” I mean before the start-ups actually have to earn revenue – much less become profitable – which would be an impossibility for the overwhelming majority.

This shift in age tremendously alters the context of this $30,000  number.  A “real” VP at a company like Cisco or IBM back in the day could easily invest that $30K – no problem.   But the moment we’re talking about a 20-something being able to do so, we are indeed for the most part restricting ourselves to the population of those from upper middle class backgrounds or better.

Furthermore, that $30K won’t actually get you very far. A large law firm will take easily a third of that amount just to do the incorporation.  By the time the few founders have each bought nice new laptops, printed business cards, and taken care of little else, that $30K will be gone. Poof.

But even that $30K is far less of a problem than having to pay for one’s basic living expenses, especially in high cost areas like the SF Bay Area in which rents are easily $2k – $3K a month.  If the founder’s family and friends can invest in the start-up and/or can financially support him – or her – should the need arise, everything is peachy. But if not, it becomes far more daunting than the one-time $30K because it is essentially an open-ended commitment.

So it is no surprise that Stanford produces a great many entrepreneurs, or that 2/3 of Harvard MBA students intern at startups.  It’s a matter of access to capital, in both large and small amounts. Nor is it a surprise that the overwhelming number of startups these days are focused directly or indirectly on ad revenue generation, and on apps that will mostly be used by those under the age of 30.  These combined filters of youth and wealth restrict broader and deeper technology innovation significantly.  They thus ultimately create an opportunity for pockets of more varied innovation to flourish outside of Silicon Valley. It will be interesting to see in the coming years who, if anyone, manages to seize that opportunity. These are the bigger questions that the Kauffman guys would do well to ponder.

 

2 Comments

  1. With a tech start-up, what is the best way to set up equity structure between founders and future investors?

    • The answer to this all depends on two things:

      1) At what stage you plan to take investor money. For example, there is a GIANT difference between doing this when you are self-sustaining at a reasonable payroll level versus needing the money to pay yourselves or to stay afloat. This of course also impacts how much money you’ll need.
      2) What type of investor we are talking about. If standard venture investors, best to stay within the norms of what they expect, since that is going to be where you’ll end up anyway. There are plenty of websites that discuss the current splits that are standard at present. Otherwise, there can be a large spread.

      I would suggest that the biggest issue is setting expectations within your team correctly, rather than necessarily trying to figure out exactly how many shares to print. People should understand that venture investors very often end up owning 80-90% of the company by the end. That said, if you want a nice round number, in Silicon Valley, the default number of shares to print at the beginning was 10 million. But that may be out of date. Hope this helps.

Leave a Reply

Required fields are marked *.