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The Importance of Location in a Tough Fundraising Environment

  9 years and 2 months ago 14 Jul 2009 Fundraising;

This article probably isn’t the article you were expecting to read; most articles with a title like this one will usually talk about how important it is to be in Silicon Valley. Rather, I think it’s important to consider the other side of this conventional wisdom.

As I wrote in the past, there are valid reasons why you shouldn’t start a tech company in Silicon Valley. Obviously, one of the key elements there was money and, in particular, the accessibility of early stage money. Given the changes in the fundraising market since I first wrote the article, I thought it would be worthwhile to revisit that discussion.

Raising money from VCs is more difficult

Even though venture fundraising was down an astounding 82% less in Q2 (with half the number of firms being raised), the reality is that many VC firms still have way too much capital to deploy. In order to realize the returns necessary on these larger sums of capital, VCs are doing fewer deals but putting in massive amounts of money, often to negative effect.

None of this is to say that good companies won’t be able to raise money – just that the traditional fundraising model seems to be changing. Because it’s cheaper to build a business, you’re expected to be further along by the time you start raising institutional money. Unless you’re a serial entrepreneur with a history of big exits, the days of raising $5m on a PowerPoint are largely gone. 

Higher expectations for seed stage

This is further exacerbated by a tighter market for seed money in the $250k-$750k range. Angel investors have gotten a lot more organized in recent years, forming angel groups that syndicate deals and allow them to move into territory that was once exclusive to the VC. On top of this, many casual angels aren’t investing in light massive losses in the public markets. Ultimately, this means that more actual money may be deployed by angels today, but at the same time the relative number of companies that are angel funded is dropping. Of course, these bigger deals come with the same higher expectations that VCs have today.

Some VC firms have launched “seed” programs that provide funding up to $250k, but the untold secret there is that the standard is even higher than a traditional Series A. The reason for this higher standard is that the VC will often spend just as much time on the small deal as the large one, even though it won’t fundamentally affect the fund’s bottom line. As a result, the VC has to be even more selective about who they commit to so early in the process. (This doesn’t apply to all such programs; some are more passive with the VC not taking a board seat or otherwise getting heavily involved).

There may be less money – but you also need less of it

In other words, your initial $25k needs to go a lot further if you want your business to have any chance of survival. With that seed money, you either need to start generating revenue such that the business will be self-sustaining or you need to cross that ever-widening chasm to institutional investment.

The good news is that, while expectations are higher, the cost of starting a business is a lot cheaper. Infrastructure costs have dropped dramatically in the last few years. Better tools and frameworks, cheaper outsourced talent and the availability of open-source software have driven down the cost of building and launching a product.

For an early-stage startup, talent and office space make up the most significant portion of your burn rate by far. Our hosting and development costs were virtually zero by comparison. I recently worked with a company that had one of the most aggressive (and perhaps unrealistic) growth plans I’ve ever seen. Even with an estimated $6,000/mo in server hosting, $10,000/mo in employee benefits and $10,000/mo in travel, over 90% of their expenses were office space and salaries.

And here’s the thing – you have the ability to control these costs, because location plays a major role. San Francisco and New York City are the two most expensive places to live in the United States which directly translates to a higher burn rate. For example, we raised around $80,000 for Notches last year. Much of this funding was used to hire an engineer at $65,000 – less than market rate in a competitive job market at the time, though perhaps still a little higher than you’d pay in San Francisco. We spent another $1,575 per month for rent on three desks in a shared office space. Without myself or my my co-founder collecting a salary, we were spending nearly $7,000 a month.

If we had started the company in Pittsburgh instead, our monthly costs would have been 30-40% less. Right off the bat, talent is at least 15-20% cheaper. Given the city’s affordability, you’re also more likely to find people willing and able to work for less relative salary and a greater slice of equity. Office space is much cheaper as well – 200-300 sq ft turnkey offices are available for less than we were paying for a single desk.

On a small $25k raise, we’re talking about an extra two months of runway for a company – a difference which may very well determine whether your business survives or not.

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