Finding your runway – A guide for startup founders self-financing
At the beginning of a startup’s life, time is way more valuable than money
The work day is over, but the real work day begins. You heat up leftovers in the microwave for dinner, and you set yourself up for another long evening. Your day job has served its purpose for so long but is now time to attempt your startup idea. Silence fills the room, as the lines of code you create are a foreign language to loved ones. This evening is just the same as all of the other nights this month, and it will continue until the job is complete.
It is now 3 am, and you have to get some sleep, your alarm is set to go off in five hours. You wake up groggy and head to your day job. Your mind is racing as you long to be back at home working on your startup. The banter between co-workers fade to white noise; you visualize your idea come to life. You are not out of paper drawing flowcharts as you eagerly wait for 5 pm.
Why isn’t there more time in the day to get everything done?
The idea of returning to work gives you anxiety, and your stomach is tied in knots. Tomorrow is the day you will give your notice. You wish, without a plan, you fear you will run out of money. Doubt occupies your thoughts, and you find comfort in the free office coffee and Friday afternoon beers. You reach out to others in the startup community by attending meetups. Trying to find your way, you feel even more isolated as the loudest ones in the room have nothing worth repeating.
Your head is spinning, and you work even later hours than before. Sleep? There will be time for that later in the week. Maybe call in sick. You can’t keep going at this pace as you fear that your progress is going too slow behind potential competitors. Or you physically can’t continue on this path as your mental health is in jeopardy.
Building a plan based on your capacity
First, we have to establish the financial ability of a startup founder. One’s position will vary from individual to individual, as no two founders will have the same foundation. Many startups have received the memo. Founders are mostly on their own until they create a profitable venture that is scalable where investors incur next to no risk. With that in mind, one should anticipate planning the long run with minimal support. Some may run for the exit at this point; however, the startup life is not meant to be an easy one.
For those remaining, let’s begin:
Say goodbye to the cushy life you had working full time (from champagne to ramen budget):
Drafting an existing budget is an ideal starting point. Let’s create a scenario involving a 29-year-old startup prospect that has a great idea. Also, they can develop most of their design before pursuing a co-founder or self-funding a development team.
They have the following data:
Full-time salary: $68,000
(Net hourly after-tax rate equals to $24.63 per hour)
After-tax monthly budget: $4,265
(Basic needs can be satisfied with $2,529 after-tax aka “Ramen Budget”)
Freelance wage (if working part-time): $50 per hour
(Assuming current employer agrees to 10 to 20 hours per week)
Or work 103 hours per month at the current hourly rate
(Revised budget of $2,529 divided by the net hourly rate of $24.63 per hour)
There are very minimal savings, and they have access to $35,300 in consumer credit ( the majority of credit available on a line of credit). Since a prototype is necessary before raising funds from family and friends or an angel, forecasting twelve months initially would be a great start.
With a ramen budget of $2,529 per month, the startup founder will need $30,348 in the first year. With the current state of remaining full time, we will not acknowledge the prospect of the founder saving up $30K by working full-time.
Option 1 – Jumping full-time into the startup venture for 12 months
Quitting your job is tempting, but it might not be practical. Without a full-time salary, the startup founder could not afford their current budget. Therefore, the ramen budget will be mandatory for this option. Even with a favorable borrowing rate (5 to 7% APR), the startup founder will find themselves maxed out at the end of the 12 month period. They may also have little bargaining power if they do not finish their prototype.
The founders capacity is limited as they are at the mercy of completing their MVP before they run out of credit.
PROS: With more time the founder creates their MVP under 12 months time. Early-stage investors (post-MVP) and first revenue sources cover ongoing operations.
CONS: Development exceeds 12 months, causing the startup founder to take on higher risk loans and sell common share equity prematurely. With so much time, procrastination may be your greatest enemy.
Option 2 – Freelancing to cover ramen budget until MVP is complete
Stepping down to a part-time work schedule and part-time (quasi-full-time) founder has higher potential. With the calculations above the startup founder would need to work 25 hours per week to cover their ramen budget. Depending on the ability to negotiate schedules they could arrange three full days on and four off. Scheduling will vary from individual. Some may prefer Monday, Wednesday, and Friday (or Thursday instead), whereas others may want to dedicate working Tuesday to Thursday.
Compared to Option 1, this path may take a little longer to complete the MVP. However, by covering the bare minimums, the startup founder may feel less pressure to meet a strict deadline.
PROS: Peace of mind is coming with rent paid and there will be food on the table. Stepping down gradually from a full-time job may feel more natural.
CONS: Longer development time, still have to deal with non-related work.
Option 3 – Combining Option 1 and Option 2
Knowing how much debt you are willing to take on from day one is vital. You care about your startup enough that you are ready to bet on it. There are two frames of mind when self-financing your business with your credit:
1. You will want to know how long it will take to pay off the debt if the startup is a bust (aggressively clearing the debt).
OR
2. You want to know how many hours you would need to work to cover the minimum payment in hopes that the startup will eventually make money.
To simplify Option 3, let’s assume the startup founder is willing to go up to $20,000 in consumer debt to finance their MVP. The startup founder can decide how many hours they wish to work and borrow whenever they are unable to cover the full ramen budget. Assuming the individual has a 6% APR Line of Credit, they may discover working part-time they hit this balance after 15 months.
Decisions, decisions
If they hit their maximum balance target, they can evaluate where they are in the process. If they are close to finishing their MVP, they can decide to A) Pay down the balance full-time; B) Add part-time freelance hours to make a sizeable monthly contribution; or C) Work to pay the minimum payment and ensure they are working enough hours to cover the ramen budget.
Assuming the startup found continues on with their existing employer, they would need to work 864 hours to pay off the balance over a two year period. That is approximately dedicating 36 hours per month to wipe out the debt. Or they may want only to work 8 hours just to afford the minimum payment. The pros and cons are a mixture of Option 1 and 2.
Conclusion
Without discussing the viability of each startup’s business hypothesis, we have focused on an individual’s ability to afford the initial phase of their development. A deterrent for many is the prospect of going into debt without a guarantee of making money. Before investing resources into developing full-time, you may want to research before fully committing. Option 2 may have its limitations; however, you will discover that you have greater control over development when dealing with prospective investors.
What works for one startup may not work for others. Be diligent with your limited resources. Finally, it is your startup, as time goes by it will start making sense.
