Wednesday, October 1, 2008

What is the typical funding cycle of a startup software entrepreneur?

More often than not when I get a question from a budding software entrepreneur the question is about funding: How to get it? What are the next steps? How can I be sure I'm getting the best dollar for my investment?

At OS-Cubed we only work with companies that have at least some funding. Not necessarily angel or venture funding - but FFA (Friends, Family or Acquaintences), self funded bootstraps, SBIR or STTR grant funded, or some other sort of funding mechanism. In today's Web 2.0 world, most of the "big funders" - the angels or ventures of the world - expect that you will have some "skin in the game" and already spent some dollars or sweat equity building the demo or proof of concept of your site.

Web entrepreneur and funding expert Brad Feld says that a typical Venture or Angel firm might see 2000 applications for funding in a year, and 15-25% of those will be for software development projects. If we take the 20% median that means 400 of those applications are for software projects. He also said that of those 400, 1/2 of them had already spent between $25,000 and $1M on building a demo or proof of concept for their site - before they applied for funding! That's 200 demos or proofs of concept per year - all funded by FFA, Grant or bootstrap dollars - and that's just for one firm.

So how does that funding actually work? We've worked with a number of entrepreneurs and here are a few models that can be successful:
  • Grant funding - public or private grants from interested parties that can assist you in startup. The most obvious of these is SBIR, but there are others.
  • Bootstrap funding - create a small app using FFA/Self funding, convince people to use it, use the revenue from the small app to pour back into the app itself, convince more people to invest, and build it bigger and bigger until you have a provable model that you can get funded for.
  • Sweat equity - give yourself and/or others a portion of your equity to build the first versions for free. Use that result to apply for other funding sources.

Each of these has it's upsides and downsides. We'll address each one in a future post.