Sweat Equity as Alternative Funding Model

In an earlier blog post I argued that the funding model for software startups is fundamentally changing. This is hardly an argument and more of an observation of the expense side going down for IT startups and legacy funds largely still caught in their bubble investment models.

There is a LOT of talk in the entrepreneur and VC community about the survivability of this model especially regarding the ability to raise more funds in the coming year. And with that, how many VC's will go into hibernation, change models (i.e. lower raise from largely non-institutional money focusing on companies requiring less capital or switch focus to industries with larger capital requirements), or quietly close their doors.

Seth Levine has an interesting article firing back at the Business Week article on How Venture Capital Lost it's Way. Here's another from Fred Wilson earlier this year on the math of venture capital. And Above the Crowd with his post on Asset Allocation and Venture Capital.

In the face of these facts the early stage software and software as a service (SaaS) early stage ecosystem remains healthy. Companies are figuring out how to generate cash flow earlier, get by with less and raise less, and in increasing numbers are eschewing venture capital paths altogether. Angels have stepped in to fill a larger role in seed stage investment but so too have the entrepreneurs and developer communities.

Contract developers are a lot like angel investors with the exception that they're throwing development skills instead of money in alongside the founders. Their "yes/no" analysis is a mix of knowledge of the founders (friends), attractiveness of the problem/solution (skills), and recognition of the market (money - or Net Present Value - NPV). There's a mix of people who've been through the bubble(s), heavy in skills and slightly jaded on the NPV calc. And there are the people who haven't been through the bubble, are anxious to make their mark and want to believe but are much more pragmatic than similar folks in the heady bubble days.

Both of these groups are willing to work for some amount of equity, and depending on the friendship card and personal cash flow needs, some requirement of cash. After all, food doesn't find its way to the table on it's own. This enables you to get your product built without having to hire someone full time and at a discounted rate. I must admit that I've put in a hell of a lot of time on my recent project to get it off the ground doing a large chunk of the development, but I've also managed to get the entire beta launched in the very low five figure range.

As a side note, I think it's infinitely useful to go back and read 37 Signals Getting Real

I've put together a few of these agreements and they're all fairly similar. Please add a comment if you would like a sample version of one and I'll send it to you. And if your needs are greater, I'll refer you to friend and former Cooley attorney Michael Stack who has helped with some of these agreements in the past.

The mechanism is essentially this:

• Agree upon a discounted rate per hour that will be paid out in cash
• Agree upon a bonus compensation that involves granting a set number of shares per hour that feels fair. You might be able to back into this number by giving a nod to what the company might be worth if someone priced a round. So let's say you think the company could be worth $1M pre-money and there are $1M shares outstanding. After the discounted rate, the developer is willing to take in a bonus of 50 shares per hour worked.
  
• Create an agreement that contains both the discounted rate, bonus stock rate, and expectations, ceilings on hours, IP protection.
  
• 1099 the contractor for the discounted rate plus the bonus stock at the current stock value (which at a very early stage could be as low as .01/share)
• Downside to be aware of is a larger pool of shareholders in your company and some additional dilution.
  

First Things First - Creating the Pitch Deck

At the very beginning stages of a company, even if that company is merely an idea jotted on a coffee stained napkin, the first real step to moving forward is to create a pitch deck. The long and short of company creation, fund raising, and selling is that you need a way to explain what you do in simple straightforward language. This will obviously take various forms depending on the audience. Get started with an investor presentation. Taking the perspective of an investor will force you to answer the hard questions of why someone else would believe in your ingenious world-changing idea enough to give you their money.

Guy Kawasaki broke this exercise out into 10 slides in his book "The Art of the Start" published back in 2001. His 10/20/30 rule holds up.

The people you are pitching to have limited attention spans and have heard 100 business plans in the last 60 days. Guys advice on the 10 slides follow. They don't have to strictly follow this order but the order is good. The biggest one I would consider swapping is "Team." If your team is a very strong component (and it is a primary reason people will invest) then stick it up front, perhaps right after your solution slide.

Ten slides. Ten is the optimal number of slides in a PowerPoint presentation because a normal human being cannot comprehend more than ten concepts in a meeting—and venture capitalists are very normal. (The only difference between you and venture capitalist is that he is getting paid to gamble with someone else’s money). If you must use more than ten slides to explain your business, you probably don’t have a business. The ten topics that a venture capitalist cares about are:

1. Problem
2. Your solution
3. Business model
4. Underlying magic/technology
5. Marketing and sales
6. Competition
7. Team
8. Projections and milestones
9. Status and timeline
10. Summary and call to action

Read more: http://blog.guykawasaki.com/2005/12/the_102030_rule.html#ixzz0XW8WIxS7

After you've collected your ideas, pitch it. Pitch it to your close business mentors and associates, pitch it to your girlfriend, spouse, people in your target market. Pitch, rinse, and repeat.

And when you're ready to take the presentation to the next level to put a finer point on it, check out Presentation Zen. Thanks Catherine for turning me onto it.

I ran my most recent Twitter cloud on wordle via Tweetstats. Looks like I'm mostly running, watching, listening, and meeting.

I believe the habit and purpose of tweeting are changing, or at least changing among the people with whom I tweet. Tweeting is useful as either information dissemination or entertainment. Tweets of the mundane sort are becoming less common in favor of purposeful tweets with an audience in mind. While I still do tweet about the mundane during times when I feel like reaching out and letting the world know I'm alive and usually out of some sense of social insecurity, my other tweets tend to pass on information that I think will somehow be useful. These fall into the categories of: some interesting bit of news happening in the world, a funny encounter or OH, or marking some personal milestone that I think people who know me best will appreciate.

I'm still trying to figure out the best way to interact with all of you tweeps out there, so let me know. How would you categorize why you follow someone?