When I talk with an unfunded startup about their burn rate I am often quite impressed with their intelligent frugality and capital efficiency. These tech startup founders usually assume they will be continue to be extremely capital efficient post venture financing, and for the most part they are correct. However, these entrepreneurs sometimes do not take into account the additional costs of doing business with a venture capital firm. There is some legitimate additional overhead required to keep your venture capital partner happy, and some of it is not cheap. Keep these items in mind when you think about your cash flows post venture investment:
Audit/tax work
Most VCs will require some sort of audit from a known auditor. These can get quite pricey. Hopefully the VC has enough pull with the auditor to get you a reduced price in your first few years of working with them. Most real auditors will do this, and I’ve heard from some audit partners that they don’t actually make money on auditing startups in the first few years. Regardless, this is still an expensive proposition. Tax wise, you will need to do what is called a 409 report if you are granting options to employees. The trick is that the commons stock options that you grant are probably worth less than the implied company valuation that you get from the VC. This is a good thing, as it lowers the tax burden for the employees who are getting the options. Unfortunately these things are not as cheap as you’d like. You can easily end up spending over $40k a year on these items. Most of these costs will spike around year end, April tax season and when you are raising additional capital.
CFO/Controller
Most of our really early stage companies have part time CFOs. You probably don’t need a full time CFO or controller if you are a real startup, but you do need someone who knows what they are doing manning the finance wheel. Once you start sending out invoices you’ll want a person who can call up and gently remind customers to pay you. It is also quite natural for a venture firm to want a trusted person managing the cash balances of the business, and these part time CFOs can greatly ease the work burden of the startup’s CEO. They also help in the financial preparation work for your monthly board of directors meetings. I’ve been very impressed with the work ethic and output of the outsourced CFOs I’ve worked with at our portfolio companies. Their cost should be less than the cost of a controller. Once your business grows to the point where your part time CFO is costing you, on an hourly basis, as much as a full time controller would cost it is probably time to hire a controller. The cost for a part time CFO can really vary depending on the amount that you are using them, and will spike at the same times of year as your audit costs jump. You should expect to spend anywhere from $30k to $75+k on this service per year.
Legal
The transaction expenses associated with bringing on a venture investor are quite expensive - but I’m not going to talk about that here. Instead, little items that you might let slide when you don’t have a venture firm as an investor actually need to get done when you have a professional investor on the board. In addition to your everyday legal costs, I’d add another $20k a year at least. Keep in mind this is legal work that you probably should have gotten done anyways, but is stuff that a lot of private, unfunded companies tend to ignore (such as getting all signatures on certain stockholders agreements actually signed, etc.)
Insurance
You’ll have a couple of additional insurance items that you need to take care of once you’ve brought a professional investor into your company. These will include Directors and Officers (D&O) insurance and key man life insurance. I’m not actually sure how much these cost, but I think it is about $12k a year for decent coverage - consult a real insurance agent here, not me!
Board of Directors meetings
This goes beyond the tasty cookies that you should supply to keep your directors and investors high on sugar during your monthly board meetings - little things like perhaps paying for a director to travel to the meeting or rush delivering the first prototype in time for the board to see it. Of course, the real cost is the time required to prepare for the board meeting, which leads me to the final hidden cost of VC:
Time
There is also the additional investment that can be even more precious for a startup entrepreneur: time. Your VC will require attention! Calls, meetings, coffees, etc. Don’t forget about this! Hopefully you’ve ended up with a VC that you like spending time with. When the venture capitalist is doing due diligence on you, you should be doing the same on them. Some of the questions you need to ask other CEOs in that partner’s portfolio is how do you interact with the partner, how often to you speak with them, how much time does this take? Hopefully the venture capitalist is adding value in these discussions, either around strategy or introductions to customers, etc. Regardless, there will likely be some minor requests that don’t add real value to you as a company. These include various metrics that the VC needs for internal purposes, such as the valuation work that auditors now require venture funds do annually or perhaps a clean copy of your logo so they can brag about you in their annual meeting. Make sure your VC doesn’t overwhelm other portfolio companies with these silly little requests. They shouldn’t be that onerous and should definitely not come that often - I’m more just letting you know that this is another hidden cost of taking on venture capital.
