The “valley of death” is a common term in the startup world, referring to the difficulty of covering the negative cash flow in the early stages of a startup, before their new product or service is bringing in revenue from real customers. I often get asked about the real alternatives to bridge this valley, and there are some good ones I will outline here.
According to a Gompers and Lerner study, the challenge is very real, with a majority of new ventures that don’t attract investors failing within the first three years. The problem is that professional investors (Angels and Venture Capital) want a proven business model before they invest, ready to scale, rather than the more risky research and development efforts.
My first advice for new entrepreneurs is to pick a domain that doesn’t have the sky-high up-front development costs, like online web sites and smartphone apps. Leave the world of new computer chips and new drugs to the big companies, and people with deep pockets. For the rest of us, the following suggestions will help you survive the valley of death:
- Accumulate some resources before you start. It always reduces risk to plan your business first. That includes estimating the money required to get to the revenue stage, and saving money to cover costs before you jump off the cliff. Self-funding or bootstrapping is still the most common and safest approach for startups.
- Keep your day job until revenue starts to flow. A common alternative is to work on your startup on nights and weekends, surviving the valley of death via another job, or the support of a working spouse. Of course, we all realize that this approach will take longer, and could jeopardize both roles if not managed effectively. Set expectations accordingly.
- Solicit funds from friends and family. After bootstrapping, friends and family are the most common funding sources for early-stage startups. As a rule of thumb, it is a required step anyway, since outside investors will not normally consider providing any funding until they see “skin in the game” from inside.
- Use crowd funding. The hottest new way of funding startups is to use online sites, like Kickstarter, to request donations, pre-order, get a reward, or even give equity (coming soon). If your offering is exciting enough, you may get millions in small amounts from other people on the Internet to help you fly high over the valley of death.
- Apply for contests and business grants. This source is a major focus these days, due to government initiatives to incent research and development on alternative energy and other technologies. The positives are that you give up no equity, and these apply to the early startup stages, but they do take time and much effort to win.
- Get a loan or line-of-credit. This is only a viable alternative if you have personal assets or a home you are willing to commit as collateral to back the loan or credit card. In general, banks won’t give you a loan until the business is cash-flow positive, no matter what the future potential. Nevertheless, it’s an option that doesn’t cost you equity.
- Join a startup incubator. A startup incubator is a company, university, or other organization which provides resources for equity to nurture young companies, helping them to survive and grow during the startup period when they are most vulnerable. These resources often include a cash investment, as well as office space, and consulting.
- Barter your services for their services. Bartering technically means exchanging goods or services as a substitute for money. An example would be getting free office space by agreeing to be the property manager for the owner. Exchanging your services for services is possible with legal counsel, accountants, engineers, and even sales people.
- Joint venture with distributor or beneficiary. A related or strategically interested company may see the value of your product as complementary to theirs, and be willing to advance funding very early, which can be repaid when you develop your revenue stream later. Consider licensing your product or intellectual property, and “white labeling.”
- Commit to a major customer. Find a customer who would benefit greatly from getting your product first, and be willing to advance you the cost of development, based on their experience with you in the past. The advantage to the customer is that he will have enough control to make sure it meets his requirements, and will get dedicated support.
The good news is that the cost for new startups is at an all-time low. In the early days (20 years ago), most new e-commerce sites cost a million dollars to set up. Now the price is closer to 100 dollars, if you are willing to do the work yourself. Software apps that once required a 10-person team can now be done with the Lean Development methodology by two people in a couple of months.
The bad news is that the valley’s depth before real revenue, considering the high costs of marketing, manufacturing, and sales, can still add up to 500,000 dollars, on up to one million dollars or more, before you will be attractive to Angel investors or venture capital.
In reality, the financing valley of death tests the commitment, determination, and problem solving ability of every entrepreneur. It’s the time when you create tremendous value out of nothing. It’s what separates the true entrepreneurs from the wannabes. Yet, in many ways, this starting period is the most satisfying time you will ever have as an entrepreneur. Are you ready to start?
Image credit: CC by Chris Potter