Ask HN: What do these startups need so much money for?

https://news.ycombinator.com/item?id=455687

by zepolen • 17 years ago

36 43 17 years ago

news.ycombinator.com

Every day there is a post about some startup getting funding, and these aren't trivial amounts either, millions of dollars are being passed around.

What could they possibly need /so/ much money for? Is it for hardware, developers, running costs, marketing?

Can someone please enlighten me?

sirsean• 17 years ago

Because VCs don't invest anything less than a crapload of money?

rantfoil• 17 years ago

This is actually true. Bad/mediocre VC's only make money on management fees and not on actual returns. So in order to maximize profit, they raise large funds (the bigger the better), and then pump valuations up.

They're only interested in 10x home runs so valuations are almost irrelevant. Since a finite number of partners can only sit on a finite number of boards, they can't have 50 or 100 investments at lower valuation / smaller sums.

High valuations also pump up expectations on the startup -- which is bad for the entrepreneur because if you fail to hit your goals, it means a down round and a ton more dilution.

gravitycop• 17 years ago

VCs don't invest anything less than a crapload of money

A comic strip illustrates the point: http://www.thevc.com/strips/strip38.html

"C'mon folks, we need major cash outlays. [...] Work with me here, we're talking BILLION with a B..."

I think this could also be called an instance of perverse incentive. VC's have perverse incentive to invest more money than given startups need. http://en.wikipedia.org/wiki/Perverse_incentive

matthias2• 17 years ago

The barrier to entry has toppled by an order of magnitude and the market is slow to adapt to such changes.

FiReaNG3L• 17 years ago

I suspect there's a heavy amount of marketing, as most startups that receive millions of VC money tend to have enormous 'growth' - in parenthesis because im sure there's an artificial part of it - I suspect that some of them increase their traffic by paying for fake traffic, so they can say 'look at how our service is popular'.

justin• 17 years ago

1) Salaries. Many engineers, salesmen, etc who have been out of college for a year or two don't want to go back to making basically nothing. Yes, you can find talented people who will work for you for little, but it's going to take a long time to do so. It's lovely to think that every company should be able to bootstrap off ramen indefinitely, but it turns out that often times you find that in order to do all the things that need to be done you need to expand beyond the founding team, and, so sorry, those new mouths want to get fed.

2) Capital expenditures. It's nice to run on EC2 for awhile, but it might not be the best hardware fit for your product. Similarly, it's nice to use Cisco switches and not crappy switches when you want your network to work at high volumes.

3) Marginal costs. When you have millions of people using your site all the time, bandwidth, power, free tshirts you give new signups, etc all cost more and more money.

For many companies that are pre-product/market fit, raising millions of VC might not make sense. But for many rapidly growing companies where there is a lag time between user acquisition and user monetization, something needs to fill in the gap. Guess what that is.

zepolen4• 17 years ago

Thanks for your first hand experience input.

Your first two points I can agree with, but it's the 3rd that troubles me.

Shouldn't a company that means to stay in business want to have slow but steady growth, a gradual climb, giving the them time to adapt.

Doesn't a company want to put its money making plan in action before it goes big time?

I know justin.tv has major bandwidth requirements, and from what I can see there is no revenue model apart from adverts in place, which probably can't cover the cost of the bandwidth alone let alone everything else.

Please take no offence but if a company has a cash gap it's usually a bad sign, and throwing money at the problem will only work for so long.

ojbyrne• 17 years ago

If you want a "slow but steady growth, a gradual climb, giving them time to adapt" then you shouldn't be financing with VC money. That's not what they do.

redrobot50502• 17 years ago

Organic growth models, like you suggest, exist.

But most of the time VCs want what 37signals calls a "Hollywood Launch". One day your site isn't live, just a beta to a few select friends/classmates, the next, everyone and their mother is checking out your live site. And you have a product to sell/revenue model.

jfornear3• 17 years ago

Exactly... startups aren't aiming to maximize profits (where marginal cost is equal to marginal revenue).

When marginal cost is greater than marginal revenue a startup can either a) find more vc funding to raise marginal revenue, or b) cut expenses to lower marginal cost.

Startups will press a) until the button breaks leaving b) the only option.

zepolen4• 17 years ago

I took an economics class at school and while I don't give much merit to theory vs practice, one lesson that was taught was that if MR < MC you close the business /right away/ because with every passing day you are losing money.

Now when investing it's a different matter, but the point stands, and so the after b) the only real option is actually c) liquidation

paulgb• 17 years ago

Payroll and office space. Occasionally Aeron chairs.

staunch3• 17 years ago

For a VC backed startup that's at 15-25 employees with a successful product I can make up some numbers that aren't totally unrealistic:

Advertising: $30k/mo

PR firm: $10k/mo

Rent: $12k/mo

Salaries: $100k/mo

Servers/bandwidth: $20k/mo

That's a $2 million/year run rate and I don't think this is even particularly on the high side and doesn't include upfront investments in servers, desktops, furniture, software, etc. I'm leaving out lots of stuff, really.

Taking VC means you're aiming high. Spending $2 million/year to take a shot at becoming a huge business is not that extravagant.

tptacek2• 17 years ago

$10k/mo for a PR firm. Like, I know that people do it, but it's such a stunningly retarded expense.

$100k/mo salary for 20 people is a fully loaded $60k/yr; that's less than half of what your mean FTE headcount cost will be in the Bay area.

ltbarcly23• 17 years ago

(note: my other account posts stuff marked [DEAD], no doubt because I called one of PG's articles retarded. It was the one where he said the history of unions could completely understood by looking at web startups. It was retarded.)

15 people for 100k/month would mean you are paying an average of 74k/year. Who would willingly work for a startup for that, without lots and lots of equity (answer: the exact people that you would never actually want to hire)? And you can't give lots of equity to 15 people, and even if you give them 8% each you would be left with nothing yourself.

$12k per month on rent? You would have to be retarded to pay that as a startup. Rent an old house and get lots of card tables.

Servers/bandwidth at 20k/month? What kind of site is this? That's $240k per year of bandwidth. If you are serving up that much content and aren't making a profit already, you are either going to get bought out in a few months or go under in a few months after that.

My hypothetical startup budget:

Salary: Pay myself enough to pay bills and live on, as well as 2 or 3 talented confederates (if I happen to have 2 or 3 talented people, with skills I need, on tap. Otherwise, wait until some are located before hiring anyone. Nobody is getting my equity unless they totally rock.) Estimate: 6k-25k per month.

Rent: $0, I happen to have an office large enough for 4 people to comfortably work in at my home. If I didn't, I would charge a one time expense of $2000 to put some carpet in the garage, install an AC out there, and run some wiring and so on.

Furniture, equipment, etc: $500. Find your nearest very large public university. They probably have a depot that just sells old furniture and equipment. You can drive up with a truck and get enough furniture to outfit a small army for under $500 (one time fee). http://www.purchase.umd.edu/ttrader/items/showroom/index.htm....

Servers/bandwidth: This obviously depends on what site you are making. A Youtube needs way way more bandwidth/servers/rackspace than a yelp for the same size audience. Using EC2 as a guide, a small instance is $70 per month if used constantly. If you used say 100 instances constantly, and transfered 1TB a day, you would be paying around $12000 per month. That is a metric assload of servers and bandwidth, so the $20k number is probably retarded also.

PR/Advertising: I'm not sure. 10k per month buys a fuckload of adwords. At a CPC of .40, you are talking 40k * 2.5 = 100k impressions a month with that advertising budget. In reality you can get clicks for .20, and lately even less, unless you are selling asbestos litigation.

So my point is you can get a hell of a site out there for like $300k per year or way way way less, unless you are an idiot.

rms2• 17 years ago

http://news.ycombinator.com/item?id=430795

staunch3• 17 years ago

These are just different stages and kinds of companies. There are many angel or self-funded companies that operate exactly as you describe. There's nothing novel about it. The question from the submission was how startups typically spend VC money.

shaunxcode• 17 years ago

I have a feeling constantly saying "retarded" is not helping your karma out that much. You would definitely benefit with expounding upon what you mean every time you fall back on just saying "retarded".

inerte2• 17 years ago

10 people making 80k per year, that's a million dollars already. Now add taxes.

If you think VCs are interested in companies that won't need 10 people to run their business, ever... you're thinking to small :) And not only there are your employees, but imagine hiring accountants, lawyers, cleaning staff... the list, only with actual human beings, is already huge!

Now add costs like transportation, hotels, food, all the furniture, the stuff you need just to have the office open, like electricity and water and... fumigation? Ad on Techcrunch? 20k for 2 months. NY Times front page on Sundays? 100k. And let's not even mention prime-time TV... It just costs a lot of money to have a big business running.

Open a spreadsheet anyday and do some calculations. I've only skimmed some of the costs with my examples here (even though I am sure someone will comment how NY Times ads don't apply to your question).

matthias2• 17 years ago

That outlay is fine if you're a year into trading and are showing signs of being top 1% successful. However, many of these huge sums that are raised pre-launch or pre-build just seem like madness and I can't see it continuing.

The yc vision seems more sustainable: $5k+$5kpf = you build something. If it's good you get to raise a couple hundred k to turn it into a company. If at that point it looks like you might be google, then raise the millions that you need.

inerte2• 17 years ago

I can't figure out if you're agreeing or disagreeing with me :)

The OP asked why VC funded companies need millions, and you've said yourself, they do need.

You don't need to be on the top 1% to have 10 employees. If you do have ~10 people working, then your operating expenses are in the million range.

But let's use your Google example. We know that the search market is dominated by Google, followed by Yahoo and MSN. Who are the others? I've searched and all I could come up in 10 seconds in this:

http://marketshare.hitslink.com/report.aspx?qprid=4

Let's go with Lycos. 0.01% market share. They have 500-1000 employees. Huge costs there. I am ignoring Terra, and Daum.

I guess what I am trying to say is that even a 0.01% market share can make you profitable, or attractive enough to get bought. And depending on the market (I did "cheat" a little by picking the largest internet market possible, search), even a 0.01% share might cost you millions to get there.

These huge sums are raised pre-launch/build because they're essentially, bets. Educated bets at best, but still, bets. The thing is that the payoff (for the VCs) can be huge, so they gamble on dozens hoping that 3 or 4 will provide return.

It's not my cup of tea, btw. I am currently building my Micro-ISV and I am quite happy, aspiring at most a nice boat, perhaps a bigger house. But the VC world is a reality :)

It's like complaining about software patents. They SUCK. But the system is set up in a way that you need them. It's part of the rules. You can complain about it, but they're there. So what makes most sense in the business sense of things is to get them. Just like VCs when you're trying to dominate a market.

tptacek2• 17 years ago

Big ticket items:

* Carrying inventory, if you sell hardware.

* A 6-10 region direct sales force.

* A full time customer service operation.

* The reconstituted powdered startup marketing packets they sell you when you buy your CEO.

* The pro-forma engineering staff-up you do almost subconsciously to end up with a 50/50 b-team/engineering split.

johnrob• 17 years ago

7 man years per million, all costs considered.

hs• 17 years ago

plentyoffish: top 10 site on 8 servers -- admined, designed, developed (in asp, no less) -- by one guy, and profitable

can yc/angel/vc backed startup be plentyoffish killer? i doubt money will help shrug

timtrueman• 17 years ago

Top 10 site? Maybe in the free dating site category…

tdavis• 17 years ago

For many startups, the short answer is: they don't right now. Everyone involved is betting on them needing it later.

But I understand your confusion. VCs are always knocking at our door and we still haven't answered the question, "What the hell would we do with 2 million dollars?" This is precisely why we haven't taken it.

Well, we've answered it, but it involves the words "hookers" and "blow".

known• 17 years ago

I heard that Vista advertising budget was $2 billion.

axod• 17 years ago

Depends on your game plan I think. If you want to look all big and important so you'll hopefully get acquired, you need to spend tons of money on things that impress potential acquirers.

If however you just want to make money, profit, things like that, you don't need to spend much money for a web based startup at all.

anthonyrubin• 17 years ago

To impress potential investors and acquirers.

jazer• 17 years ago

As so many others have said: yes, good people are expensive. And if you expect to grow to a non-trivial size, hosting/servers/bandwidth are going to cost you.

There is also the issue of leverage. If you need $500k, you don't raise $500k, because when you run out and start looking for more money, your negotiating position is very poor. Instead you raise $2M, then start to talk to investors again when you have spent half of it.

In my experience marketing is not a significant portion of expenses for a startup.

Ask HN: What do these startups need so much money for?

Related Stories