How Much Money Does a Startup Really Need?

What sort of funding will your company need? Unless you're one of a very elite type of entrepreneur -- like the semi-mythical coding whiz-kid building a Web site in his bedroom -- the question of funding is likely to be the most significant challenge early in your company's story. Your startup funding will determine whether your plan lives up to its potential or fizzles out when customers fail to show up in the expected numbers, or don't pay on time.

That said, there's a surprising range of views on how a startup should plan its early life. In my conversations with serial entrepreneurs in Silicon Valley, I've learned that even among successful entrepreneurs, one can find very divergent views on how to fund a new venture. In general, these opinions can be divided into two camps.

The first school of thought holds that you should raise as much cash as humanly possible. This means hitting up other people, whether they're angel investors, venture capitalists, or well-heeled members of your family. You can also try finding government grants, taking out loans, saving up beforehand, or even draining your own credit cards (but I wouldn't recommend trying that last maneuver). Can you raise too much? Yes, but according to this school of thought, you should just proceed to spend what you raise if you don't have enough money, ensuring that your fledgling business will survive even a lengthy drought.

Most people aren't the kind of daredevil networkers that can pull off raising lots of capital without giving their company away, so a second philosophy is more common. This one holds that you should carefully estimate your initial costs and ongoing burn rate for one year to a year and a half, then attempt to raise enough money to last that period of time. When you're six months from running out of cash, start planning to raise more, with the amount of the second funding round determined by how far away profitability appears to be.

If you belong in this second camp, you can begin making a few more intelligent predictions about how much you'll need. Networking in your chosen industry can get you some good advice from peers, which together with your own calculations on initial costs (rental of space, tables, chairs, a kitchen and the cook's wages for a restaurant, for example) will help produce what seems like a good figure.

Got your figure? Good. Now add 40 percent. That's the figure that a project manager named Norman Augustine, who eventually become CEO of an aerospace company in the 1980s, found was the average cost overrun for the dozens of projects he was involved in. Tongue-in-cheek though this "Augustine's Law" may be, it's a good way of dealing with the only true rule of the startup world: Nothing will unfold the way you expect. And in a startup, your only safety net is your cash reserves.