This is a post I was putting on the bench for some time but I think enough time has passed for it to go live.
One of the invaluable lessons I learned as one of the founders of EyeView was about closing costs. Simply put, Closing costs is the minimal amount of money you will need to close the company. I'll go into more details about how to calculate it but let me share the lesson first.
After raising a first round of $1M, it almost seemed like EyeView can never run out of money. We were young and inexperienced at that time so that sum of money seemed like it can last for a very long time. Reality was different. Once you move from a garage based operation to actually having employees and offices the money start to vanish quickly from your bank account. Our case was no different. We arrived very quickly to a situaiton where additional funding was needed.
One advantages to having a VC back you up is that you have a pretty good idea where the extra funding can come from. However, that extra level of comfort comes with a price - you don't know if you are getting a fair deal or not. As inexperienced as we were we decided that we should shop around before taking the initial offer from our VCs. In retrospect, this was a bad move especially as we overlooked two critical points. One false assumption that we made is that the offer we received from our existing VCs will be waiting for us after we shop around - this was not true. The other mistake was ignoring our closing costs in our assessment of how much time we have before we will have to default to the original offer.
The end of that story was that we realized our closing costs in the middle of a round and didn't have time to close the external round. We had to come back to our VCs with almost 0 negotiation power and the initial offer that we weren't sure about got a lot worse. The round we raised wasn't a down round but we lost much more equity on that than we needed.
How to calculate closing costs
I'm sure there are more thorough ways of doing the math but the following rough estimations could save you 90% of the trouble. Assuming your notice period for employees is 30 days and the accomulated unused vacation time is 14 days (since it's unlikely that your employees used their vacation balance / PTO balance), you need to calculate 1.5 months worth of salary for any non-founder employee. For 6 developers this would roughly be $100K. To that you want to add the notice period on your office rent contract multiplied by your monthly rent and any other significant commitment you might have such as hosting, freelancers and vendors.
What to do with that number
So after you calculated that, you might have some dollar figure in your hands let's say $150K. This is actual money you need to put aside. Painful as it may be, you don't really have that money as you already comitted to pay it. If you don't put it aside, my advice is to consistantly deduct it from any cash balance calculation you are doing and to make sure every time you calculate how much time you have before you need more funding, you don't relay own that money.
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