How much does a start-up really cost? | February 5, 2011

In 1884 Thomas Marks opened his first market stall in Leeds. Over the next few years he opened 20 other stalls around the UK. In 1894, Thomas Spencer invested in the business and retail chain Marks & Spencer was born. From it’s humble beginnings M&S—as it was colloquially called—became one of the UK’s biggest success stories and was the first retailer to make a pre-tax profit of over £1 billion. Companies like WH Smith, Woolworth’s and AMSTRAD all started the same way, so it would seem that in order to make it big, you should start small. Can the same thing be said of the Web?

As the founder of a relatively well known digital design consultancy I’m often approached by entrepreneurs wanting to start their own online business. I try to help them as much as I can, but I’m constantly amazed how little they know about the web or the cost of doing business online.

Starting your own online business has definitely got cheaper over the last few years. For instance you no longer need to buy expensive hardware or suffer crippling data costs. It’s also possible to piggy back off existing technologies and string together open source projects. Even so, setting up a company which you hope will become a multi-million dollar business isn’t cheap. As such you have to invest in proportion to what you hope to achieve.

I often see entrepreneurs lured by tales of plucky geeks starting their own business on a shoestring and making it big. Movies like Social Network don’t help quell the myth of the overnight success. The reality is somewhat different, with many of these so-called overnight successes spending 3 or 4 years in the wilderness and burning through hundreds of thousands—if not millions—of dollars before they make it big. More importantly, for every overnight success, we see tens of thousands of start-ups sink without trace.

Popular culture has created the myth that start-ups are cheap—cheaper than regular businesses anyway. This can be true for designers and developers who band together and use their own labour in the form of sweat equity. However if you don’t have the necessary skills and connections yourself, you have to hire in talent and that isn’t going to be cheap. Good products take time and effort after all.

A competent freelancer will typically cost you around £8k per month—a good agency staffer doubly so. With these rates in mind, an early prototype taking two people a couple of months could cost in the region of £30-60k. For a fully fleshed out beta version, you’d probably want a team of three or four people working on it over a four to six month period. Plugging those figures in you’re looking at anything from £100-350k before you’ve even launched. Suddenly this starts to feel less like a cottage industry and more like a real business.

Having spoken to several successful investors, these figures seem to stack up. It would seem that most investors expect it to cost around £50k to get your proof of concept and around £250k to get that product to market.

In 1978, John Mackey borrowed $45k from the bank to set up a small, natural health store called SaferWay. Two years later they merged with Clarksville Natural Grocery to form Whole Food Market. At 12,500 square foot and a staff of 19, their first store was larger than most health food shops at the time. The place was beautifully designed, the staff were knowledgeable and the quality was exceptionally high. By 1984 they had expanded to Houston, Dallas and New Orleans and continued to grow throughout the eighties and ninties. At the end of 2009 they owned 302 stores in 3 countries and were considered by many as the best grocery store of it’s kind.

The story of John Mackey in not dissimilar to that of Thomas Marks. Both started small and both rose to the heady heights of success. The main differences is that what counted for small back in 1884 was very different to what counted for small in 1980. The competition was stronger and peoples expectations had changed.

I try to explain to potential entrepreneurs that the amount you invest needs to be in proportion with your expectations. If you want to make a living wage then the digital equivalent of a market stall is just fine. However if you want to set up a national or even global business, you need to maximise your chances of success and invest accordingly. Good start-ups don’t come cheap so you need to spend as much on your digital business as would on it’s physical equivalent. It’s as simple as that!

Posted at February 5, 2011 2:42 PM

Comments

Mike D. said on February 5, 2011 6:32 PM

Strange, this is probably the first post in like two years that I’ve seen pop into your RSS feed. Thought you stopped writing!

With regard to “cheap”, there is “entrepreneur cheap” and “investor cheap”. $50k or less, to me, is “entrepreneur cheap”. $2m or less is “investor cheap”. So, yes, I would say founding a startup is indeed cheap these days… it’s just more often “investor cheap”. If your business is going to bankrupt you if it fails, I’m a huge fail of shifting this risk to investors. They are professional risk-takers with their money, and you are just a professional risk-taker with your time and reputation. If, however, you can build a service-based business slowly, managing your cash flows such that you are taking in more than you are spending almost from the start (like with a design agency), then perhaps outside investment isn’t necessary.

chriseo said on February 9, 2011 3:34 PM

i totally agree that you need to invest just as much in your online business as you would in an offline bricks and mortar business

i deliver SEO Training and Consultancy and ive invested in showcasing my services at the Business Start Up Exhibition in London in May 2011, i also spend considerably on PPC even though i’m an SEO. (funnily enough theres people exhibiting who are taking the wrong message with them, the sort of crap like spend £500 and achieve success!!! yeah likes thats going to happen)

but, if you invest time, money, resource and approach with the mindset that you will succeed if you stick at it then you stand a good chance, if you approach with the mindset that a few £££ or $$$ and a few weeks effort is your main route to success then you’ll join the failure club, no one is owed a living!

great post i enjoyed it ;)

Paul M said on February 9, 2011 7:01 PM

Think ‘investor cheap’ has come down a lot now, mainly because of Y-Combinator and all the accelerator programs in the US. The idea there is that for $15-20k you can give a team of 2-3 people enough time (usually 12 weeks) and space to see whether they can make something work. If it does work, then obviously more cash required, but it’s a very good way of trying things out that has benefits both for the founders and the investors.

Salim Virani said on February 9, 2011 7:46 PM

Andy, we seem to live in opposite ends of the same street! From what I’ve seen, £50k can go quite a long way - well beyond proof-of-concept and launch!

Backing up Paul’s point about Y Combinator, “investor cheap” is getting cheaper by using the design process to focus on customer and market understanding first. This is less costly than focusing on designing the product itself at early stages, and reduces market risks which are the big startup killers. It makes sense to focus first on what to build and who will buy it. Even a little design help goes a long way here.

The Silicon Valley startup community - which is heavily investor-backed - has been moving steadily in this direction, even codifying the process with methodologies like Customer Development and Lean Startup. And we have vibrant entrepreneurs in the UK thinking the same way.

Locally, the companies supported by Seedcamp are good examples. There are early success stories there, and they got going on investment at the 30-50k level.

http://seedcamp.com/pages/2009winners

There are examples of companies that have launched well-designed products with notable market penetration for a lot less too. Teamly and PlayNice.ly spring to mind. They are benefitting from design as a competitive advantage, but without the heavy price tag.

Chris Parsons said on February 9, 2011 8:03 PM

These numbers stack up in my experience. If you are lucky enough to have the skills and experience to build your own infrastructure, then you can do it very cheaply. Many are not in this position.

We put our prices on our website1 recently; they’re broadly similar to the ones you quote. We got a range of interesting reactions, mostly positive.

[1] http://edendevelopment.co.uk

Erin Lynch said on February 9, 2011 8:23 PM

Great article. It makes sense that the development of a digital product such as a mobile app or software is going to mimic development cycles and costs of things in the physical world.

I think people loose sight of that because the internet has always had this big “Get rich quick” label that’s been applied to it by the media and Hollywood, so the average person thinks that all you need is an idea, and once you get it on the internet the coins will just fall into your pockets. Sadly, that’s just not so as evidenced by the bust in the 90’s.

Gary Bury said on February 10, 2011 1:57 PM

Hang on a minute, I respect your opinion but my more than competent freelancer sat next to me has just increased his price tag to £8k per month.

Obviously freelance rates are somewhat more expensive in Brighton.

Michael Slater said on February 10, 2011 4:39 PM

Your figures seem reasonable, assuming you need to hire others to build the prototype. As you mention, the other path, which is a common one, is for the founders to build a decent 1.0 version on their own, perhaps with a modest amount of freelance design help, investing a bunch of their time and a little bit of money. This dramatically reduces the cash needed to get started, as long as the founders have the required skills and the ability to invest the time.

It is hard to raise money without at least a prototype, so you need to have either the skills and time to build the prototype yourself or the capital to hire others to do it (or investors who really believe in you and your idea and are willing to invest at an earlier stage that usual).

We have raised over $1 million in angel investment, mostly to support sales, marketing, and operations until the customer base builds to a size large enough to make the company self-sustaining. But almost all of this was raised after we had built the initial product.

If you are lucky and you have a product that takes off rapidly, you might not need as much capital. But note that Facebook has needed massive amounts of capital to support its rapid growth. For many businesses with rapid growth, the growth in expenses leads the growth in revenue, so the faster you’re growing the more capital you need.

FrankyJ said on February 14, 2011 3:21 AM

Business is still expensive if you want to look like a reputable company, and have a nice office, internet, phone line, insurance, etc etc..

annmark said on February 18, 2011 11:43 AM

Its quite true that cost of doing business online is very high these days.Though over the last few years it was in reach of a common person but now setting up a company which we hope will become a multi-million dollar business isn’t cheap.