Home » entrepreneurship (Page 4)
Category Archives: entrepreneurship
Banned from the USA
So this young businessman named Nick remixes a Disney movie with their permission, and US Border Protection decides that the US wants none of that. So they deport him, and they put his name into the computer so that he won’t be able to get back in for ten years. I’ll let you hear the deportee tell it his way:
The truth is, if I could vote on which would-be immigrants to let into the US, I wouldn’t be voting against remixers. Nor would I vote against scientists, entrepreneurs, or any other ambitious person. Just think if Andrew Carnegie’s father had been deported! That’s why bills like the Startup Visa are important steps for the US.
To end on a positive note, check out one of this deportee’s “crimes”:
Are Startup Stock Options a Form of Fraud?
Wikipedia’s page on securities fraud says, “Offers of risky investment opportunities to unsophisticated investors who are unable to evaluate risk adequately and cannot afford loss of capital is a central problem.”
Let’s go down the line:
Are Stock Options Risky?
Imagine you were given options with a strike price at 25 cents per share, and then suddenly, due to circumstances beyond your control, the company stumbles badly. Have your options lost value? Yes. If the company goes bankrupt, they’re worthless. If the company raises another round at anything less than 25 cents per share, your options are temporarily worthless, possibly for as long again as it took you to get to this point, possibly indefinitely.
Are Options an Investment Opportunity?
Not in dollars directly, but in time, yes they are. Most folks take options in lieu of full market salary. This means there’s a very real opportunity cost associated with working at a startup. If you’re an MBA at half market salary, we might be talking $50,000/yr plus interest.
Are Startup Employees Unsophisticated?
You don’t have to be accredited, which has a very specific legal definition, but you do need to be able to “evaluate the risks and merits of an investment” before you can be called “sophisticated.” So, how many skilled technicians can perform a discounted cash flow analysis? How many gifted programmers think in probabilities? How many of the potentially dozens of super-star employees who get stock options are also successful value investors, small business owners, accountants, or other money-savvy people?
Are They Unable to Evaluate the Risk?
Here comes my main point.
I was at a networking event recently where an attorney said, speaking to startup founders, “You want to have a lot of shares authorized and a big option pool so you can give eye-popping numbers of options to your employees.”
Someone said, “But it only matters what percent of the company they could get.”
To which the attorney said, “But most folks don’t think to ask.”
That’s terrible.
The standard form “employee incentive stock option agreement,” of which I’ve now seen a couple, doesn’t offer a cap table, doesn’t offer a fully diluted number of shares, and doesn’t offer anything that a sophisticated investor would need to properly value the incentive. So how can an unsophisticated investor value it?
It’s completely dishonest to withhold the relevant financial information from a would-be optionee.
You shouldn’t even have to ask. All this should come standard on the agreement with a link to somewhere that explains how to value it.
Finally, Can the Employee Afford a Loss?
According to CNN Money, a lot of folks are going to retire with too little cash. Nine out of ten startups fail to hit it big. Odds are good that your options package is going to fail to materialize, and then your years of hard work at that startup are going to impact your retirement plans.
So what do you think? Fraud or not? Use the comments below and let me know!
And follow me here on RSS or WordPress to watch for a future article on how to value options step-by-step.
How to Count in Sklansky Dollars
Here’s a neat concept that everyone can use, from professional poker players to Warren Buffett. In Alice Schroeder’s biography, The Snowball, she describes how in his youth, Warren was good at assigning odds to each horse in a race. This is called “handicapping.” Schroeder uses this as an analogy to explain how Buffett calculates investment probabilities.
It’s also the same concept underlying my previous post, How much is my startup worth?
Here it is in simple terms:
Your roof is leaking somewhere. The roofer offers a complete replacement of the roof for $10,000. He offers a 100% guarantee that your roof will be leak-free for three years, or else he’ll come back and completely replace it again for free. He gives you an alternative, as well: he can patch this one mossy spot for $2,000. He estimates that there’s a 25% chance this patch will fix the leak.
If you choose the patch, you have a 25% chance of saving yourself a $10,000 replacement. That’s kinda like saving 25% of $10,000, or $2,500. To get this chance, you have to spend $2,000 for the patch. In mathematical terms,
Value of Patch = -$2,000 + 0.25*$10,000 = $500
The $500 is what I’m calling Sklansky dollars, and it represents the increased economy of trying the repair first.
Crucially, these 500 Sklanksy dollars were still there even if you elect the repair and it doesn’t work. Now you’re in for the cost of the patch, $2,500, plus the cost of the replacement, $10,000, or $12,500 total. It hurts. But it was justifiably the right call to try the patch first because you had positive Sklansky dollars for that decision.
For further reading, read it in poker terms.
How to Make $1 Million in Six Months
No, it’s not a scam, it’s called entrepreneurship.
Qualified startups seeking their first angel funding usually get valued at between $1 million and $3 million and usually have little or no corporate track record. So what are the attributes of such valuable new companies? Surprisingly, it’s not so much the product, nor is it real earnings:
- Make a Team from Diverse Skills
- At its best, diversity in business means diversity in training and experience. One of the teams I know has among the six:
- a few small business owners for general acumen,
- an experienced numbers person for financials,
- a professional manager for coaching and shepherding,
- a programmer to develop the product and check the work of an outsource house,
- an industry insider,
- a savvy sales person,
- an intuitive marketer,
- and the visionary around which they all rallied.
- It’s okay for one or more to do double duty, as long as you legitimately have the skillset covered.
- At its best, diversity in business means diversity in training and experience. One of the teams I know has among the six:
- Build Relationships that Endure
- Define your roles and responsibilities among the team. That doesn’t mean silo off, but it does mean have a decision process (see Andrew Grove’s High Output Management).
- Know your customers and keep them engaged early on. Get them to pay for your good or service, even if you could give it away for free, as a vote in favor of your vision.
- In split market situations (e.g., you’re trying to connect two different groups of customers), get them to know one another.
- You need all this because your product and business model are going to change, and you need to carry folks through all the changes.
- Build a Product that Tests the Key Idea
- Eric Ries has done yeoman’s work popularizing this idea with his book The Lean Startup.
- Since entrepreneurs have no money and no time, you can barely test what matters. Don’t put time into what doesn’t.
- Have a Good Business Model
- I think a lot of high profile companies like Groupon give the wrong message when they grow big without making public their ideas on profitability. I’m sure they have them. If you think they don’t, you should call your stock broker and shout, “sell! sell!” (Oh wait, I see you did already.)
- Don’t think it’s okay just to get “eyeballs” on your site. You must have a plan to make (and keep) money.
- It helps a lot if your idea has a potentially big ($1 billion) market. You can rework a piece of the $70 trillion world economy, or you can tack your new billion onto the end.
So to summarize, you’re in good shape if you have a diverse team, some paying customers, a de minimis product, and a plausible way to make (and keep) money (a lot of it). Go to it.
What Entrepreneurs can learn from Vaseline
Marketing will make or break a new venture, so why not study some good examples? Here’s a new commercial I like a lot, with features any startup should emulate:
Why I like it:
- Lead with the product
- Get folks thinking along the right lines. This commercial leads with a shiny bottle featuring the brand prominently, which gets us thinking “health and beauty,” and a visible tagline, “Spray and Go,” which gets us thinking “fast.”
- Grab their attention
- Someone remarkable (attractive, not yet dressed) does something surprising (runs in and grabs the product).
- Demonstrate and differentiate
- “Oh, so she’s spraying it on… that’s different!”
- Delight
- When the actress sits down and flips her top on, you’re surprised by how fast it is. That carries forward with the hat, pants, and shoes.
- This sense of surprise accentuates the message from the beginning about being fast.
- Motivate
- The uplifting soundtrack does more than set the pace, it inspires action. You want folks to buy this.
- Summarize
- Right at the end you have a narrator explaining what we just saw in six words, “Moisturizes deeply and absorbs in seconds,” with visuals reminding us about a single rub to get it in and how it sprays.
- End quickly
- All this happens in 30 seconds. This gives you plenty of time to watch it again for the delight factor (how many times did you watch it?).
Use the buttons below to comment or share this commercial if you like it, too!
How much is my startup worth?
This is the question for any startup looking to measure their personal wealth creation, take on additional capital, or sell their business. Unfortunately, the answer is usually, “Somewhere between nothing and a whole lot.” You can do better.
Working Backwards: Step One
Think about what your business is going to look like when it’s big and stable (or stabilizing). For instance, “we’re going to be selling units (or service hours) to about 35% of the market, which will be growing at 3% a year, and increasing our penetration of that market by about 5% a year.” This sets some top-line revenue numbers.
Compare yourself to other businesses in similar roles and apply similar operating margins, R&D budgets, or other ratios to your business. This gets you to the bottom line.
Think in terms of different scenarios (“best case,” “worst case,” dissolution, etc.) and how likely those scenarios are.
Working Backwards, Step Two
For each scenario above, run the forecast from Step One for about seven or ten years, from a period of no earnings (you’re reinvesting everything) to a period of justifiable margins. If you’re going to be the first arrival on the scene, you can justify higher margins; if you’re second or third to market, you’re going to have smaller margins.
Use a discounted cash flow analysis to create a valuation for each scenario as of the start of your “stable” period.
Product-sum the valuations and the probabilities to derive a weighted valuation.
Working Backwards, Step Three
Use your detailed project plan (perhaps using EVMS) to estimate the total capital and amount of time needed to get from where you are to where that future forecast begins. Give yourself lots of margin, because it’s not going to go according to plan.
The time required is the time horizon over which you further discount that valuation from Step Two.
The capital required is how much money you’re going to need, altogether.
For more information
Leave your comments below! Or if you feel like going to the library, see McKinsey & Company, Tim Koller, Marc Goedhart, and David Wessels, Valuation: Measuring and Managing the Value of Companies, 5th Edition. Hoboken, New Jersey: John Wiley & Sons, Inc., 2010. Print.
Due Diligence Comes Before Joining a Startup
This week a friend of mine was offered a chance to work for an exciting startup in the consumer packaged goods industry (think food and beverages). He wanted to know what he should ask before accepting the offer, which was a below-market salary in exchange for equity ownership in the company. Oftentimes this equity ownership comes in the form of stock options. I’ll write about that later. In this case, he was being asked to join a Limited Liability Company (LLC).
So here’s some of the advice I shared with him:
- As an LLC, there is no stock, there are only units. Properly structured LLC’s have an operating agreement explaining how the units behave, so you might ask to see that.
- LLC’s may be have classes of units, and their distribution may be arbitrary (i.e., unfair) so you need to read the operating agreement to learn whether or how you can be diluted or underprivileged.
- Having experienced a motivation misalignment before, I would try to find out whether the folks running the company are motivated more by wealth or more by control. I’m wealth-motivated, so whatever produces the greatest long-term value is what I want to do. In the past I’ve worked for control motivated folks, and we often disagreed about what to do.
- Business owners acting in their own best interest should only use ownership as a form of currency when the ownership is being over-valued by the employee or deal partner. Options and units can be great examples of this. Give out an “eye-popping” amount to employees (“Oh, that sounds like a lot!”) and hope they don’t realize what it’s actually worth. Be wary. Specifically, for an LLC you want to see that operating agreement to know how many units there are, how many you’ll get, and how new units will be created.
- I’d ask to see financial statements. If the company is a going-concern with a history of profitability, your units are absolutely taxable, and the valuation could be performed by an expert or by me or someone else. Regardless of who values the company, the IRS always retains the right to disagree.
- If they are a going-concern with a history of profitability, or else if the founders have done this successfully before, I’d be highly inclined to find a way to take the ownership. You can live very comfortably on a corporate salary, but you can be “set for life” if you hit it big with a young company that you purchased with your labor when it was worth very little.
- If they’re a loosey-goosey operation, they may flinch at showing you their underwear drawer: they may not have an operating agreement or financials. If that’s the case, I’d be highly inclined to take all or most of the compensation in cash at market rates, rather than equity. Remember that most startups fail, and if it’s not your baby, you need to make a living from it.
So that’s some food for thought beyond the global picture, which is “what is the business, does it make sense to me, etc.” Keep an eye out for your own interests, and you’ll make a good decision.
For further reading, I suggest
- Noam Wasserman’s “The Founder’s Dilemmas”
