Recently I was talking with a friend of mine who was thinking about raising money for his startup. He’s self-funded the business to date but is finding out that it’s going to take twice as long and cost twice as much to reach break-even. The topic of dilution and how much to sell came up, prompting me to introduce the concept of return on founder equity that I learned from a different friend.
Return on equity, as defined by Investopedia:
Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.
So, the return on founder equity can be thought of as the amount of money the founder made relative to the amount of money the founder invested in the business. As an example, say you invest $5,000 and turn it into $1,000,000,000 like the Spanx founder did, you’d have a return on founder equity of $1b/$5k = 200,000. A more modest, but still very successful example would be investing $50,000 and turning it into $5,000,000 for a RoFE of 100.
The next time an entrepreneur mentions raising money, ask about their expected return on founder equity.
What else? What are your thoughts on the concept of return on founder equity in startups?