Category: Entrepreneurship

After the post last week outlining an example value multiplier of 5 to raise VC money, an entrepreneur pointed out to me that some startups choose a middle ground between bootstrapping and raising institutional money: exclusively raising angel money. Comparing angel investors to VCs is relatively straightforward but there isn’t much talk about startups that only raise money from angels.

Only raising money from angels would be considered for a more capital-light business with the idea that there might be three rounds over five years raising amounts more modest than from VCs (e.g. $500k, $750k, and then $1 million for a total of $2.25 million). By raising money from angels it’s likely that there wouldn’t be the typical 1x participating preferred liquidity preference and that the angels wouldn’t require selling roughly 1/3rd of the company for each round (the 10-20% range would be more likely).

Let’s look at the math from purely a co-founder’s financial return for only raising angel money vs bootstrapping:

• As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
• At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
• As a co-founder that owns 40% of the business, assume you raise three rounds of angel financing (roughly one every 18 months). Assume angels buy approximately 15% of the business with each round of financing and assume the option pool grows by 5% (less hiring with less money), so multiply the ownership stake by .8 (representing the amount sold to the angels and the amount for the new option pool). Here’s the math: .4*.8*.8*.8 which equals 20.5%.
• Assume everything else is equal, which it isn’t, the value multiplier to raise angel money is 2. That is, it makes financial sense to raise angel money if the business will be significantly greater than 2 times more valuable in five years.
• A quick example: if you can build a company worth $10 million with no angels, the same company would have to be worth $20 million for the personal gain to be financially equivalent.

Raising angel money, depending on the terms, is likely to be slightly more entrepreneur-friendly than institutional money, but still requires the full commitment of a board and other fiduciary responsibilities.

What else? What are your thoughts on the value multiplier to only raise angel money?

I know some people that focus on minimizing the potential downside of an initiative, project, idea, etc. It isn’t that they have negative personalities, it’s that they worry about what could go wrong as part of their core being. They can’t turn it off, no matter how hard they try.

I know some people that focus on maximizing the potential upside of an initiative, project, idea, etc. It isn’t that they are ignorant of the challenges, it’s that they focus on the potential and inherently have blinders on to all the nuances. They often hate the details.

The world needs all types of people. Startups often do well having both types of people on the co-founding team, with a healthy give and take relationship. Someone needs to think big and maximize the upside while someone else needs to counterbalance and look for ways to minimize the downside. Dreamers and worriers go well together.

What else? What are your thoughts on maximizing the upside and minimizing the downside?

Hockey stick growth curves are a desirable path for startups. The idea is that growth is slow and steady, much like the base of a hockey stick, and then at some point it really starts to take off, much like the long part of a hockey stick. There’s another concept, escape velocity, that isn’t talked about as much but is still important.

According to Wikipedia, escape velocity is the speed at which the kinetic energy plus the gravitational potential energy of an object is zero. You can think of it as the point where something breaks free from whatever is holding it back, and thus  carries on indefinitely. For startups, escape velocity has to do with becoming the dominant vendor and growing indefinitely. All too often, a startup goes through the hockey stick growth path, only the fast growth eventually plateaus and the startup has slow or no growth. The startup didn’t fully achieve escape velocity.

A company like Salesforce.com that’s still growing at double digit rates, even with billions of dollars of recurring revenue, achieved escape velocity and shows no signs of slowing down. Few startups achieve the hockey stick growth curve and even fewer achieve escape velocity. Pay attention to the growth paths of other startups and ask yourself if it achieved escape velocity.

What else? What are your thoughts on escape velocity?

Recently I was meeting with an entrepreneur who’s out raising a Series A round from VCs. He’s already raised an angel round, built an almost complete version one of the product, and has a handful of customers. Personally, his goal is to build a large successful company, on someone else’s dime, and then do it again on his own timeframe without investors in the future. The clock is ticking now.

When the founder started asking questions about raising money from VCs I quickly asked what his value multiplier was to raise VC money. That is, how much money would he make on his current growth path with an exit in five years vs raising multiple rounds of money from VCs and also exiting in five years. Now, I believe the best companies don’t have an exit strategy but I understand that’s not the standard view.

Here’s a super simple way I think about the value multiplier to raise VC money from a spreadsheet jockey perspective:

• As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
• At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
• As a co-founder that owns 40% of the business, assume you raise three rounds of VC financing (roughly one every 18 months). VCs buy approximately 33% of the business with each round of financing and assume the option pool grows by 10%, so multiply the ownership stake by .57 (representing the amount sold to the VCs and the amount for the new option pool, not taking into account liquidity preferences). Here’s the math: .4*.57*.57*.57 which equals 7.4%.
• Assume everything else is equal, which it isn’t, the value multiplier to raise VC money is 5.4. That is, it makes financial sense to raise VC money if the business will be significantly greater than 5.4 times more valuable in five years.
• A quick example: if you can build a company worth $10 million with no VCs, the same company would have to be worth $54 million for the personal gain to be financially equivalent.

Raising VC money creates a number of other opportunities and challenges and shouldn’t be viewed just as money. If it is viewed purely to create more personal wealth then the approximate value multiplier is 5.4 for a five year window.

What else? What are your thoughts on the value multiplier to raise VC money?

Have you ever worked on a project and felt like there wasn’t enough communication? Now, have 100 projects going on around you with a small group of people — that’s how it is in a startup. If there wasn’t enough communication with one project imagine how it is with 100 simultaneously. You should always over-communicate in startups.

Over-communicating is different than micro-managing. I’m a big fan of empowering people through autonomy, mastery, and purpose where autonomy comes partly from trust. Now, with so many things going on in a startup it can be difficult to find time to communicate. Don’t let that happen.

The most effective communication tool I’ve found is the daily check-in. Daily check-ins are simple — everyone on your team meets for 10 minutes in-person and/or over Skype Video to answer three simple questions. The questions are what did you accomplish yesterday, what are you going to do today, and do you have any roadblocks. Simple and powerful. And, yes, you do this every single day.

What else? What are your thoughts on over-communicating in startups?