Category: Entrepreneurship

There’s an interesting phenomenon that takes places with startups looking to raise money: the startup is more valuable on day one than on day 100. Naturally, you’d think that working over three months on a business would make it more valuable, but for startups with no operating history a clean slate makes it easier to paint a big picture on this new, valuable business. You see, after 100 days, the entrepreneur should have launched the product or service in a minimum viable manner, have prospects and (hopefully) customers, and be well on his/her way to making money.

The strange disconnect occurs when the company starts generating revenue and has paying customers. Now, with real numbers, an investor can start doing projections and come up with a model for how the company will grow and be valued. Almost always this results in a company valuation which is less than the pie-in-the-sky value assigned to the business on day one.

So, if you’re raising money, and have a track record (required to raise money in Atlanta for an idea-stage startup), think hard about how the value of the business is likely to be higher at the beginning when you don’t have real-world data.

Two weeks ago I was at Jimmy John’s in Buckhead near my house and there was a sign on the wall with a parable (see photo I took from iPhone to the right). Here is the story titled How Much is Enough:

The American investment banker was at the pier of a small coastal Mexican village when a small boat with just one fisherman docked. Inside the small boat were several large fin tuna. The American complimented the Mexican on the quality of his fish and asked how long it took to catch them.

The Mexican replied, “only a little while.”

The American then asked why he didn’t stay out longer and catch more fish?

The Mexican said he had enough to support his family’s immediate needs.

The American then asked, “but what do you do with the rest of your time?”

The Mexican fisherman said, “I sleep late, fish a little, play with my children, take siesta with my wife, Maria, stroll into the village each evening where I sip wine and play guitar with my amigos, I have a full and busy life.”

The American scoffed, “I am a Harvard MBA and could help you. You should spend more time fishing and with the proceeds, buy a bigger boat, and with the proceeds from the bigger boat you could buy several boats. Eventually, you would have a fleet of fishing boats. Instead of selling your catch to a middleman you would sell directly to the processor, eventually opening your own cannery. You would control the product, processing and distribution. You would need to leave this small coastal fishing village and move to Mexico City, then LA and eventually NYC where you will run your expanding enterprise.”

The Mexican fisherman asked, “But, how long will this take?”

To which the American replied, “15-20 years.”

“But what then?”

The American laughed and said that’s the best part. “When the time is right you would announce an IPO and sell your company stock to the public and become very rich, you would make millions.”

“Millions?” asked the fisherman, “Then what?”

The American said, “Then you would retire. Move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evening, sip wine and play your guitar with your amigos!”

(Author Unknown)

 

 

A few nights ago we saw the movie The Social Network and really enjoyed it. One of my favorite anecdotes came when the characters were debating the potential of Facebook. I’ll paraphrase the story without giving away too many details of the movie. One of the main characters poses a question to the founder of Facebook: Have you ever seen a photo of a fisherman with 14 trout caught in one day? Of course he hadn’t as fishermen like to show off the pictures of a giant marlin. The character’s point in the movie was that the entrepreneur needs to decide if Facebook is going to be a trout or a marlin.

There’s no right or wrong answer but I think it’s important for entrepreneurs to think through the question of what they want to be in the future.

What else? What are your thoughts on the trout vs marlin question? What did you think of the movie?

Stock options have been a part of the startup world for decades. We’ve all read how the receptionist and chef at Google became millionaires from their stock options that multiplied in value 100s of times by the IPO. Unfortunately, there’s a problem: most employees of startups over-value stock options in their compensation.

I know of a startup in town that asked everyone on the team to take a serious pay cut when times were tough in exchange for many more stock options. Well, stock options are not well understood by most people and for the options to be in the money at this startup (e.g. worth more than the strike price), the startup needed to be valued at 15x the revenue. That’s right, the strike price was ridiculous. Most companies are valued at a multiple of profits (e.g. 4x-6x) or in the software business usually 2x-5x revenue. Thus the bar was crazy high and the employees were focused on the number of options as opposed to the percent ownership of the company. Having 100,000 options in one company could be less ownership than having 1,000 options in another company as it depends on how many total shares the company has and how many of those shares have been issued.

For my company we generally don’t do stock options and instead focus on having our average compensation across all employees be in the 75th percentile as well as providing exceptional benefits (health, dental, 401k, disability, food, drinks, etc). People understand the value of a salary and benefits. Now, many startups would disagree with this approach but it has worked well for our culture.

If you are an employee considering stock options as part of compensation I would ask the following questions:

• How many total shares are there and how many outstanding? What percentage ownership of the company does this represent?
• If the company sells for $5MM, $10MM, $25MM, or $50MM how much money would I get? Liquidity preferences of preferred shareholders can significantly affect how much money you take home e.g. even though you own 1% of the company you don’t get 1% of the proceeds.
• What is the likelihood of raising more money and what would the dilution of shareholders look like?

Stock options, or more commonly restricted stock now, represent a part of the startup world. My recommendation is to really understand them when considering overall compensation.

What else? What other tips do you have when considering stock options as part of compensation?