Planning, Startups, Stories


Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

5 Things Entrepreneurs Need to Know About Valuation 2

Valuation is one of those four-syllable business buzzwords you’re going to have to deal with, eventually, if you either want to start a business or own a business. If it doesn’t come up when you start, it will come up later. Here is what I think you need to know, in five short points.

  1. The word has vastly Different meanings: don’t you hate it when the same words mean different things? Valuation means at least three different things:
    1. What a business is worth to accountants for legal purposes, such as divorce settlements, inheritance taxes, and gift taxes. A certified valuation professional, usually a CPA, makes a guess. Most of them use financial statements and analyze financial details.
    2. What a business is worth to a buyer. Small businesses go up for sale with  business  brokers. Hardware stores, for example,  get about 40-50% of annual sales plus inventory, as a starting point. Plus a bonus for growth and special strengths, or a discount for lack of growth and special problems.
    3. The pivot point in an investment proposal: it’s simple math, but tough negotiations. If you say you want to get $1 million for 50% of your company, you just proposed a valuation of $2 million.
  2. What’s anything worth? Like your car, your house, and a share of IBM stock, something’s worth what somebody will pay for it. The valuation in A is theoretical, hypothetical, but legal. With B and C, though, valuation is as real as agreeing to buy a house. It’s not what the seller says it is; it’s what the buyer is willing to pay. And this cold hard fact drives many entrepreneurs crazy.
  3. For Small businesses, there are guidelines and rules of thumb. If you do a good search, or work with a business broker, you can find general rules of thumb for what your long-standing small business is worth. For example, a hardware story is worth roughly half a year’s sales plus inventory, with bonuses for positive factors like  recent growth,  and discounts for negatives like lack of growth. You could read up on it in bizbuysell.com, bizequity.com, or business brokerage press. Or do a web search and check the ads for valuation experts.
  4. For Startups, it’s what founders and investors negotiate. Startups and investors and culture clash over valuation.  Investors care about valuation. Founders often misunderstand valuation. And never the twain shall meet. I’ve seen these kinds of problems many times:  Founders walk into the valuation discussion full of folklore and fantasy like stories of Facebook and Twitter. They want lots of money for very little ownership. Investors see two or three people with no sales history thinking their dream startup is already worth $2 or $3 million.
  5. Irony: sometimes traction, and revenues, make things worse. It’s easier to buy the dream than the reality. The same investors who’ll seriously consider a $2 million valuation for a good idea, business plan, and a credible 3-person management team – but with no sales ever — might just as easily balk at a valuation of $600,000 for a company with three years history, 20% growth, and annual sales of $300,000.  Despite the irony, it makes sense: few existing businesses are worth more than a multiple of revenues, but, still, before the battle, it’s easier to dream big. Or so it seems. I’ve been on both sides of this table, and I don’t have any easy solutions to offer.

If it hasn’t come up yet, it will. Every business deals with valuation eventually. The place any business sees it is during the early investment phases; but most businesses don’t get investment, so they can ignore it at that point. But then if it survives, or grows, valuation comes up again, because even if the business is immortal, the people aren’t: so eventually you either sell it or pass it on to a new team, an acquiring company, or your own family. And there’s the divorce and estate planning elements that require valuation. So every entrepreneur and business owner should have some idea what it is.

(Image: courtesy of wordle.net)

Planning, Startups, Stories


Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

True Story: Dollars vs. Eyeballs in Business Valuation 2

It was a warm late-spring day in 1999. I sat in my office with a venture capitalist, my lawyer, and my son. The sun beamed in the patio outside my office. We talked about Palo Alto Software and its web subsidiary bplans.com. At one point the VC said:

You wouldn’t be an attractive investment for VCs. You’re too profitable.

I chuckled. I thought it was a joke. We’d grown sales in four years from less than $1 million to more than $5 million annual sales. We had to be profitable because we had no outside money.

He said:

That’s no joke. It’s like the Oklahoma gold rush, a land grab, and the assumption is that if you’re profitable, you’ve stopped too soon. You should be spending more to build traffic.

Those were strange times.

(Image: iDesign/Shutterstock)

Planning, Startups, Stories


Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

BizEquity Adds Tools for Estimating Valuation 0

I’ve posted here before on BizEquity, the “Zillow of small business valuation” site offering quick estimates of business valuation.

BizEquity founder Tom Taulli — a true expert in the field — has added some interesting new tools for the site. Most notably, a valuation wizard that can take your inputs and give you a quick and dirty estimate of what your business is worth.

I did a test run over the weekend, by inventing hypothetical numbers for an Internet company. I had it started just three years ago, growing sales to $350,000. It had little or no profits, a bit of debt, and a lot of dependence on the owner (the site’s auto wizard asked me the right questions). The estimate ended up at about $275,000, with interesting variations above and below that depending on how I set several sliders. You probably can’t read the details in the shrunken illustration below, but the sliders are asking how favorable the location is, the level of competition, and how you foresee the future financial performance.

Bizequity input

With the way the sliders work, you can see instantly how valuation would change with different settings.

Obviously, these are just estimates. As with estimates of house values, before you list your house, these estimates give you some idea, but are far from exact. They’re based on some standard formulas that estimate valuation using factors like sales, profits, assets, liabilities, and so forth. Don’t even dream of using this for a tax-related valuation, which requires a certified valuation professional; but it’s still a useful first look.

I think valuation is fascinating. What is a company worth? With the larger publicly traded companies you can easily calculate a valuation using the wisdom of the crowd, the market itself, by multiplying shares outstanding times price per share. But in the real world of small business, gulp, this is much harder.

Concretely: how much is your business worth? How much could you sell it for? How would you decide? What formulas would you use? More importantly, what formulas would your hypothetical or theoretical buyers use?

Ultimately, like it or not, just about anything is worth what somebody else will pay for it. Your business is worth what you could sell it for.

And what would that be? Well, that’s really hard to know, until you go to the market. Some people talk about 5 or 10 or more times profits, but then face it, in small business, in the real world, profits is a very vague number, an accounting conceit. Some people talk about 1 or 2 or more times sales, which eliminates a lot of the accounting fiction. Others talk about valuations based on book value, or assets.

I’m amused at how much of this stuff is loosey-goosey, even though it’s in the realm of finance, which is supposed to be mathematical and exact. And isn’t.

I posted here last Fall about BizEquity.com, Tom Taulli’s really intriguing site that’s attempting to create a database of first-cut estimated valuations of businesses all over the United States. I talked to Tom last month after the big meltdown, and found, happily, he’s still optimistic about the long-term value of the BizEquity site. They’re working on it. I suggested he take his September data and multiply it by about 0.5 or so; and I was only partially joking. Tom knows this area very well, but of course the whole volatility burst has been a challenge. Last summer might not have been the most opportune time for Tom and his backers to start.

So I was interested yesterday Monday morning as I soaked in coffee and I noted — thanks to Ann Handley in Twitter — Advertising Age‘s Simon Dumenco’s angry analysis of the Huffington Post’s recent venture capital infusion at a valuation of $100 million.

His title, unfortunately, is What’s $200 Million Divided by 2009 Reality. That’s too bad, because the $100 million (or less) estimated valuation was widely publicized when Oak Investment Partners announced the investment last November. Simon doesn’t enhance his argument by referring to the twice-as-large-as-fact figure, $200 million, that actually appeared much earlier, last Spring. The phrase “straw man” comes to mind.

That glaring error aside, he seems offended by the VC’s reported valuation. He has references to the big Internet bubble of the late 1990s. It should be only $2 million, according to him.

I think he exaggerates his point, not just by doubling the figure, but also by lowballing his real estimate. The Huffington Post has made huge (and well reported) gains in traffic. Furthermore, unlike a lot of the Web 2.0 sites he wants to knock, this one has an actual revenue model. For better or worse, the Huffington Post is almost like old-fashioned media. It generates readers with news and opinion, and it sells advertising. So somewhere in the numbers — which are not public — is a number for revenues, and a valuation based on (among other things) revenues as well as traffic.

And it all goes to illustrate my point, today: valuation is hard to figure. It’s also important. And, in the end, a company is worth what buyers will pay for it. In the case of Huffington Post, it’s not a vague theoretical guess. The VCs who invested in Huffington set a price, and, with that, a valuation.

The best readily-available valuation of business consulting services is 1.12 times annual sales. For automotive repair shops, it’s .41 times annual sales. Physical fitness facilities are going for .66 times gross annual profit. Grocery stores are going for .28 times annual sales, and sporting goods stores for .34 times annual sales.

There’s a valuation report in Inc Magazine’s April issue that turned me on to Business Valuation Resources, which sells information like the above, culled from data on actual transactions.  I registered (free) to get a free download of a complex chart — sophisticated, innovative, imaginative, but really hard to read. And I gather that the underlying data isn’t cheap, because I can’t find anywhere to send you for a link to the data table, industry by industry, that I used to do the snippets in my first paragraph.

Conclusion: if you’re dealing with valuation, this could be a good resource. Valuation information is something like insurance account numbers: you don’t need it very often, but when you need it, you really need it. Like when you want to sell your company, or sell part of your company, or predict valuation as part of an investment negotiation, or when there’s a divorce, and … well, you get it.

Gripe: once they’ve published the data and put it out into the world as hard copy, can I get it online somewhere? Oh yeah, I get it, there’s value to the data. Tough call for BVR, how much do you give away to promote your data?

(Note: I posted this on Up and Running yesterday. I’m crossposting it here for reader’s convenience. – Tim)

I really don’t like the word “valuation”; it sounds too much like an MBA buzzword. But I like even less the general confusion about the concept. We talk about starting businesses, we talk about running businesses, getting investment, getting financed, and we should take discussion of valuation for granted. Valuation is at the same time frequently necessary, obvious and extremely arcane. It is nothing more than what a company is worth. It becomes necessary more often than you’d realize, with buy-sell agreements and tax implications after death and divorce, plus financing and investment. It’s obvious because a business is worth what a buyer will pay for it. And then it breaks down into complex formulas and negotiations.

So here are 10 (I hope simple) rules for valuation.

  1. Valuation is what a company is worth. It’s like what a house or a car is worth–less than the seller says, more than the buyer says.
  2. A company’s ownership is almost always divided into shares. Let’s say your company has 100 shares, 51 yours and 49 your co-owner’s.Valuation
  3. Valuation equals shares outstanding times the price of one share. If the company is worth $500,000 and there are 100 shares, then each share is worth $5,000. (OK, there are exceptions, preferred shares and such, but leave the fine tuning for later.)
  4. Tax authorities say the price of a share is whatever it was at the last transaction. (There, too, there are exceptions, but let’s keep this simple.)
  5. When startups offer shares–equity–to investors, then that, too, is simple math. If you sell 20 percent of the company for $100,000, that means the company is worth $500,000.
  6. Investment deals frequently revolve around valuation. When investors question your valuation, they’re saying they want more ownership for their money, or want to invest less money for their ownership.
  7. Analysts often apply formulas. The most common formula is called “times profits” because it multiplies profits times some number. Another common formula is “times sales.” Companies might be worth two times sales or 10 times profits. There’s also book value, which is assets less liabilities. And there’s the estimated sale value of assets.
  8. Privately held companies are worth less than publicly traded companies. They get discounted for the disadvantage of not being able to convert ownership to cash easily.
  9. Growing companies are worth more than stable or declining companies.
  10. As with real estate, comparable sales matter. Analysts look for recent transactions involving similar businesses.

Today the angel investment group I’m a member of (Willamette Angel Conference) finished our eighth year of choosing a startup to invest in. Our investment runs $100K to $500K, roughly. It’s announced every year on the second Thursday in May. The announcement comes later in the day, not here.

Our annual angel investors process

Every year we review 40 or so submissions from startups. We look at summaries, videos, financial projections, and pitches posted online at gust.com. We invite our favorites to pitch to us live in a series of meetings. We assign due diligence teams to read their business plans thoroughly, check documents, talk to customers, test products, look at their legal situations, and so on. And eventually we choose a winner (or two or three).

My personal list of 10 things I want to know

Push PinDuring the process, we’ve had to review again what we want to know from startups as we review them. What information is essential? With that in mind, I wrote up my own list of what I look for in startups, from the outset. This is what I want a startup to tell me from the beginning.

  1. The startup team’s background, experience, and credibility. Specifically, what experience do you have with startups. Have you run a startup? Have you been an employee or team member of a startup? And of course your education, degrees, schools, etc. And your work experience. That goes for founder or founders, and main team members. If you don’t have a complete team, have you identified the key skills you need and candidates to hire? Are they likely to come on board? What are their backgrounds, skills, and experience? Who will do the administration, production, marketing, and sales?
  2. What problem do you solve, and how? I want to understand the needs and wants so I can decide for myself on product-market fit. What kinds of people or organizations have that problem, and how badly do they need or want what you are going to sell? For that you have to give me the whys and the background, the stories, not just the numbers; but numbers are good.
  3. And why you? Why are you more qualified than anybody else. How can you keep others from jumping in on your business if it’s successful?
  4. And who else? Who else is doing what you are, or solving what you solve? How do they do it?
  5. Key Metrics. What traction do you have so far? How long have you been up and running, and how many customers or subscribers or sales or visits or downloads or conversions or leads and inquiries? What are your metrics so far? Where do you see them going.
  6. Milestones met and milestones to come. I want to see both what you’ve done and what you plan to do. Your valuation today is about what you’ve accomplished already. What you plan to accomplish gives me an idea of possible future valuations.
  7. How much money are you raising and what are you spending it on. Investment should be used to finance deficit spending that’s going to generate a lot of growth and increased valuations. If you can relate your financial ask to milestones you plan to meet, then that’s great.
  8. Strategy. Strategy is focus. What markets, what products, what specific attributes of your business make this focus realistic? What markets and solutions are you ruling out, or leaving for later?
  9. Tactics. Tactics are essentials like pricing, channels, online, social, marketing, sales, financial plans.
  10. Essential projections. Sales forecast built from bottoms-up assumptions, spending budget, projected P&L, balance, and cash flow. I’m annoyed if you don’t provide these, but I should add that I’m also not going to eliminate a startup for bad financials. Bad financials are the easiest problem to fix.

I should note that I do care a lot about exit strategies, and even more so about the intention to exit. But I assume the intention is there when you seek angel investment. And I want to go from your product and solution to your market, your competition, and my guess about future exits. Exits happen 3-5 years from now. I want you to focus on your business, and I’ll decide whether I believe you’ll eventually become an attractive acquisition so we can get an exit.

Also, on financials, I look for understanding the relationship between spending and growth, how much you need spend in the main spending categories, in broad brush, to be able to grow. I expect growth to cost a lot of money and almost always rule out profits. If you were going to be profitable, you wouldn’t need investment, and you wouldn’t offer a great ROI. I don’t hold you accountable for accurately projecting your essential  numbers, but I do expect you to understand the assumptions and the drivers that you use to develop the forecasts.

And, a third point: We usually get this information several ways, starting with the summaries our startups post on gust.com. There are summaries, slides, videos, and financials. I do always want to see a business plan, but I don’t care about all the text summaries and descriptions. I do want the business plan to include strategy, tactics, metrics, milestones, and essential business numbers.

I stumbled on this brilliant video of an after-hours startup funding event at the Stanford business school, a panel discussion putting two of the best-known, most influential, and most successful investors (Marc Andreessen and Ron Conway) together with another successful entrepreneur (Parker Conrad, founder of Zenefits), a moderator, and a group of interested entrepreneurs. The video format is perhaps less than optimal, unless you like the rapid-access panel on the left (I do, actually) … but the content is outstanding.

Make sure, please, that you hear Ron Conway suggesting “bootstrap as long as you can.” You can find that with the navigation on the left.

And also, what both investors say about how they choose investments, what makes them successful, and valuation. And Marc Andreeson quoting Steve Martin on “be so good they can’t ignore you, and then, adding:

“Focus on making your business better, not making your pitch better.”

The original for this is on Sam Altman’s online course. Click here for that.

Some excellent quotes:

Marc Andreessen on startup funding as hit or miss:

The venture capital business is one hundred percent a game of outliers, it is extreme outliers. So the conventional statistics are in the order of four thousand venture fundable companies a year that want to raise venture capital. About two hundred of those will get funded by what is considered a top tier VC. About fifteen of those will, someday, get to a hundred million dollars in revenue. And those fifteen, for that year, will generate something on the order of 97% of the returns for the entire category of venture capital in that year. So venture capital is such an extreme feast or famine business. You are either in one of the fifteen or you’re not. Or you are in one of the two hundred, or you are not. And so the big thing that we’re looking for, no matter which sort of particular criteria we talked about, they all have the characteristics that you are looking for the extreme outlier.

Ron Conway on bootstrapping before startup funding:

Bootstrap for as long as you can. I met with one of the best founders in tech who’s starting a new company and I said to her “Well, when are you going to raise money?” “I might not,” and I go, “That is awesome.” Never forget the bootstrap.

I was amused to check in with Quora this morning and find somebody had asked me to answer “How Did Tim Berry Grow Palo Alto Software?” Obviously that’s a question dear to my heart. So here’s what I answered, which seems fitting for this blog today.

Business Plan Toolkit

The first Business Plan Toolkit in 1988

Slowly, carefully, bolstered by good product and reviews that validated, doing a lot of coding and documentation myself, and not spending money we didn’t have.

It started as spreadsheet templates. The first of those was published in 1984 to accompany a book “How to Develop Your Business Plan,” published by Oasis Press. In 1988 I separated from that book, and redid the templates to accompany my own book when I published “Business Plan Toolkit,” released in MacWorld January 1988. All of these early products were 100% my work, my spreadsheet macros and my documentation. It helped to have a diverse background, including 10 years as a professional journalist, foreign correspondent in Mexico City, plus a Stanford MBA. I could write about business so (people told me) others could understand.

Throughout the early years I kept up a healthy consulting practice doing business plans for some startups and some larger high tech companies, plus workshops on business planning for dealers of high tech companies. Apple was by far my best client, with repeat business in consulting on business planning from the beginning until 1994 (Hector Saldana was a steady client for years, and a supporter of the business idea, and informal advisor). The consulting supported marketing expenses. There was no Internet to speak of until 1995, so the early marketing was a combination of small ads in the back of magazines and product reviews in major computer magazines.

It was a major struggle for years.  I was sacrificing consulting revenues to prop up products. The motivator, for years, was “I want to sell boxes, not hours.”

My wife’s role was especially important during those long hard years. She didn’t give up on me. We have five kids and we depended financially on my consulting, but she stick with my idea of “boxes not hours” as I continued to use scarce funds to keep the product dream alive. We had some money to deal with because my role in Borland International paid off in 1986, but we were still struggling, with small houses and used cars. And by the way we’re still married as I write this in 2016.

When we moved it from Palo Alto to Eugene OR in 1992, I had three early equity shareholders (1% each) who agreed to surrender their shares because there was no value in them. My wife and I moved to Oregon because we wanted to. She said to me: “we put up with all the downside of you having your own business; let’s get the upside and move to where we want to live.”

By 1994 I was in deep trouble, with a quarter of a million dollars of unsold product stuck in retail, coming back from channels. The template products never made it. And in the words of Kathy Colder, a key purchasing executive from Fry’s, “Tim, your boxes suck.” At the worst point, we had three mortgages and 65K$ credit card debt.

Business Plan Pro

Business Plan Pro circa 2000

What I did then was decide not to just repackage, but to build stand-alone product instead, dumping templates entirely.  I found a local three-person programming company (Cascade Technologies, which no longer exists; its founder was Ken Barley) to take my templates and my vision and create stand-alone product for Windows using Visual Basic and an Excel-compatible spreadsheet we were able to buy as a tool, and include in the software. It added a complete interface to include the words as well as the numbers, and keep it all, even formatting and printing, inside the one application. I wrote about a third of the code myself, in Visual Basic. My vendor got a low monthly fee for 12 months, plus a percent of future revenue. We were still not able to spend money we didn’t have.

That effort was launched in 1995 and became successful as Business Plan Pro so I was able to stop consulting and dedicate myself to the business. My son Paul Berry joined me in 1998 and developed the web business with downloadable software. We grew quickly to more than $5 million annual revenues by 2000. (Paul left in 2001 and became CTO of Huffington Post in 2007 and founded RebelMouse in 2012).

In 1999 we took on a minority investment from Palo Alto venture capital, RB Webber and Associates. That was our first outside investment. In 2002 we negotiated a buyback with them because after the dot-com crash valuations had plummeted and the company was worth more to me and my family members than what an acquirer would pay for it.

I stepped aside in 2007 and asked Sabrina Parsons to become CEO while I focused on blogging, writing books, speaking, and teaching. She and the team released LivePlan in 2012 and that – a web app, SaaS, browser based has become very successful, having had several hundred thousand paid accounts already. I’m still chairman, and founder, but Sabrina and her team get a pretty free rein to run the company. Market share and awareness keeps growing and we’ve had several years of double-digit growth in revenues again, after the great recession. And it is entirely family owned.

Here is the source on Quora: How did Tim Berry grow Palo Alto software?

I had an interesting exchange over the weekend. Shane Diffily tweeted:

Setting the Scene

Shane was referring there to a post on startup equity I did a while back, highlighting the problems that happen all too often as founders fail to define their own functions and ownership, in writing, in time. The situation I described was a hypothetical. Here’s a quick summary of that post for you:

Parker  comes up with a great idea for an iPhone application, and works on it for three months in spare time. … develops sketches and designs…

About three months into it, Parker has spent maybe 10 to 20 hours on it so far. [enter Leslie, programmer] … Leslie is excited, which rekindles Parker’s excitement. They agree to be partners in a new business based on this initial iPhone application.

Four months go by. Leslie … gets into the code … discovers Parker’s initial idea isn’t quite possible … revises the idea radically, makes it practical and develops a prototype. Parker meets with him three times, they talk, she accepts his changes begrudgingly. At this point Parker’s total hours have gone from 15 to 25, but Leslie has worked a lot, probably 120 hours, on the programming. … [they] … take the prototype to Terry, who has been through a failed startup, has a business education and is looking for a startup to do again … Terry does a business plan and networks with local business development groups to find angel investors. They win an opportunity to present to an angel investment group. Another three months have gone by. Parker has now put in more like 40 hours, Leslie 250 hours, and Terry 120 hours. Leslie wants to quit a current job and work full-time on the new thing but needs to get paid. Parker doesn’t want to quit a current job but wants to stay involved; she’s not quite sure how. Terry wants to lead the new company as soon as he can get financing.

I asked three questions at the end of the post. I asked, but didn’t answer them:

  1. How would you suggest that Parker, Leslie and Terry divide up the 100 percent ownership of the company now, before they go to the angel investors. Who owns how much?What do you think of the management team here?
  2. Leslie and Terry both want to work full-time on the business when there’s money to pay them. What titles should they take? How much salary?
  3. How much of the company should these three offer to the seed investor for $250,000?

Pre-money Valuation

It was relatively easy to answer the third for Shane. I put it into a tweet:

“Pre-money” means the valuation for the transaction with the initial seed round investors. To clarify, “post-money” would be the valuation after new investment funds are received. So if “pre-money” was $750K, then the angel investors’ $250K would buy 33.3% of the shares and the founders would end up with 66.7% of a business values post-money at $1 million.

I can’t get more specific than that without filling in some value judgments about the relative value of the application, the presumed product-market fit, and the credibility of the team. If all three factors are positive, then I’d suggest starting the negotiation with a valuation of $1 million. That would give the angels 25% ownership and the founders 75%. That leaves enough equity for future rounds. Otherwise, if the deal isn’t that stellar, then the three founders would have to go down to $750K or even $500K, hoping to get some angel investment to develop traction and increase the valuation later.

For the sake of explaining dilution, I’m going to go with the $750K valuation for the discussion on dilution below.

Startup Equity

Shane then asked the much harder question:

Keep in mind that I just made these people up and imagined an unspecified iPhone app without describing what it does for whom. In the real world it would take a lot more of understanding who these three people are and how credible their real skills. Here’s what I think:

  1. First, Parker can’t have much equity because she hasn’t done that much. Her initial idea didn’t work. She has put in only 40 of the 410 hours (less than 10%) and her hours weren’t all that useful. Still, she was the originator, she came up with the market need, and she set the wheels in motion. So she should stay involved as long as she wants. However – also very important – Parker doesn’t even want a full-time job. I’d ask her to take 10% of the pre-investment 100% shared by the founders. And I’d give her a seat on the three-person early board of directors, with the assumption that she’s going to go off to make room for investors.
  2. With Terry and Leslie, I’d put Terry in charge and at the top of the business, with a title like CEO or President or some such; and Leslie should be the technology/product development lead, reporting to Terry. I’d want both of them to take minimum possible full-time salaries as soon as possible, Terry’s a bit more than Leslie’s. Their salaries should be a compromise, enough to support them and their families, but less than market value because they have to keep the burn rate low. And I’d want to get their salaries up to their market value as soon as possible. In a real company, if it’s going to make it, the people it depends on get paid.
  3. I’d want Leslie to take 50% of the founders’ 100%, and Terry 40%, bringing the total, including Parker’s 10%, to 100%.

Why? Obviously I’m making some assumptions on the unknowns. I assume that Terry has a credible background in startups and holds up as lead founder. I assume Leslie has a credible background in tech and can run the technology, even as the business grows. I assume Parker has knowledge and experience beyond just the idea, and can contribute to the business even if not an employee. I assume all three are there for the long term.

I confess to some bias here too. I don’t believe the original idea has much value without ongoing contribution. I do believe in product-driven businesses, and technology-driven businesses, which is why I end up giving Leslie more equity than Terry. And I assume Terry’s MBA is a healthy number of years in the past, which means (to me) that it has been tempered in the field and has more value.

Valuation and Dilution

founder-shares-and-dilutionAfter angel investors put in $250K, they own one third of the shares. Usually the legal work is done with preferred shares and more subtlety, but, for purpose of illustration, let’s assume this is all done with common shares and the total founders’ shares, before the angel investment are 1,000. That’s a small number because startup attorneys usually write up the original corporate documents with more shares, such as 10 million instead of the 1,000 I’m showing. I’m using these simple numbers because it shows how the founders are diluted when the angel investors join the ownership. Each of the founders retains the founder shares he or she has, but the additional shares mean that they end up owning less of the company than they did before the deal.