6 ms·

Paths to $5M for a startup founder

108 points by icey 16y ago

brk 16y ago
Interesting article, and I think part of the underlying point is that you might be better off building a smaller, less complex company if your primary goal is just to get to some (relatively small) exit. It doesn't address the Equity Equation though. In theory you should be assigning shares based on some roughly calculated guess as to how much additional value those other employees (or founders) will bring. Sure, if you can do it all yourself there is no need or reason for massive dilution by handing out shares to other people. But the reality is that you often have the "technical" founder and the "business" founder. In the majority of cases they are both worthless without their combined talents and contributions.
sthomps 16y ago
great post
garply 16y ago
Interesting that all the paths involve selling the company. What about generating $5M for yourself through sales of the company's products instead of a sale of the company itself?
- replicatorblog 16y ago
  The 37 Signals approach is a good one, but one thing they ignore is that there are opportunities to make money in fast moving/growing areas that may not be the founder's true passion, in a short time period. 37S decries this as lottery thinking, but the odds are better, the process is repeatable, and methods are trainable. Gabriel happens to be in that part of the ecosystem and it is where his expertise lies.
  - dhh 16y ago
    The odds of making a $17-50MM exit is higher than what? Turning a $1M/yr profit over 5 years? I think not. If the process was so "repeatable and the methods so trainable", the world would be flush with quick flip, sell-out millionaires. It is not. It is however full of people who became comfortably rich building up a profitable business.
    - replicatorblog 16y ago
      I was trying to articulate the odds of "flipping" a startup are greater than those of winning the lottery which is your oft stated comparison. You guys are all about boot strapping and you provide an awesome contra view to the conventional wisdom. That said, I know a great many more people who have sold web businesses and never have to work again than those who are reaping millions in profits via the same. Honestly, I'm amazed at how many people I meet who are financially set based on some obscure web business they sold to a non-traditional acquirer. I'm not even that plugged into the startup community and I've met a couple dozen folks easily. Heck, among YC alums alone I bet you would find a bunch, even the under publicized ones. Are the odds long? sure. Are you more likely to become wealthy spending a few post college years doing a funded startup rather than working at Google? Hell yes. I really liked Rework, and like the "Profitable and Proud" series, but there are opportunities for people to fill small product niches and "sell out" quickly. Especially in unsexy categories like analytics and other B2B applications. You might find it distasteful, but I'm sure a moderately well connected VC or angel could match every company in your P&P series with a series called "This company sold for XX millions and you never heard of them once."
maccman 16y ago
One other thing is that Tax man takes ~25% (capital gains)
- joelhaus 16y ago
  Generally, short-term (assets held less than one year) is taxed at your personal tax rate. Long-term (more than one year) is currently taxed at 15%, but will revert back to 20% beginning in 2011. [EDIT: based on US law]
- vicaya 16y ago
  That's why it's important to know about 83b election to cap the tax rate at 15%. Any start-up lawyer/law firm worth its salt would do this for you as part of the pile of forms to sign when you incorporate.
yosho 16y ago
Yes, the odds of a single founder exiting for 10M is greater than 3 founders exiting for 100M, however, the article fails to take into account the odds of a single founder start-up being profitable vs a multi-founder start-up being profitable. I believe the second case is much more likely due to the sharing of responsibilities, overlapping skill sets and the ability to bounce ideas off one another. There's always going to be a trade-off, things aren't so black and white.
- jimboyoungblood 16y ago
  Since when does one need to be profitable in order to exit? :)
axiom 16y ago
As much as it's fun to think about how much you personally stand to gain in an exit, it's all just pie in the sky silliness. Your number one goal should be to maximize your odds of success without constraining yourself to any arbitrary parameter like "no more than 2 cofounders." Building a profitable company is such a difficult and volatile process that if you try and focus on anything other than just success (e.g. your personal take) you're going to end up shooting yourself in the foot and end up with nothing.
- kljensen 16y ago
  Well put. Would be entertaining to see the same basic maths with an adjustment for probability of success. E.g. "if you feel the extra confounder increases your odds of success 40% ..."
  - dasil003 16y ago
    At the end of the day though, I don't think this kind of percentage calculation is useful (entertaining, sure). The human mind doesn't work that way. Similarly I think it's a mistake to bring on a cofounder purely for the fundraising benefits. The decision to bring on a cofounder should be based on whether they bring critical skills, connections, and if you really want to work with them. IMHO, going with your gut is going to be a much safer bet than putting a number on it and using that to influence your decision.
    - kljensen 16y ago
      Agreed, not useful, but entertaining. (Similarly, how about a webapp for simulation of various founder /funding scenarios?)
- epi0Bauqu 16y ago
  On the contrary, there are many concrete decision points where this logic should come into play--dispelling your logic was exactly the point of the post. In particular: --whether to go it alone for a while at the beginning and see if you can make something happen --whether to bring on more than one co-founder; this may seem like a no-brainier, but I've seen plenty of startups with 3, 4 and even 5 initial founders. --how much to raise in the first round of financing, which directly correlates to dilution --what to do with the first round of financing, which directly correlates into whether you will need a second round and how much --how much control to give up in terms of whether small exits are still on or off the table I wasn't saying you should constrain yourself at all costs. I was saying you should really look hard at the potential personal financial outcomes that flow from these decisions.
christonog 16y ago
I'm curious as to why you chose $5M and not another number like $3M or $2M? Is that the (gross) magic number to change your life financially? Edit: fixed typo.
- aditya 16y ago
  Yeah, with $5M in the bank you can live off the interest "forever" - ideally you'd spread the risk and stuff but with anything less than that amount it's hard to call yourself financially independent...
  - boucher 16y ago
    Of course, a $5 million exit is not $5 million in the bank. Depending on where you live, and a lot of other factors about the sale, it could mean as little as <$3 million after taxes (avg. case probably being around $4 million).
    - nostrademons 16y ago
      I'm curious whether stock-swap acquisitions get taxed as income or capital gains. If it's capital gains, can you hold the acquiring company's stock until you're fully vested, then quit and sell while unemployed to take advantage of the long-term capital gains rates in a really low bracket? (Which, last time I checked, were something like 5%.) What's your cost basis then? Is it the initial par value when you formed the original company?
    - vicaya 16y ago
      I'd assume all founders would know about 83b election (us founders anyway.) to cap the tax rate at 15% (long term capital gain)
      - rdl 16y ago
        By 15% you actually now (as of next year) mean 20% + 3.8% + (state tax, such as California's 10.3%)
  - 16y ago
thafman 16y ago
I tend to think of these steps as analogous to lifelines in "Who Wants to Be a Millionaire"; some people can make it to the million with no help, some need lifelines and just others cash out (not to mention those unfortunate souls who guess wrongly).
staunch 16y ago
Two co-founders that give up a total of 15% - 25% to raise $500k - $1M (ideally from well known investors) and never take another dime of investment. That seems like the best balance all things considered. Your odds of success are much higher, and your opportunity to exit (if you want to) at a low price is still there. 1) You can still accept a relatively low acquisition price. 2) Your share is still 37% - 43%, which is a huge chunk. 3) You have investors that will help with acquisition offers/hiring/partnerships, etc. 4) You can afford to pay for things that significantly accelerate your growth, that you would otherwise shy away from. 5) You're instantly full time (compared with a day job, or consulting work on the side). 6) Other companies/people will take you more seriously because you have investors.
- dasil003 16y ago
  Yeah that sounds good. However I think there are a lot of ideas where a solo engineer could hack out a prototype over 6-12 months and significantly increase the pre-investment value of the company. I guess it depends on the type of product and the hacker's skillset.
simonreed 16y ago
What I don't like in discussions like this is that people are looking for a binary answer to a problem that clearly has no this type of solution (it actually may be sensible to start up alone but it depends on personal situation of the person with the initial idea...). The issue is made even worse by those who 'have already done it'. We hear this all the time: you have to do A, C and F but never M to achieve Z. Finally, I've always thought that delicious.com was started by one guy working part-time and only when there was some traction there was another guy taken on board. Am I correct?
schoudha 16y ago
As soon as you start doing calculations like this to determine how many co-founders you should have it's almost a guaranteed you're not going to be successful. Build something people want with people you love to work with. The rest will work itself out.
webwright 16y ago
Love the post, though the dilution #s seem whacky to me (my experience is somewhat limited). First, it seems like an odd assumption that you'll be doing 3-4 rounds of financing before you exit. I've no idea to what degree that's the norm, but the founders I've known who've seen exits, very few had done a B round, much less a C or D. Certainly, companies who do C and D rounds tend to exit for MUCH higher sums than $30-50m. Gabriel, you saw an exit. At the time, did YOU own 30% of the company? I assume not. do you think 30% is the a normal number for founders to share at an exit? I don't-- but again, my experience is limited.
- epi0Bauqu 16y ago
  In my case, the founders owned 100% of the company--we never had any external investment or employees. Just to clarify, I was only suggesting further rounds (beyond A) for when you're really swinging for the fences, i.e. gunning for an IPO or a really really big exit. As for the dilution numbers, 30% is accurate if you raise a series A. For some data check out http://www.wsgr.com/publications/PDFSearch/entreport/Winter2008/private-company-financing-trends.htm http://www.wsgr.com/publications/PDFSearch/entreport/Winter2... and scroll down to the graphs. To quote a friend, "In an A round, VCs typically do an 'n on n' investment, e.g. $3M on a $3M pre-money, or $4M on $4M, or 5 on 5." That means they're taking 50%. Then you add in the option pool. You could get less if you have a lot of traction, but to get there you probably raised an angel round that had dilution, so you're about at the same place. Play around with http://www.ownyourventure.com/equitySim.html http://www.ownyourventure.com/equitySim.html to see the possibilities.
  - webwright 16y ago
    I don't think those charts support your numbers (they show a median of $3m raised on $6m pre... $9m post-money, 33% sold). The idea that founders collectively own 30% of the company after a Series A is pretty wrong in my experience (I've raised a Series A and have lots of friends who have as well-- inside and outside of the "YC Mafia"). If I ever had a friend tell me they had a term sheet for $3m on a $3m pre-money valuation, I'd tell them they were either lacking leverage or that someone was trying to take advantage of them.

108 points by icey 16y ago

brk 16y ago

Interesting article, and I think part of the underlying point is that you might be better off building a smaller, less complex company if your primary goal is just to get to some (relatively small) exit. It doesn't address the Equity Equation though. In theory you should be assigning shares based on some roughly calculated guess as to how much additional value those other employees (or founders) will bring. Sure, if you can do it all yourself there is no need or reason for massive dilution by handing out shares to other people. But the reality is that you often have the "technical" founder and the "business" founder. In the majority of cases they are both worthless without their combined talents and contributions.

sthomps 16y ago

great post

garply 16y ago

Interesting that all the paths involve selling the company. What about generating $5M for yourself through sales of the company's products instead of a sale of the company itself?

replicatorblog 16y ago
The 37 Signals approach is a good one, but one thing they ignore is that there are opportunities to make money in fast moving/growing areas that may not be the founder's true passion, in a short time period. 37S decries this as lottery thinking, but the odds are better, the process is repeatable, and methods are trainable. Gabriel happens to be in that part of the ecosystem and it is where his expertise lies.
- dhh 16y ago
  The odds of making a $17-50MM exit is higher than what? Turning a $1M/yr profit over 5 years? I think not. If the process was so "repeatable and the methods so trainable", the world would be flush with quick flip, sell-out millionaires. It is not. It is however full of people who became comfortably rich building up a profitable business.
  - replicatorblog 16y ago
    I was trying to articulate the odds of "flipping" a startup are greater than those of winning the lottery which is your oft stated comparison. You guys are all about boot strapping and you provide an awesome contra view to the conventional wisdom. That said, I know a great many more people who have sold web businesses and never have to work again than those who are reaping millions in profits via the same. Honestly, I'm amazed at how many people I meet who are financially set based on some obscure web business they sold to a non-traditional acquirer. I'm not even that plugged into the startup community and I've met a couple dozen folks easily. Heck, among YC alums alone I bet you would find a bunch, even the under publicized ones. Are the odds long? sure. Are you more likely to become wealthy spending a few post college years doing a funded startup rather than working at Google? Hell yes. I really liked Rework, and like the "Profitable and Proud" series, but there are opportunities for people to fill small product niches and "sell out" quickly. Especially in unsexy categories like analytics and other B2B applications. You might find it distasteful, but I'm sure a moderately well connected VC or angel could match every company in your P&P series with a series called "This company sold for XX millions and you never heard of them once."

maccman 16y ago

One other thing is that Tax man takes ~25% (capital gains)

joelhaus 16y ago
Generally, short-term (assets held less than one year) is taxed at your personal tax rate. Long-term (more than one year) is currently taxed at 15%, but will revert back to 20% beginning in 2011. [EDIT: based on US law]
vicaya 16y ago
That's why it's important to know about 83b election to cap the tax rate at 15%. Any start-up lawyer/law firm worth its salt would do this for you as part of the pile of forms to sign when you incorporate.

yosho 16y ago

Yes, the odds of a single founder exiting for 10M is greater than 3 founders exiting for 100M, however, the article fails to take into account the odds of a single founder start-up being profitable vs a multi-founder start-up being profitable. I believe the second case is much more likely due to the sharing of responsibilities, overlapping skill sets and the ability to bounce ideas off one another. There's always going to be a trade-off, things aren't so black and white.

jimboyoungblood 16y ago
Since when does one need to be profitable in order to exit? :)

axiom 16y ago

As much as it's fun to think about how much you personally stand to gain in an exit, it's all just pie in the sky silliness. Your number one goal should be to maximize your odds of success without constraining yourself to any arbitrary parameter like "no more than 2 cofounders." Building a profitable company is such a difficult and volatile process that if you try and focus on anything other than just success (e.g. your personal take) you're going to end up shooting yourself in the foot and end up with nothing.

kljensen 16y ago
Well put. Would be entertaining to see the same basic maths with an adjustment for probability of success. E.g. "if you feel the extra confounder increases your odds of success 40% ..."
- dasil003 16y ago
  At the end of the day though, I don't think this kind of percentage calculation is useful (entertaining, sure). The human mind doesn't work that way. Similarly I think it's a mistake to bring on a cofounder purely for the fundraising benefits. The decision to bring on a cofounder should be based on whether they bring critical skills, connections, and if you really want to work with them. IMHO, going with your gut is going to be a much safer bet than putting a number on it and using that to influence your decision.
  - kljensen 16y ago
    Agreed, not useful, but entertaining. (Similarly, how about a webapp for simulation of various founder /funding scenarios?)
epi0Bauqu 16y ago
On the contrary, there are many concrete decision points where this logic should come into play--dispelling your logic was exactly the point of the post. In particular: --whether to go it alone for a while at the beginning and see if you can make something happen --whether to bring on more than one co-founder; this may seem like a no-brainier, but I've seen plenty of startups with 3, 4 and even 5 initial founders. --how much to raise in the first round of financing, which directly correlates to dilution --what to do with the first round of financing, which directly correlates into whether you will need a second round and how much --how much control to give up in terms of whether small exits are still on or off the table I wasn't saying you should constrain yourself at all costs. I was saying you should really look hard at the potential personal financial outcomes that flow from these decisions.

christonog 16y ago

I'm curious as to why you chose $5M and not another number like $3M or $2M? Is that the (gross) magic number to change your life financially? Edit: fixed typo.

aditya 16y ago
Yeah, with $5M in the bank you can live off the interest "forever" - ideally you'd spread the risk and stuff but with anything less than that amount it's hard to call yourself financially independent...
- boucher 16y ago
  Of course, a $5 million exit is not $5 million in the bank. Depending on where you live, and a lot of other factors about the sale, it could mean as little as <$3 million after taxes (avg. case probably being around $4 million).
  - nostrademons 16y ago
    I'm curious whether stock-swap acquisitions get taxed as income or capital gains. If it's capital gains, can you hold the acquiring company's stock until you're fully vested, then quit and sell while unemployed to take advantage of the long-term capital gains rates in a really low bracket? (Which, last time I checked, were something like 5%.) What's your cost basis then? Is it the initial par value when you formed the original company?
  - vicaya 16y ago
    I'd assume all founders would know about 83b election (us founders anyway.) to cap the tax rate at 15% (long term capital gain)
    - rdl 16y ago
      By 15% you actually now (as of next year) mean 20% + 3.8% + (state tax, such as California's 10.3%)
- 16y ago

thafman 16y ago

I tend to think of these steps as analogous to lifelines in "Who Wants to Be a Millionaire"; some people can make it to the million with no help, some need lifelines and just others cash out (not to mention those unfortunate souls who guess wrongly).

staunch 16y ago

Two co-founders that give up a total of 15% - 25% to raise $500k - $1M (ideally from well known investors) and never take another dime of investment. That seems like the best balance all things considered. Your odds of success are much higher, and your opportunity to exit (if you want to) at a low price is still there. 1) You can still accept a relatively low acquisition price. 2) Your share is still 37% - 43%, which is a huge chunk. 3) You have investors that will help with acquisition offers/hiring/partnerships, etc. 4) You can afford to pay for things that significantly accelerate your growth, that you would otherwise shy away from. 5) You're instantly full time (compared with a day job, or consulting work on the side). 6) Other companies/people will take you more seriously because you have investors.

dasil003 16y ago
Yeah that sounds good. However I think there are a lot of ideas where a solo engineer could hack out a prototype over 6-12 months and significantly increase the pre-investment value of the company. I guess it depends on the type of product and the hacker's skillset.

simonreed 16y ago

What I don't like in discussions like this is that people are looking for a binary answer to a problem that clearly has no this type of solution (it actually may be sensible to start up alone but it depends on personal situation of the person with the initial idea...). The issue is made even worse by those who 'have already done it'. We hear this all the time: you have to do A, C and F but never M to achieve Z. Finally, I've always thought that delicious.com was started by one guy working part-time and only when there was some traction there was another guy taken on board. Am I correct?

schoudha 16y ago

As soon as you start doing calculations like this to determine how many co-founders you should have it's almost a guaranteed you're not going to be successful. Build something people want with people you love to work with. The rest will work itself out.

webwright 16y ago

Love the post, though the dilution #s seem whacky to me (my experience is somewhat limited). First, it seems like an odd assumption that you'll be doing 3-4 rounds of financing before you exit. I've no idea to what degree that's the norm, but the founders I've known who've seen exits, very few had done a B round, much less a C or D. Certainly, companies who do C and D rounds tend to exit for MUCH higher sums than $30-50m. Gabriel, you saw an exit. At the time, did YOU own 30% of the company? I assume not. do you think 30% is the a normal number for founders to share at an exit? I don't-- but again, my experience is limited.

epi0Bauqu 16y ago
In my case, the founders owned 100% of the company--we never had any external investment or employees. Just to clarify, I was only suggesting further rounds (beyond A) for when you're really swinging for the fences, i.e. gunning for an IPO or a really really big exit. As for the dilution numbers, 30% is accurate if you raise a series A. For some data check out http://www.wsgr.com/publications/PDFSearch/entreport/Winter2008/private-company-financing-trends.htm http://www.wsgr.com/publications/PDFSearch/entreport/Winter2... and scroll down to the graphs. To quote a friend, "In an A round, VCs typically do an 'n on n' investment, e.g. $3M on a $3M pre-money, or $4M on $4M, or 5 on 5." That means they're taking 50%. Then you add in the option pool. You could get less if you have a lot of traction, but to get there you probably raised an angel round that had dilution, so you're about at the same place. Play around with http://www.ownyourventure.com/equitySim.html http://www.ownyourventure.com/equitySim.html to see the possibilities.
- webwright 16y ago
  I don't think those charts support your numbers (they show a median of $3m raised on $6m pre... $9m post-money, 33% sold). The idea that founders collectively own 30% of the company after a Series A is pretty wrong in my experience (I've raised a Series A and have lots of friends who have as well-- inside and outside of the "YC Mafia"). If I ever had a friend tell me they had a term sheet for $3m on a $3m pre-money valuation, I'd tell them they were either lacking leverage or that someone was trying to take advantage of them.