4 ms·

Is Your Startup A Cash or Equity Business?

55 points by eladgil 16y ago

avichal 16y ago
Great post. Keep it up Elad!
aresant 16y ago
One thing that's not mentioned, is the tax implications of each. In a cash-flow business you're going to wind up paying out ~45 - 50% in taxes on the income (especially if you live in CA!!!) In an equity business you wind up paying on capital gains, which if you hold your stock for more than 1 year can be as low as 15% (in the US, anyways). Once you do the math accross 3 - 5 years it often makes more sense to build an equity valuable company for sale. For cash-flow heavy businesses, a strategy to reduce tax and increase equity value can be to pay modest salaries and pump the bulk of the cash back into business expansion.
- eladgil 16y ago
  Really good point. I was thinking of putting this in the post but decided to not get into it. Thanks for pointing it out.
  - sushrutbidwai 16y ago
    It will be great to build a business which is cash + equity similar to 37signals. It had early cash-flow and value of equity is definitely similar to equity based businesses.
- deleted 16y ago
  [deleted]
JangoSteve 16y ago
Figuring out what sort of business you want to start, (or, in hindsight, have started) impacts everything from whether you should raise money to how to compensate your employees. Interestingly enough, the corollary is also true. Figuring out what sort of headaches you want to deal with helps you decide what sort of business you should start. I prefer release early/often, grassroots B2B customer development, and bootstrapping over large development cycles, long-handed B2C marketing, and funding. That is precisely why I focus my efforts on creating cash businesses that are finely targeted and strive for profitability as soon as possible.
- eladgil 16y ago
  Absolutely agree - founders should think through what they want from their business up front, and what sorts of headaches they do or do not want to have to deal with over time.
JacobAldridge 16y ago
This is a very useful distinction, especially for partnerships. I've seen many partnerships in my role (as a business coach) where this distinction has been the root of all their disputes - one is choosing to invest for the future in an equity business, while the other is choosing to maximise the immediate cash income. FWIWI, most businesses I've encountered are cash businesses - some consciously ("I bought myself a job") and many through lack of realisation that there is an alternative they can choose. I agree wholeheartedly with the point that companies change over time - founders need a cash reward for their effort at some point, and companies (Microsoft is a great example) will often reach the peak of their equity build, in which case switching to cash may be in the better interests of stockholders, employees etc.
asanwal 16y ago
Interesting viewpoint Elad. A few points/considerations: Building equity valuable companies is way tougher and much riskier. Your examples of Google, Facebook, Twitter are all rare. And for every Goog, Twitter, FB, there are many carcasses of others who've not made it. For entrepreneurs balancing risk-reward, trying to build a company that is solely equity valuable is tough. Also, I don't think the equation is quite so binary. Cash businesses, by virtue of the cash they generate, can expand and enter adjacent markets and these growth initiatives can increase the equity value of the company. Amazon comes to mind. Lastly, although these cash businesses are not as sexy, there is still equity value there. There is a whole ecosystem of mid-market private equity firms interested in these types of companies and buying their equity.
- lsc 16y ago
  for many cash businesses, the equity is much smaller than you would think. I run what is essentially a hosting company, right? I've gotten a few offers, and do you know how hosting companies are valued? approximately one year revenue plus the value of your hardware. And this is a growing company in a rapidly growing market (I double every 6-8 months) I mean, it's something, but not compared to what you expect from equity businesses, and not nearly enough to cause a rational agent to sell at the margins we see, I mean, unless you were just sick of doing it.
- eladgil 16y ago
  Good points. However, think of all the talent buys or technology buys or "strategic buys" that companies make. E.g. Aardvark was acquired by Google for $50 million and I doubt they had any revenue. For early stage technology companies, most of the value is often in the equity. So you don't need to be a huge company to have most of the value in the equity.
yurylifshits 16y ago
Event business (conferences, tradeshows, music events) is another example of cash business. You can be profitable within weeks from the start.

55 points by eladgil 16y ago

Great post. Keep it up Elad!

One thing that's not mentioned, is the tax implications of each. In a cash-flow business you're going to wind up paying out ~45 - 50% in taxes on the income (especially if you live in CA!!!) In an equity business you wind up paying on capital gains, which if you hold your stock for more than 1 year can be as low as 15% (in the US, anyways). Once you do the math accross 3 - 5 years it often makes more sense to build an equity valuable company for sale. For cash-flow heavy businesses, a strategy to reduce tax and increase equity value can be to pay modest salaries and pump the bulk of the cash back into business expansion.

eladgil 16y ago
Really good point. I was thinking of putting this in the post but decided to not get into it. Thanks for pointing it out.
- sushrutbidwai 16y ago
  It will be great to build a business which is cash + equity similar to 37signals. It had early cash-flow and value of equity is definitely similar to equity based businesses.
deleted 16y ago
[deleted]

JangoSteve 16y ago

Figuring out what sort of business you want to start, (or, in hindsight, have started) impacts everything from whether you should raise money to how to compensate your employees. Interestingly enough, the corollary is also true. Figuring out what sort of headaches you want to deal with helps you decide what sort of business you should start. I prefer release early/often, grassroots B2B customer development, and bootstrapping over large development cycles, long-handed B2C marketing, and funding. That is precisely why I focus my efforts on creating cash businesses that are finely targeted and strive for profitability as soon as possible.

eladgil 16y ago
Absolutely agree - founders should think through what they want from their business up front, and what sorts of headaches they do or do not want to have to deal with over time.

JacobAldridge 16y ago

This is a very useful distinction, especially for partnerships. I've seen many partnerships in my role (as a business coach) where this distinction has been the root of all their disputes - one is choosing to invest for the future in an equity business, while the other is choosing to maximise the immediate cash income. FWIWI, most businesses I've encountered are cash businesses - some consciously ("I bought myself a job") and many through lack of realisation that there is an alternative they can choose. I agree wholeheartedly with the point that companies change over time - founders need a cash reward for their effort at some point, and companies (Microsoft is a great example) will often reach the peak of their equity build, in which case switching to cash may be in the better interests of stockholders, employees etc.

asanwal 16y ago

Interesting viewpoint Elad. A few points/considerations: Building equity valuable companies is way tougher and much riskier. Your examples of Google, Facebook, Twitter are all rare. And for every Goog, Twitter, FB, there are many carcasses of others who've not made it. For entrepreneurs balancing risk-reward, trying to build a company that is solely equity valuable is tough. Also, I don't think the equation is quite so binary. Cash businesses, by virtue of the cash they generate, can expand and enter adjacent markets and these growth initiatives can increase the equity value of the company. Amazon comes to mind. Lastly, although these cash businesses are not as sexy, there is still equity value there. There is a whole ecosystem of mid-market private equity firms interested in these types of companies and buying their equity.

lsc 16y ago
for many cash businesses, the equity is much smaller than you would think. I run what is essentially a hosting company, right? I've gotten a few offers, and do you know how hosting companies are valued? approximately one year revenue plus the value of your hardware. And this is a growing company in a rapidly growing market (I double every 6-8 months) I mean, it's something, but not compared to what you expect from equity businesses, and not nearly enough to cause a rational agent to sell at the margins we see, I mean, unless you were just sick of doing it.
eladgil 16y ago
Good points. However, think of all the talent buys or technology buys or "strategic buys" that companies make. E.g. Aardvark was acquired by Google for $50 million and I doubt they had any revenue. For early stage technology companies, most of the value is often in the equity. So you don't need to be a huge company to have most of the value in the equity.

yurylifshits 16y ago

Event business (conferences, tradeshows, music events) is another example of cash business. You can be profitable within weeks from the start.