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Feels a bit like this whole issue is conflicting the management team with the investors - which is obviously very common in the startup world. Need to take a s

by RyanZAG 14y ago

Feels a bit like this whole issue is conflicting the management team with the investors - which is obviously very common in the startup world. Need to take a step back and look at the primary purpose of acquiring investors: taking capital from them now in exchange for future cash flows to them later. To maximize this in favour of our business, we need to take the most money for the minimum amount of equity sold. Now look at the primary purpose of the management team: to use the assets and resources placed in their care to create the highest future cash flows possible. This includes the tasks that Chris is conflating with investors: secure deals, find the best lawyers and accounts, getting meetings with difficult people. The management team is then compensated directly for their efforts. The above is how it works in traditional companies. The investors invest capital and decide on the management team. The management team actually runs all facets of the business. In the startup world this relationship is not as simple, as the founders are both the primary shareholders and the management team itself. What Chris is proposing is not as outlandish as it sounds - he is proposing joining the investors as part of the management team by selling shares to them for cheaper. If a share is worth $10 on the open market, but we sell it at $5 in exchange for valuable help from investors, then we are doing something very simple: we are paying these investors to be part of the management team, and in this case we are paying them $5 per share. This is a good option to take if the skills they bring are worth the $5, and a very bad option if we could hire better/more skills by taking the $10/share and then directly hiring on the market. TLDR: Nothing to see here - you can pay people in equity or in cash, and the choice is as difficult as it ever was.

amirmc 14y ago
What you've said could also be summed up as the difference between 'dumb money' and 'smart money'. The latter might be more 'expensive' but also more valuable. I disagree with your TLDR. There's definitely something worth seeing here as Chris has just described a fundraising tactic that's useful to be aware of (it's not one I'd have thought of independently).
- RyanZAG 14y ago
  My TLDR didn't imply that the decision or discussion wasn't important - choosing the equity structure is an incredibly important part of any business. Using the valuation number to try and buy skills and experience is novel (I think?), but the underlying idea is very much not novel. When you hire an engineer, you can either pay him $100 or give him $100 worth of stock. If the engineer chooses to be paid $100 in cash, you need to acquire that cash. If you have revenues, you can pass those onto the engineer. If you don't, you can sell $100 worth of stock, and pass on that $100 to the engineer. Valuations are identical - you are selling off the stock for cash - it is identical to the case above when distilled, and the actual choices involved are the same. Example: Option A Investor 1 who will give $100 in exchange for $100 stock Investor 1 will not help the company recommendations etc. Option B Investor 2 who will give $50 in exchange for $100 stock Investor 2 will get you a meeting with Investor 3 (X) Investor 2 will help you with his experience (Y) The above Option A and Option B is directly equivalent to the engineer dilemma above. You need to take Option B only if Value(X + Y) > $50
  - gregpilling 14y ago
    OPTION C Investor 1 who will give you $100 in exchange for $100 stock Investor 1 is a good person who cares about your startup and helps with his/her experience.
    - RyanZAG 14y ago
      Helps to consider the different valuations at play here: Real value of your company - This one can only be found by using a time machine to jump forward and see the true cashflows. - It is the true value that the other values try estimate. Your estimate of the value - You get this by being objective about your business. - You should base all your decisions off this number. Other people's valuations of your business - Everybody has their own unique value - You don't want to sell stock to people who have a low value of your business. So obviously, there is not just option A and B, there are many different options based off other people's valuation of your business. There is another factor too, as you brought up, in that you can receive a sales discount - 25% off - with that 25% off either being in free work for your company, or in a plain 25% better offer than they really want to offer. This happens in the same way an orange store may sell oranges for 25% less than their competitor across the road, even if the oranges come from the same farm. The only important number is your own estimate of the value, and you should base all share decisions off that number alone. And try to get that number as close to the real value as possible. So if there is an Option C which is just plain better than the other options, it's the obvious choice to take - but be careful of any strings that may come attached in lieu of a cash payment - he may be expecting bigger rewards in future and can cause drama in your business getting them. Not everything with no cost is free...
sskates 14y ago
You would expect that investors would help your startup more if they had more equity from a lower valuation and were rationally trying to maximize the expected value of their holdings. However, in seed stage investing in startups, investors do not end up looking at their equity stakes when they decide to help or not help a startup. The primary determinants of whether an investor helps you are: 1) Whether they are the type that generally want to help the companies they invest in 2) Their relationship with the founders 3) How successful they perceive the startup will be and whether they feel they can contribute to that success
- diego 14y ago
  I have different amounts of equity in different startups. All else being equal, I prefer to help the ones in which I have more equity. I like to help companies that I invest in, but my time is limited. I've had to make that call.

by RyanZAG 14y ago

amirmc 14y ago

What you've said could also be summed up as the difference between 'dumb money' and 'smart money'. The latter might be more 'expensive' but also more valuable. I disagree with your TLDR. There's definitely something worth seeing here as Chris has just described a fundraising tactic that's useful to be aware of (it's not one I'd have thought of independently).

RyanZAG 14y ago
My TLDR didn't imply that the decision or discussion wasn't important - choosing the equity structure is an incredibly important part of any business. Using the valuation number to try and buy skills and experience is novel (I think?), but the underlying idea is very much not novel. When you hire an engineer, you can either pay him $100 or give him $100 worth of stock. If the engineer chooses to be paid $100 in cash, you need to acquire that cash. If you have revenues, you can pass those onto the engineer. If you don't, you can sell $100 worth of stock, and pass on that $100 to the engineer. Valuations are identical - you are selling off the stock for cash - it is identical to the case above when distilled, and the actual choices involved are the same. Example: Option A Investor 1 who will give $100 in exchange for $100 stock Investor 1 will not help the company recommendations etc. Option B Investor 2 who will give $50 in exchange for $100 stock Investor 2 will get you a meeting with Investor 3 (X) Investor 2 will help you with his experience (Y) The above Option A and Option B is directly equivalent to the engineer dilemma above. You need to take Option B only if Value(X + Y) > $50
- gregpilling 14y ago
  OPTION C Investor 1 who will give you $100 in exchange for $100 stock Investor 1 is a good person who cares about your startup and helps with his/her experience.
  - RyanZAG 14y ago
    Helps to consider the different valuations at play here: Real value of your company - This one can only be found by using a time machine to jump forward and see the true cashflows. - It is the true value that the other values try estimate. Your estimate of the value - You get this by being objective about your business. - You should base all your decisions off this number. Other people's valuations of your business - Everybody has their own unique value - You don't want to sell stock to people who have a low value of your business. So obviously, there is not just option A and B, there are many different options based off other people's valuation of your business. There is another factor too, as you brought up, in that you can receive a sales discount - 25% off - with that 25% off either being in free work for your company, or in a plain 25% better offer than they really want to offer. This happens in the same way an orange store may sell oranges for 25% less than their competitor across the road, even if the oranges come from the same farm. The only important number is your own estimate of the value, and you should base all share decisions off that number alone. And try to get that number as close to the real value as possible. So if there is an Option C which is just plain better than the other options, it's the obvious choice to take - but be careful of any strings that may come attached in lieu of a cash payment - he may be expecting bigger rewards in future and can cause drama in your business getting them. Not everything with no cost is free...

sskates 14y ago

You would expect that investors would help your startup more if they had more equity from a lower valuation and were rationally trying to maximize the expected value of their holdings. However, in seed stage investing in startups, investors do not end up looking at their equity stakes when they decide to help or not help a startup. The primary determinants of whether an investor helps you are: 1) Whether they are the type that generally want to help the companies they invest in 2) Their relationship with the founders 3) How successful they perceive the startup will be and whether they feel they can contribute to that success

diego 14y ago
I have different amounts of equity in different startups. All else being equal, I prefer to help the ones in which I have more equity. I like to help companies that I invest in, but my time is limited. I've had to make that call.