Investment & Finance, Legal, Sticky

Model Equity Calculator for Founders with Option Pool Expansion

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English: Historical valuation on the secondary...

SeedCamp’s hackathon, Seedhack, took place at Google Campus, London, on the 8th to 10th of November. It brought together some of the brightest talent in the startup community from 15 countries with one of the best accelerator programs in the world and mashed it up with awesome content providers like Twitter, Facebook, BSkyB, BBC, Getty, HarperCollins, EyeEm, Nokia Music and Imagga. There were a total of 12 teams working on interesting and exciting projects.

As part of this hackathon, Ali and Will helped me aggregate resources to help founders better understand the process of raising equity and the impact it can have to their founder stakes. We aggregated resources to help entrepreneurs to understand  the numbers and implications of raising money and giving out equity. Valuing a company and calculation its impact on your equity is a very complex and confusing for entrepreneurs as well as being far from an exact science, this is the pain point that we wanted to address.

In the words of Seedhack attendee Will Martin (@willpmartin)

“Fundraising is one of the most difficult parts of the startup world, as first time founders this is an even more daunting process. Experience of raising a round and understanding the numbers and implications of that round and the related equity issued to an investor as well as employees in the form of an option pool is vital, but sadly is only fully understood by going through the process for real. Our intention was to give founders the knowledge required by being able to go through the process in a simple and easy way, thus giving the founder the confidence when it happens for real.

Ali and I are first time founders currently actively looking for investment. We know the total value we need in terms of money we want to raise as well the percentage of equity we are comfortable willing to give up to the investor. What we didn’t know and learned through the process is the implications in future rounds as a result of that initial funding round. Having an option pool for employees, advisors, board members etc. is something that complicates the issue and is often a requirement in the terms an investor is offering. This complicates the issue for the founder, so being aware of the impact of their shareholding as a result is vital for a founder as it is them that gets diluted in the first round but also any subsequent round, but it is often overlooked.

The changes to equity positions of the founders, investors, employees etc. is very important to understand as it dictates control and value of a company. Having this knowledge now gives us as founders a huge advantage over other founders we are competing with for funding and bridges the knowledge gap that exists for first time founders.”

In order to read some of the terms on this cap table model, below are some definitions which you might find useful:

Pre & Post Money Valuation –

“The pre-money valuation is the valuation that a company goes into raising a round of financing with. By establishing this valuation, it helps investors understand what amount of equity they will receive in the company in exchange for their capital. Once the financing round has been completed, the post-money valuation is the sum total of the pre-money valuation plus the additional capital raised. So, if the pre-money valuation of a company is $10 million and they raise $2.5 million from investors, their post-money valuation would be $12.5 million. Investors would own 20% of the resulting company.” – Dave Morin, Source Quora

“A PRE-MONEY VALUATION is the valuation of a company or asset BEFORE investment or financing. If an investment adds cash to a company, the company will have different valuations before and after the investment. The pre-money valuation refers to the company’s valuation before the investment.

External investors, such as venture capitalists and angel investors will use a pre-money valuation to determine how much equity to demand in return for their cash injection to an entrepreneur and his or her startup company. This is calculated on a fully diluted basis.

If a company is raising $250,000 in its seed round and willing to give up 20% of their company the pre-money valuation is $1,000,000. (250,000 * 5 -250,000 = 1,000,000)

Formula: Post money valuation – new investment

Source – http://en.wikipedia.org/wiki/Pre-money_valuation

A POST-MONEY VALUATION is the value of a company AFTER an investment has been made. This value is equal to the sum of the pre-money valuation and the amount of new equity.

The Post-money valuation is the sum of the pre-money valuation and the money raised in a given round. At the close of a round of financing, this is what your company is worth (well, at least on paper).

If a company is worth $1 million (pre-money) and an investor makes an investment of $250,000, the new, post-money valuation of the company will be $1.25 million. The investor will now own 20% of the company.

The only reason it’s worth spending time on this term at all is that it “sets the bar” for your future activities. If your post-money after your first round of financing is $4 million, you know that to achieve success, in the eyes of your investors, any future valuations will have to be well-in-excess of that amount.     

Formula: New Investment * total post investment shares outstanding/shares issued for new investment. “

Source – http://en.wikipedia.org/wiki/Post-money_valuation

Option Pools –

“An option pool is an amount of a startup’s common stock reserved for future issuances to employees, directors, advisors, and consultants.” – from startuplawyer.com

Option pools can also be formed by Restricted Stock Units, but whichever one you use, they are generally still called ‘Option Pools’.

The OPTION POOL is the percentage of your company that you are setting aside for future employees, advisors, consultants, and the like. Employees who get into the startup early will usually receive a greater percentage of the option pool than employees who arrive later.

“The size of the Option Pool as a percentage of the POST-MONEY Valuation and where ALL of it comes from the founder’s equity. This is the least founder-friendly way to present this, but it is also the point at which most early stage investors will start the negotiations. The expectation from traditional venture firms is that this will equal 15%-25% of the company AFTER they make their investment. The Option Pool is one of the most complex and, from the entrepreneur’s perspective, confusing terms in an equity financing scenario.” – source http://www.ownyourventure.com/content/tips/op.html

Round Size – 

The investment, or money is how much money is raised in a given round of financing. However, the decisions (and their implications) surrounding this number are among the most important that a founding team makes. It is not just about how much money is raised, it is about the terms that the money is raised on and, maybe most importantly, whose money it is and what they bring to the table in addition to money.  – Source http://www.ownyourventure.com/content/tips/inv.html

Link to the Model Cap Table: http://bit.ly/1ayKk8p


NOTE FOR MODEL TO WORK – It needs to run on Excel (Google docs coming soon) and with circular calculations turned on. This can be done by going to (Mac Excel) Preferences -> Calculation -> Iteration -> Click on Limit Iteration

If you are considering using Convertible Notes as part of your round, check out this variant of the cap table with notes on how to convert as well: http://bit.ly/17kHlSA

Additional Equity Calculation Tools (Thanks to Ali Tehrani for finding these – @tehranix) –

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Marketing, Product Market Fit

Why startups need to constantly communicate with their customers

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phone-line-786x305

Originally published on Oct 17, 2013 on TNW

A lot of entrepreneurs talk about optimizing their products so they run faster, look better, go viral – but it’s important to remember that none of this can happen unless you are constantly getting feedback from your most valuable asset: Your customers.

During Seedcamp’s recent U.S. trip, we met with many companies like Return Path, Erply, Zemanta, Percolate, OneFineStay, BarkBox, GrabCad, Pinterest, Airbnb, and RunKeeper, to name a few. The consensus from these conversations is that you must continually talk to your customers. Without doing so, you won’t be able to focus on what’s most important: Providing them the value you promised.

In concept, customer communication seems relatively straightforward. But in practice, everyone we spoke with shared that they all experienced varying degrees of difficulty.

Here are the two main reasons why it can be tough to continue listening.

1. It’s hard to tell who you should really please

As a startup, you have the pressure of fundraising and needing to articulate to potential investors a “big vision,” which in many ways can be an extension of your original value proposition. However, that can sometimes lead to an over-extension in order to give the appearance of not thinking too small.

The problem is that unless your customers validate your assumptions shortly after your successful fundraise, you may find yourself going down the wrong path to keep up an “appearance” rather than refocusing on what you know to be the real value to your customer. This may, in turn, burn valuable resources along the way.

It’s a tough call to make, but it is one that could literally cost you your startup if made too late.

2. Not everyone’s needs can be addressed

When you personally believe a product feature or functionality is what will provide value, you may suffer from self-confirmation bias rather than resorting to a real understanding of the needs of the customer. This could result in creating too many features that were requested by your customers (or yourself), thus distracting you from building on the core proposition.

When turning down feature requests from customers, you don’t always have to coldly reject the critique with a big “No.” Rather, as Jason Jacobs, CEO and founder of Boston-based startup Runkeeper suggests, think about whether their comments can be useful in the future, and tell your customers,”Not yet.”

But you still must focus on customer conversations

Continuing to listen is only half the battle. The first half is identifying who your customers are and knowing how to speak to them effectively.

Rob Fitzpatrick’s new book, “The Mom Test,” does a nice job highlighting the methodical process which you can use to avoid the typical pitfalls of customer conversations. This could include confirmation bias and looking for compliments rather than actual feedback. You may think your product is the best thing out there, but be prepared to hear otherwise from the people who matter.

Secondly, it’s important to know who your customers are in the first place. In typical B2C companies, that might be more straightforward, but for non-B2C companies, it can take a little bit more work.

Take B2B2C models for example. These cases pose a unique challenge because it can be tempting to stop short of talking to the end customer and primarily focus on the immediate buyer, partner, or distributor. Don’t forget that the “C” stands for consumer, therefore, it is crucial that the customer that derives most value from your proposition in your marketplace.

In the example of a B2B2C business, you will want to have a relationship with the end customer if you want to keep control of your brand and what it stands for. Your marketing message will likely still have to be targeted to them and you will have to invest in those efforts to reach them, even if there is an intermediary step of the ultimate “buyer.”

Customer conversations should involve understanding the dynamics of both the end user and the B2B side of things. With customers, you must communicate with them to position your product vis-a-vis the competitors. You can do this better than your distributors or partners may be able to, even if they are helping you reach them.

Focusing too much on partners may leave you with a product that the end customer doesn’t care about or is wrongly adapted to their needs because you spent too much time caring about distributors.

Another form of customer conversation that needs to be done in tandem is one that is part of a two-sided marketplace. Yes, it will be twice as much work, but it is necessary in order to make sure you aren’t building an “unbalanced” customer acquisition process and product development. Below are some of the articles that thoughtfully discusses the topic.

Keep in mind who you are talking to

The most complex situation is when the customer is not various individuals, but many people disguised as a single figure. This usually happens in situations where the end user is not empowered to actually make the decision to buy. Rather, there is a series of people within an organization that jointly make a purchasing decision.

In slides 49 to 51, Michael J. Skok has a good break down of what he calls the Decision Making Unit (DMU). He discusses the potential constituents of a DMU, and encourages you to think of them as a unit. This means “speaking to your customer” equates to speaking to all of them as they jointly make the decision. Not all organizations have all the components of Skok’s full DMU list, so it’s just about finding the ones that are required to make a decision – and think of those as the DMU.

After hearing many founders share their stories, it is clear that you need to constantly keep in touch with your customers as you continue to evolve your proposition and maintaining focus on what delivers value. The further you are from the reference customer, the more you need to be mindful of not losing touch with your users and their needs, for that can be fatal in an early stage business.

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Marketing, Product Market Fit

Must See Videos on Developing a Solid Value Proposition for your Customers

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Determining your customer and the value prop you offer them is essential early in the creation of your business. Without doing so, you really will struggle in hitting product market fit. Below are two videos to really jog your thinking about the process.

This first video is by Michael J. Skok, long time entrepreneur, lecturer at HBS, Startup Secrets blogger,  and currently Partner at Northbridge Ventures.

hard link: https://www.youtube.com/watch?v=EYJeGYboPnw#t=2019

Another great video is of “Understanding the Job” your product is hired to do by Clayton M. Christensen. He is the Kim B. Clark Professor of Business Administration at the Harvard Business School (HBS), with a joint appointment in the Technology & Operations Management and General Management faculty groups. He is best known for his study of innovation in commercial enterprises. His first book, The Innovator’s Dilemma, articulated his theory of disruptive innovation. Christensen is also a co-founder of Innosight, a management consulting and investment firm specializing in innovation. (Wikipedia)

hard link: http://www.youtube.com/watch?v=f84LymEs67Y

Lastly, here is another video which is really to drive the whole point of ‘Why’ you are doing things for your customers… it is one I’ve posted before from Simon Sinek, but always worth watching again.

hard link: http://www.youtube.com/watch?v=qp0HIF3SfI4

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General

On Becoming British

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I’m happy to announce that I’ve just become a British Citizen.

It means a lot to me to be part of this great nation that opened its doors to me and welcomed me over five years ago. In my experience, I feel the UK has a diverse community of smart people, vibrant startup ecosystem, and British people (and as an extension the larger European community) have an amazing energy to tackle problems and getting things done whenever they need evolution (for example, read about the recent Europe-wide http://startupmanifesto.eu/ initiative to help tackle many current business & economic issues).

In my journey so far, I’ve had the opportunity to meet many people that are passionate about evolving this nation and helping it continue to grow, and I’m proud to be part of that movement.

…and for the record, yes, I now know how to make a mean cup of tea.

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Human Resources

What Firing an Employee may Say about You

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Fired_stampA big thank you to Bretton Putter of the Forsyth group for Feedback and Editorial Input – http://www.forsythgroup.com/about/the-team/

This post is not about how to hire or how to fire someone. It is about highlighting the potential reasons why employees relationships can fall apart and lead to a dismissal down the road. Hopefully this is post provides with your the necessary information for you to consider on how you can prevent this from happening by setting up an appropriate hiring process and cultivating an environment where employees are not set up for failure within their defined roles.

As you likely already know, hiring and firing are probably two of the most difficult things to do in a company. That’s why usually, for key hires, a company’s leadership is directly involved in the selection and interview process. Ideally, if done right, you never find yourself in a position where you have to lay someone off, but what if you do? Was it entirely the employee’s fault, or could you have done something to prevent it from happening?

Let’s start with looking at your hiring process and mistakes that can lead to an employee relationship breaking down:

  • Hiring Process Mistakes – These are mistakes you could have prevented before hiring
  • No defined internal interview process – By not having a clear process which a candidate goes through to assess the communication skills of the new potential prospect and their fit within the company culture, you run the risk of the employee potentially not fitting in.
  • Not geographically disciplined – In a startup everyone should be together, if it’s not possible, then people should spend time with the home-team at least 3 months. Having remote teams early on is very hard although some companies do manage to pull it off at the cost of their sleep.
  • Not qualified enough to do the job – In a startup, you don’t really have the time to train someone. Be careful about relying too much on training you could give the candidate, they should be self-sufficient pretty quickly on. Also, sometimes we can project a bit of ourselves and our ambitions onto people, so be mindful of personal biases when evaluating someone.
  • Not being able to commit to the company’s work ethic – Some companies have the expectation that you will be there from 9-5 or some regular schedule (think of customer services roles that require people to be at their desks by a certain time). Other companies have results oriented work environments where there is no need for someone to be there at a specific time so long as they get their work done. Make sure you define what your work ethic is so that people aren’t caught off guard later.

After the Fact Mistakes Analysis – These are mistakes you might have committed unknowingly that led to a dismissal

  • Poor Role Definition –  If you or the hiring manager don’t know what the role this person will have (or main responsibility will be) within a company, you’re just setting up that new employee to linger in role purgatory, not knowing what they can control and what is someone else’s.
  • Poor Title Choice – If you give a new employee a title that is above their experience, particularly if you give them a C[x]O title, you set them up for potential failure if they can’t live up to it, because then you can’t hire above them to help them out and their ‘power’ position may create tension between other employees as their inexperience causes blunders. This may affect communication with peers as well. For more on the different philosophies on title choice, read the following: http://tech.fortune.cnn.com/2011/03/16/why-even-your-ultra-hip-startup-team-need-job-titles/
  • Poor Communications of responsibilities and expectations – Similar to clear role definition, poor communication of what is expected of them and by when, leads to that employee lacking direction and perhaps not going down a path that is necessarily the one that your organisation needs.
  • Not acting fast enough to rectify a situation – If something is going wrong, or an employee isn’t doing what they need to be doing according to their level, perhaps there is something awry in what they perceive things are they should be doing. Don’t wait because you feel awkward about it or want to see if it improves on its own. Jump in there and have a structured conversation with the employee to make sure roles and responsibilities are mutually agreed and that you both are aligned on what needs to happen next.
  • Poor Key Performance Indicator definition – defining how someone is doing well helps them to adjust their actions so that they reach the set goals. Not every employee will have a specific KPI tailored to their function, but if it is a key hire, they will likely have awareness of the company’s key KPIs and how their role aids the company in achieving them.
  • Poor management (in general) – Motivating people is not easy. Getting them to buy in to what you are doing is sometimes beyond just a pay check. You need to inspire them to do more not micromanage them if things aren’t going well. Read the book ‘Drive’ by Daniel H. Pink to get a feel for some of the latest thinking on motivational theory.
  • Other problematic employees – Sometimes organisations have bullies. You may hire someone that you think is a great fit for the job, and perhaps they would be if it weren’t to an already existing employee who ‘preys’ on others. Typically this bully can also be someone who is really good at their job so it isn’t always readily apparent from their performance. However, organisational bullies can create a reason for why new employees leave. Thus, never rule out this possibility as sometimes its hard for new employees to muster up the courage to report on a peer, particularly if they are senior to them.

So, some final things to consider –

As I mentioned before, when you see a problem that’s brewing, deal with it quickly. If you need to let someone go, let them go, but don’t be blind that it’s entirely their fault, review your company’s internal circumstances to see if they contributed towards the problem.

Verse yourself well with what the legal requirements are in your company’s jurisdiction. Don’t get yourself into a big mess by not going through the appropriate process, which typically requires warning before dismissing someone. You don’t want to find yourself in a lawsuit for wrongful dismissal.

In conclusion, when you hire, consider whether your hiring process is exhaustive, but also take stake and review your company’s situation so that you can prevent things from going wrong for your new team members once they are hired.

Additional Resources:

  • http://workable.com/ – Recruitment service and application tracking
  • Are CEOs to Blame for Short CMO Tenures? – http://blogs.hbr.org/cs/2013/07/ceos_are_to_blame_for_short_cmo_tenures.html
  • Startup Hiring: Why You Should Date Before Getting Married – http://www.hyperink.com/Startup-Hiring-Why-You-Should-Date-Before-Getting-Married-bD7829E3BD3a20
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