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Deal Terms: Liquidation Preferences, Founder Options

February 3, 2010 by charliecrystle

Liquidation preferences have always seemed to be a case of having your cake and eating it too for investors. I’m guessing the original intent was strictly for downside protection. But it’s become a way for investors to guarantee a certain upside–risk mitigation at the expense of common.

Put another way, it’s terms like these that value capital over people. A common example I give when explaining it to incredulous entrepreneurs is this (let me know if I have it right): say you raise $1 million at a $4 million pre, giving a total of $5 million., so 20% to the VC.

Then you exit for $10 million–double, right? So what’s the VC take?

28%.

First million out the door, leaving $9 million, then pro-rata distribution, so 20% of $9 million = $1.8 million, so $2.8 million total, or 28% of the exit. Return of capital is important–I think as an entrepreneur I am obligated to return capital, so I don’t mind the downside preferences—a 1x cap makes sense to me.

Of course a $20 million exit makes the impact of the preference a lot less, but it still values that capital more than the people, which, ironically, are what VCs typically say they value most in a deal.

On options for founders: I have mixed feelings about this and have been on both sides of the argument. As a founder you create the idea, company, revenue, model, value, etc. And you have stock for that.

And then you play a ton of roles getting the company to greater value, for which everyone is compensated through salary and options, except you, where you end up donating your labor for the benefit of everyone else. As you add more people, you get more and more diluted.

And I say suck it up early on.

You get a lot of special treatment as a founder, so don’t nitpick about a couple points of employee options. Not early, anyway. Later on, though, you get past the love stage.

If you’re CEO, you now have tons of liability and new, real responsibilities and obligations that go far beyond the creation and founding of a company. And I think you should get market-average options, and market-average salary if there’s enough revenue and investment, and if you take less than market salary your options should increase with a 20% kicker or so to address their illiquidity.

My biggest regret in the 4 companies I’ve started, funded, and run has nothing to do with ownership, though. It’s that I put in 80 to 100 hour weeks, thinking that I had to do that to make it work, and nearly killed myself doing it. It’s amazing how much time some of us spend obsessing about opportunity while neglecting ourselves.

Options? Screw the options. You’ll get much more out of a life coach, and none of the resentment from employees and investors because you’re dickering over a few points in options on top of your massive stake.

Posted in Fundraising, Startups, Venture Capital, founders | 3 Comments »

The Importance of Call Volume for Execs

February 2, 2010 by charliecrystle

First, let me say I always appreciate the courtesy of a phone call, even when it’s disappointing news. I think people deserve the call back. When I don’t want to buy something from someone who calls repeatedly, I call back or email back to let them know they should move on. Courtesy is easy and always good for business. I don’t always get that same courtesy, and I notice. Moving along…

At two of my companies we had sales teams in smile and dial mode. Leads were plentiful from word of mouth, buzz, and partners, so the calls were always to largely qualified leads.

This week (already) I was reminded of how important call volume is for anyone in “sales” mode. Whether you’re a startup exec, a salesperson, or advocate, your success isn’t going to just show up one day–you have to work for it. That means you have to make a certain number of contacts to get results. Same for fundraising for startups–you only need 1 of the 100 VC you’ll talk with to fund you. Hopefully it’s someone in the first 20, saving you the hassle of presenting over and over, but eat your spinach, it’s good for you. (Don’t raise money if you can at all avoid it).

Let’s say you have 400 leads with phone numbers and you need appointments with each person. That’s a lot of phone calls–intimidating. Start calling! Try this for a week: make 10 calls an hour, giving yourself 2 5-minute breaks. After 8 hours, you will have made 80 calls. Only 320 more calls to go–still sounds daunting. But it’s really only 4 more days.

Of course you won’t connect with all of those the first time, so you’ll need to call back, and that takes time. Let’s be generous and say you only have to make 3 calls on average to reach the person. So your 5 days of calling has now extended to 15 days or 3 business weeks, and you’ve made 1500 calls. That’s not easy–it’s work to make that many calls and have crisp enough conversations to land the meeting.

Last night I drove 1.5 hours to and from Harrisburg for a meetup to show some new software, and didn’t take my cell phone. That’s another way of saying my time wasn’t effectively applied–I could have been making calls (to the chagrin of the legislature, which is considering a ban on calls while driving).

For me, I need to get on the phone for about 6 hours each day, every other day, for the next 8 weeks (to March). It’s hard work, but I’m working on building a consulting practice to advice startups, which means I need to get out there. If I had made enough calls prior to today, I would have had several meetings scheduled in Harrisburg instead of just one.

My point is that if you don’t make the calls, you don’t get the results you need. A scenario for you nonprofit and business folks:

80 calls a day
20 connects
1 sale/donation for every 10 connects
= 10% close rate of connects (maybe higher/lower depending on how good the leads are)
= 2 closes per 20 connects
= 2.5% close rate of all calls
= 42 closes per month, based on 21 business days monthly

Your close rate will vary widely depending on what you’re selling. But if you’re selling appointments to learn about a new bill, you’ll get about 80% of your goal. If it’s a $5,000 item for which you get 5% commission, 2.5% of your call volume is about right and you’ll end up with 42 * $250, or $10,500. Not bad at all. TIP: Measure everything. Rate each call. Analyze everything. You’ll improve dramatically over time.

Now you just have to find a $5,000 something and enough qualified leads ;) Get crackin…

Posted in Startup Management | 1 Comment »

100% of Nothing

February 1, 2010 by charliecrystle

One of my investors argued with me that I’d end up with 100% of nothing if I passed on a deal. And I know the argument well.

In that case, it was a bad deal, but it was the only deal, and was something we likely should have done. I didn’t block it but did ask so many questions they tabled the deal. Bad deals are like that–they don’t do the job of convincing everyone it should get done, and then they languish.
With deals, there’s negative dilution and positive dilution. Negative dilution is when you give up a percentage of ownership and get nothing (or worse) for it. Positive dilution is when you give up a percentage and get more than what you gave for it. Employee options, new capital, partnerships, new equipment–every investment is about positive or negative dilution.

When something costs you nothing but brings the possibility of revenue, new markets, brand awareness, and opportunities, you’re nuts to say no. When it costs you nothing, you say yes. But many, many entrepreneurs say no for one reason or another–scarcity mentality, control issues, fear.
And many amazing technologies go unknown and unused, without benefit to the world or to their inventors. I’ve heard about this, read about it, experienced it with Mission Research, and just recently witnessed something in freefall that has no reason to fail and every reason to succeed. Owning 100% of nothing gets you nowhere. Sometimes you need to give to get–a cliche, but meaningful.
But great ideas need at least mediocre execution to thrive. My dad gave all of his kids a framed piece with a quote from Calvin Coolidge–perhaps his only great contribution to the world:

Nothing in the world can take the place of Persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan ‘Press On’ has solved and always will solve the problems of the human race.

Tenacity, persistence–yes. But openness and trust make a huge difference too. The 100% of Nothing argument is a good one, but don’t ever let someone influence your choices using the fear of losing everything.

You can lose everything and bounce back–that’s why entrepreneurs are so admired. We lose everything, we fight back, we win against the odds, and then some of us lose it again, just to rediscover that tenacity and fight back to win another day. So don’t give up, and don’t give in to the fears.

Posted in Startup Management | Leave a Comment »

Beta Update

February 1, 2010 by charliecrystle

Sometimes things just aren’t going well, yet things are going really well. I haven’t worked in over a year, and have been kicking about trying new things out, figuring things out, and finally committing to an idea I’ve had for a long time.
In between I’ve consulted to a number of companies–mostly startups. A few actually paid me; the rest I was happy to help for nothing because I was, well, figuring it out. Lacking confidence. Despite all of the experience I’ve accumulated over the years, confidence in that experience is sometimes weak, sometimes strong. So back to software.
But getting the software out has been tough. Every time I want to refine the software, I have to learn some new programming technique. What seems like a simple fix, ends up taking 5 hours to learn that the syntax is a bit different from earlier syntax.
Every week I’ve had major breakthroughs and spurts of great progress. But in between there’s been a lot of hard work and research that doesn’t end up in the software. Mostly.
Finally, I end up questioning whether it’s a good set of features or a real business. Or both. Today I ran some models again, and I think it can be a business. Yesterday, not so much.
In a day, a week, maybe two weeks, I’ll release a beta. Which really means alpha–good enough for people to use, but not ready for primetime.
Such is the struggle of the startup. Some startups know exactly the market, the problem, the solution. I know the problem–attention, focus, noise, distraction. I’m building the solution, I think. And maybe people will care. Enough people.
Tonight, I took a break. Tomorrow, I press on. It’s time to make it happen.

Posted in Startup Management | Leave a Comment »

Sign Up for the Focus Beta

January 26, 2010 by charliecrystle

The new software is coming along slowly. Ironically, it’s to help people focus while using the computer, and I’ve had trouble focusing throughout the development progress.

While the software isn’t just for those with ADD/ADHD, it’s been helpful for me ever since I finished a few features that help block out distractions. A few years ago I was formally diagnosed with ADD; if you know me this likely won’t surprise you.

To sign up to try the software, please click here. Your feedback can significantly influence the design and functionality, and will be helpful to anyone who adopts the software.

Posted in General | Leave a Comment »

Private Beta

January 13, 2010 by charliecrystle

I’ve been working on something for about 6 months. The results are decent, but it’s not where I want it to be yet. It’s time for feedback!

The software is designed to help me focus. The funny thing is, it’s taken so long to get it finished because I’m having trouble focusing. With the software near completion, it’s definitely been helpful for managing my time better. Maybe it can help you too. And maybe you can give me some direction and feedback.

Please sign up for the private beta. I’ll send an email in a week with instructions for participation.

OTHER SOFTWARE LIKE THIS
There’s a lot of software for managing tasks and time. There’s even software very much like what I’m building, but it’s more big-brother software than personal productivity software.

The reason I decided to build this is that none of the software really worked well for me. As a guy who struggles with ADD, I found the other software too distracting or too cumbersome. This isn’t perfect yet, but it’s decent, and it will get a lot better in the coming months.

Thanks for helping out.

Posted in General | Leave a Comment »

Startup Equity Allocation

January 11, 2010 by charliecrystle

I might be building a new team for the new company. While I’m a little reluctant to do so because it’s always a risk, I do miss having people I can count on and who are pulling for the work we’re doing. Teams can be great (and they can break down, as well–a subject for another post).

So a question I get from entrepreneurs is how to allocate stock. There are a lot of other posts about this, so I’m not going to do into great detail here (just Google “startup equity employees” and “Feld startup equity”). But here are a few thoughts.

  • Don’t be greedy.
  • There’s negative dilution and positive dilution. Positive dilution is when you give stock or options and are diluted as a result, but the person creates more value than the cost of the dilution. Negative dilution is when the contributor doesn’t increase the overall value of the company, or worse, hurts it.
  • Create a formula for “deferred” pay. There’s really no such thing as deferred pay. There’s pay not taken, and if it gets made up in the future, it is through bonuses, salary increase, or equity. If an employee takes less money for the same work, I value that more highly than the cash value and will give that employee more for their deferred salary in equity than the dollar value. Early on, 50% discount on equity makes sense.
  • Don’t value your own company. You have no idea how much your company is worth. It’s not a million. It’s definitely not $5 million. You don’t know until someone pays money for stock.
  • So if you don’t know, then don’t allocate shares according to number of shares, allocate based on percentage of ownership.
  • For the first 10 employees, don’t allocate less than 1% per employee, and give key employees more. If you have 3 key employees (not including founders), give them 4% each with typical 4-year vesting. That’s 12%. Of what? You have no idea, nor do they, but you’ve given them great incentive to kick ass. Let’s say the other 7 get 1%–so that’s 19%, and we’ll round up to 20% just for ease. That leaves founders with 80%.
  • Plan on dilution. You’ll get diluted by new employees, but at a slower rate than the first 10. Expect at least 20% dilution in your first round of funding, plus any friends and family money.
  • Don’t sweat the dilution. What matters are two numbers: your exit number, and your percentage of the exit. You’d rather have 10% of $50 million than 50% of $10 million, assuming it takes the same time and effort to get to both exits. But if you can get to $5 million twice as fast, take that route, because your time on Earth matters.
  • Don’t hire VPs or CEOs until you have a model that’s really working–meaning you have customers, revenue, and can sustain yourselves. Too many startups get top-heavy too soon, just to satisfy investors need for feeling safe and confident. Screw that–you know more than anyone what you’re doing (and if you don’t, you’ll find out).
  • Pay consultants equity instead of cash if you can, and give them the same deal you would give friends and family investors. If friends and family get a 30% discount on the Series A round for investing before that round closes, apply the same discount to the consultants deferred pay.
  • Cash is king. So don’t spend a lot on marketing, on lawyers, on deals, on mergers, on anything other than 1) serving customers and 2) serving customers.
  • Your equity is worthless without customers. Start every day asking how you can reach and serve customers that day, and if it’s too early to charge them, set a goal of getting 10, 20, 50 customers who will use your stuff for free. Their feedback and insight will solve a lot of problems for you and can create significant value down the road.

I have to get back to coding. Last year I started a book, and I’ll include a lot more about equity in that and make it available here. Regardless, the overall message here is to have an abundance mentality, and positively incent your employees to find and serve customers extremely well.

Posted in General | Leave a Comment »

Featured in Inc as “Saving the World”

December 13, 2009 by charliecrystle

Really nice–and unexpected–mention in this Inc Magazine article. They point out the 20% donation by Mission Research founders; I gave 30%, the others gave 10%, for a combined 20%; all of us gave  much more than usual.

We did this by donating stock to a donor-advised fund in a foundation. At some point the donation will be liquid, and at that point I expect we will start making grants. But that liquidity is currently unforeseen.

The rationale behind giving early is this: 30% of what? You have no idea. It’s a lot easier to give a significant percentage early on when there’s no known future value. It also makes you focus on making the 70% you have left get to your personal wealth target. Your investors will like that, because it means you’re driven to push the outcome higher, which benefits everyone.

But the one thing I would change is this: don’t execute the donation until later so you can get the benefit of a bigger tax writeoff.  Instead, place the stock in escrow with an agreement to make the donation at a later date or event.

Posted in Startups | 1 Comment »

Founders, turn off your phones. It’s Thanksgiving.

November 27, 2009 by charliecrystle

I’ve  taken advantage of my self-important missions to save the world through software in some negative ways. I ‘m guessing most founders do it; it’s easy to be so intent on trying to serve your vision you end up overworking, working ineffectively, abusing relationships, taking advantage of the benefit of the doubt–all justified by your heroic sacrificial quest to save the world, or the tweets, or the whatever.

Stop. Just stop.

I just got off the phone with a fellow founder who is in the thick of it. He’s out of money, he’s got customers he can’t serve very well just yet, and he’s trying to make things happen while in DisneyWorld.

DisneyWorld. He’s on vacation with his family, and he’s calling me to talk through merging with another company that also has no money, but might bring a good rolodex. Amazing.

I made him promise me that he will promise his wife that he’ll only be on business for an hour a day while on vacation. He said he had to answer customer questions, so we made it customer questions plus an hour. I have no faith in that promise–I’m betting  he’ll break it right away.

Why?

We’re afflicted, some of us founders. We jump into things to fast, we want things to work so we work longer and harder in the hope that more will be better than not, yet we have no evidence that overworking gets us there faster or more intact. In fact, we’re less intact as a result.

It strains our relationships, it strains our bodies and minds. It’s not healthy, and it’s not productive.

So why do we do this?

I don’t have a specific answer yet, and I’m certain there’s variation among founders. Some founders are very disciplined, very methodical. They leave their work at work. They organize their lives better. I admire that, but I don’t understand it.

Me, I have trouble opening mail. I once had a friend help me pay my bills for a while because I kept getting behind despite the fact I had the money. I just put things off, ignored the small stuff. Then the small stuff becomes big stuff, or damaging stuff, or painful stuff.

So I think personality type has a lot to do with it. I can be very disciplined, but I have to work at it. Last week was terribly unproductive for me. So Friday I packed up my work and headed to the family cabin for 4 days to focus; my wife understood and probably appreciated her own break with me gone ;)

After setting up I had nothing but me, the trees, and the lake to distract me. But it took me two days of restless work until I got into a pattern of undistracted, focused, disciplined work.

The results were great. And that felt great. And it had nothing to do with my surroundings–the first two days were no different from my work at home.

The difference was that I looked at the clock, and set a goal to work for the next hour without checking email, without browsing the web, without doing anything but what I wanted to get done. A lot of people don’t have this problem, but I do.

So how does this relate to founders working crazy hours?

Every minute you aren’t focused on your work, it’s another minute you have to work later. That later is the evening, or early morning, or the weekend. You get that nagging feeling like you’re behind, and you tell your spouse or family or friends that you have to work the weekend. Then you go in for 8 or more hours on Sunday and maybe get 4 of work done.

We put things off. We do other stuff. We rationalize. We research more than we need to. We form and express opinions to our sector, thinking we should be viewed as thought leaders. But we put off the important work. It gets done, but there’s a lot of wasted time that comes with it.

And I don’t think this is about laziness, or drift, or lack of ambition or intelligence. For me, I think it’s about two things: the need to feel connected, and the drive to discover and learn new things. The first puts me in email and on Facebook. The second puts me to wikipedia, news sites, and the Kindle.

So. Here we are. It’s 11:20 on Thanksgiving, and I’m up writing about this. I had a single, brief conversation with a friend who called today. I didn’t code at all. I didn’t surf the web other than to get a mashed potatoes recipe. I helped clean the house, made the mashed potatoes (from scratch, of course), and spent time with the family.

I didn’t get an email from my startup client, or a call. That was good. But I bet both of us are thinking about what we need to get done, and when we can focus just on the work, at which time I’m hoping it only takes a few minutes to find that great focus that comes with discipline of mind, instead of two days. Because I really enjoy time with my wife, friends, and family.

Tomorrow, I plan to focus. I’ll start by turning off my web access, and allowing myself 15 minutes at lunchtime to browse. Then back to coding.

Posted in founders | Leave a Comment »

Startup Ecosystems

November 11, 2009 by charliecrystle

Fred Wilson posted about this yesterday here.

The Lancaster/Central Penn area has suffered from the pull of the Silicon Valley and other tech centers, as entrepreneurs move their startups there and top developers get sucked into those ecosystems with the lure of good jobs at Google, Apple, and other large companies.

CoTweet moved “to be near Twitter”. I moved ChiliSoft in 1997 to be near Microsoft. We deliberately located Mission Research in our hometown, but it’s possible that might have slowed us down–it’s definitely tougher to build tech companies here.

To really create a thriving startup scene and ecosystem in Lancaster, we need outside investment of about $100 million, split into two funds. With Fund 1, expect to lose everything, but fund a lot of startups. Maybe some will make it to a modest exit, maybe they would all fail.

But failure isn’t a bad thing. Failure creates experience just as much as success does, and in a lot of cases it strengthens teams.

Fund 2 would be dedicated to investing in experienced teams that came through the first funding. Assuming 3 years of Fund 1 backing, and an average of $80k per employee (loaded), you can fund about 200 startup employees with $50 million. Revenue from those companies would fund more.

Fund 2 would likely produce enough return over the next 7 years to return the full $100 million. And in the meantime, you’ve created a tech industry where a very small one existed before. You’ve created the ecosystem of lawyers, accountants, coaches, advisors, seasoned tech entrepreneurs, engineers, developers, and marketers.

From there, Fund 3 can come from outside the area, in the form of investment from the VC industry just up the road in Philly or New York.

So the question is, what are we waiting for? Or maybe it’s this: anyone have $100 million to spare?

Posted in Startups | Leave a Comment »

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