Much has been written about the mechanics to grow a successful company. But one thing that has been noticeably absent is the interpersonal dynamic around aligning expectations.
We all live life seeking something. Rarely do we agree on the quality or quantity. When a potential hire says he or she wants to have fun at their job or work at a fun place, I want to hear examples, so that I can see if we are aligned.
Some of the trickiest expectations have to do with financial expectations. Salaries and bonuses are one thing — they can be described and managed against results; hopefully, these results are tangible and quantitative so that expectations are set properly and goals can be actually achieved!
But stock related expectations are very challenging because not only are you forecasting a sense of value into the future, but you also have multiple parties engaged in what could be a zero-sum game if the interaction gets ugly.
The percentage of ownership in a startup is one of those huge questions. It reflects on the time/money challenge of running a business; it is dependent on the value that outsiders place on the company and it depends on how much money is required to hit the next set of milestones on the road to profitability, successful sale to a strategic or IPO.
The problem is not solely about absolute percentages (oxymoron?) but about expectations on final outcomes. We all know that 100% of 0 is less than 5% of $100 million. But there is a huge gap of time (usually) between that 100% of 0 and the 5% made liquid.
How should founders expect to reap rewards for their ideas? The cases are also wildly different where there is already significant traction before outside money is received. But when an idea is being funded, the obvious metrics don’t apply.
If the value contributed is just an idea, there is not much that a founder can hold onto. In this latter situation, the founder can shop his idea in search of the highest valuation, but the market, not him, will determine his ownership stake.
Convertible Debt
One approach is to hold off on pricing a deal by using convertible debt for the angel financing. For this to work, the amount of money must be small — $500-750K — and the timeframe short — 6-12 months in order to deliver a functioning beta that select customers can use. The debt is then converted at the A round price. The better you produce in this seed stage, the better the valuation, etc.
Do the Math
I am always surprised that founders often do not do the math on their equity stake. You can figure out the amount of dilution that you will take on the next round by trying various scenarios. Pre-money valuation and the money being invested are the key metrics that will determine how much dilution (% wise) you will take and what your stake is worth.
Regardless of the approach — debt or equity — make sure you try to get alignment in your expectations early with investors and expect turndowns. Investors do not want to have a ‘battle’ on their hands with founders at the inception of the company.
You always have the option of saying no. Investors admire founders who stick to their convictions.