The example illustrates some of the key points to think about with regard to financing a start-up company, building value, and allocating stock ownership. Points of particular note are:
- When you make stock allocations, balance the dilution and the corresponding value you are buying. Make projections for several rounds of funding to estimate what will be needed in the future. Founders are often shortsighted in their initial stock grants to employees and give away too much, too early, without a real valuation of the company. Evaluate each dilution in terms of the future value it will bring.
- Do some soul-searching and ask yourself how much control you need. Can you continue managing and leading your company even if you do not have the majority of voting shares at the board level? Be careful with this issue. A “for profit” business, in most cases, never gives any one person complete control. Even where a business is owned by one person, they are still accountable to customers—there is no absolute control. Ask yourself, can you work with the investors and any new managers who might join the company?
- Complete all stock negotiations and ownership issues among founders at the outset of the company to avoid any disagreements later on.
- Make allowance for future stock options to provide incentives for new and existing employees.
- Focus on increasing the value of the company. Make this the super ordinate goal and have it permeate every employee’s vision of the future of the company. Note that of necessity, this discussion only considers the “wealth” side of the rewards for starting a company. Other factors (fulfillment, vision, passion, an interest in growing companies) may play an important role in decision-making, but their consideration would make this discussion unnecessarily complex.
Business plans usually underestimate the amount of money required to complete product development and get to market. Think carefully about projections. Try to avoid increasing numbers by percentage, but rather think about the constituents of the expenditure or revenue and estimate how much is required. - Be realistic in making market penetration/sales growth projections. Use “S” Curves to help think about market ramp up and exploding growth. This is particularly important when thinking about cash flow, which is the “lifeblood” of a start-up business.
Conclusion
One of the motivators for founders and employees of a high tech startup is to make significant amounts of money from the appreciation of company share price. To reach this goal, founders and management must focus on maximizing the value of the company at all stages of its growth.
Dilution appears at first sight to be a negative effect, but instead should be seen as an investment process in which every time the stock is diluted there is value added to the company. Stock options to new employees should be based on clear expectations that these new team members will increase the value of the company through their contribution. Taking additional investment or granting stock for strategic partnerships should be viewed through the “lens of added value.” To help with the decision making process, simply ask the question, “If it doesn’t add value, why are we doing it?”
This philosophy of adding value can percolate down through all parts of the company to all employees. As owners they can be directly involved in asking questions about how the investment of cash or stock will increase the company value. In their own role in the company they can be asking themselves, “How am I adding value to this company?” which is a far more powerful question than, “Did I do my job today?”
The bottom line is value, and if you are not delivering value, then why are you in business?
