My blog byline is: “Thoughts, ramblings, and tips from a tech nomad”. I started the blog last year (2015) and posted five or six articles since. Upon review, I’m overdue to make good on the “thoughts” part and, that, I’m certain, will spill over into the “ramblings”, too.
In Which I Catch Up with an Old Friend
So, recently, I met with an old friend, Andrew, for drinks. He was due to leave Ukraine in a couple of weeks to move to Vietnam. We’ve been friends for almost a decade now, fellow veteran expats of wild, wonderful Kiev. Now he’s already in Ho Chi Minh City, establishing a new office for his own startup, a real estate trading platform.
It was a Friday night and we were sitting in a popular, stylish bar, immersed in the type of buzz and bustle you only get in popular, stylish bars on a Friday night. The problems of Ukraine seemed far away from this place with the beautiful girls in stilettos, the fantastic hookahs lit up like lava lamps, the cocktails and champagne, the ambient lounge music. In a strange sort of way it just seemed to bring my own problems nearer.
A Tale of Two Startups
We were comparing notes. Contrasting, actually. Andrew’s business is making rapid progress; he clearly has a vision to disrupt one of the oldest, stuffiest industries in the world, and he’s planning and executing with discipline. My business on the other hand is still painfully tripping over basic hurdles four years after inception, despite it theoretically being positioned to ride on the wave of a dynamic, huge, still growing industry (mobile app discovery and app marketing).
That’s not to say we haven’t made progress, or that I haven’t learned a lot. We have, and I have. Even already having been an early employee in at least three previous tech startups—and put seven years into the last one to see it grow into a $100M company—my present startup, which has kept me perpetually alternating between being broke and stressed, has taught me a great deal more. For anyone who cares to listen, I certainly have a lot to share.
It’s nonetheless with chagrin that I recount the following conversation because apparently I am ready to forget important lessons as quickly as I learn them.
Andrew was already familiar with a lot of my challenges. He also knew about a second idea I was interested in breaking out on my own to work on. “How is that going? Are you still going to do anything with it?” he asked me.
“I’ve been discussing it,” I said. “I’ve got an offer for enough funding for six months of development for a 50% stake.”
“Fifty per cent before you’ve even started? That’s not right! Why would you agree to that?”
“I’m not saying I think it’s good. I guess it’s how we’re used to thinking.”
“Your split of your current business right now is calculated on salary sacrifice and not on contribution, yes? When we talked about that before, you admitted it was set up wrong.”
“We sort of just fell into that business so there’s a reason it is the way it is but, yes, if we were going to set it up properly, we would have done it differently.”
“Okay, but you’ve got time to plan this one. You do realize this new proposal is even worse, right?”
Of course he was right. And it was frighteningly like an idiot doomed to repeat his mistakes that I didn’t realize this enough to see the problem with the proposal the instant it was proposed.
“Yes, okay, it’s bad,” I said, “but how would you do it?”
How (Not) to Slice Your Pie
Slicing Pie. Andrew’s business is structured completely differently from mine. Equity is often likened to a pie. Founders, investors, and key personnel get slices of this pie. The proportions can change over time. The size of the pie can and does change. The size is a theoretical value for your business and your goal is to increase that theoretical value—that’s the point of a business, after all. However, the catch is that how and when you slice, and balance the slicing against the preparation and the baking, deeply affect how that pie grows or shrinks. It’s a magic pie with the potential to grow to colossal size but do it wrong and it shrinks irredeemably, flaws and all.
Andrew placed his whisky sour on its coaster. “It’s simple,” he said. “Let’s say your investor puts in $100,000. Multiply that number three or four times to recognize the risk he’s taking with his cash. The result is the value he is contributing. If it’s 4x, that means the value he’s put in is $400,000.”
“Yes, we used 4x,” I said.
“Okay, so then you build the company to a valuation of, for example, $2 million: that means you have added $1,600,000 of value to that business. The investor’s contribution of $400,000 means his split is 400K out of 2 million, or 20%. Say, instead, you only get a valuation of $1 million, then his split is 40%. What you don’t do is immediately split the business before you’ve even started. That’s just a rookie mistake.”
“Okay, that makes sense,” I said. I turned it over in my mind a bit. “Well, like you just said: in the current business, my split is based on how much I’m sacrificing of my old salary from five years ago. At least from that point of view it is sort of dynamic,” I said.
“Yes, I know, but you multiplied the cash investment contribution while not accounting for your contribution, only your time,” Andrew said. “In this case, you are better off getting a job with a good salary. Cash is important but it’s just cash. The business is not a business with just cash. It’s your ability to make and grow a business that gives the business its value. The value each individual brings is how you calculate the splits.”
There’s an excellent book with exactly this name, Slicing Pie (available on Amazon). I read it a while ago and, to me, it offered an effective yet simple recipe for equitably incentivizing and rewarding all the people and resources that must come together before your startup can succeed. It says essentially the same as Andrew had just put in a nutshell. And, yet, in spite of that book, I was considering a structure that ran exactly counter to what I had just claimed to have learned and embraced. That is scary.
Get Everyone on the Same Page!
So here is the next catch, and it’s just as critical as the first I mentioned: if your investors or co-founders do not subscribe to the same approach for structuring a business and apportioning equity, then your business is set up to be an expensive exercise in frustration. In my case, the investor’s primary concern is with how much out of pocket he is. Now let’s be clear: that is fair. That first seed or friend and family investor is putting up precious cash against something that doesn’t really exist yet. That takes a certain leap of faith and trust. So, the multiplier is intended exactly for that purpose: to reward the up-front cash. Nevertheless, if the investor finds it difficult to see past the cash, I believe that in his or her mind their outlay is not balanced out by the sacrifice and contribution of founders like me because said contribution is not cash and cannot be seen or touched, or taken to the store to buy a house or a car or even a carton of milk.
In situations characterized by such disparity in thinking, I would urge you to vigorously adjudge the wisdom of getting into business together at all. Or ask your potential partners to read Slicing Pie. It’s just over 200 very readable pages and practical from the first to last. You need this common mindset, even among the most well-intentioned parties, which by the way I don’t hesitate to declare ourselves to be. Without it, if you have a great idea and an ability to execute, you can maybe still make some money—maybe. On the other hand, I think you avoidably introduce a real risk of failure. If you have the idea and the ability, why would you not want to set yourself up with the best chance to succeed? This is not selfishness in deal-making. Ultimately, your investors and partners also stand to lose in a badly structured venture. In looking out for your own interests, you also save them from probable financial loss and heartache. However, don’t just take my word for it. Go ahead and read some of the 240 reader comments on Amazon for Slicing Pie and see if you don’t get a clear idea of what I’m talking about.
While I’m at it, I should mention another important book, and probably the best-known book on this topic: The Founder’s Dilemmas, also available on Amazon. The Founder’s Dilemmas draws on a decade of research to offer advice on how to avoid these common startup pitfalls.
I tipped up my glass. Some round lumps of half-melted ice clinked onto my teeth. Andrew raised his hand and looked over at the waiter. He spotted and headed toward us.
“Hookah as well?” Andrew asked me. I nodded. Andrew said a few words to the waiter and then turned back toward me. “Well, bud! I hope you’re clear on what you want your outcomes to be.”
Knowing what I want is not something I’ve been struggling with. “Sure, the first thing is to stabilize our business. That’s my whole focus.”
Andrew leaned forward. “Just don’t forget that time is slipping. It’s good to know what you want but don’t be afraid to give the universe a bit of a push, too!”
“Yes, thank you,” I said, and I meant it.
I understood him. I would have given the same advice to anyone else on my side of the table. Sometimes, however, being reminded of the obvious is valuable. This goes double for startup founders who can get so mired in the daily tumult and noise of their businesses that they actually lose focus, or misdirect it.
If you are a first-time, tech startup founder, I recommend learning and reading widely and constantly. Getting things set up right is like placing a blessing upon the business; getting them set up wrong, a curse. If you think you can just wing it, then the best of luck to you! Or as Meilir Page-Jones said: “May a thousand angry scorpions infest your cubicle.” 1
“Oh, and by the way,” Andrew added, “Never split exactly 50/50.”
Feature photo: After celebrating New Year’s Eve in Las Vegas in 2009, Andrew and I drove to Los Angeles. This was the sun rising over the mountains as we were travelling through Red Rock State Park, Arizona.
1. Practical Guide to Structured Systems Design (2nd Edition) by Meilir Page-Jones, 1998. This was a remark he made to programmers who choose to ignore proven structured design heuristics.↩