Popular Posts

Thursday, October 04, 2007

Treat your Options like Organs


Treat your Options like Organs

The equity in your startup company, often distributed in the form of stock options, is the most valuable asset you will ever part with. They are like the organs in your body you only start with a limited amount and at first they seem like they are free. But like the organs in your body, you only get one chance to give them away, so you had better be real careful about giving them away. It all starts innocently enough. We have a great idea. We need people to implement and support the idea, and since we don't have a ton of actual cash we start to divvy up this funny money called equity. After all, what does it really cost you to give away 20% of a company that isn't worth anything right now?
It costs a lot more than you think, and determining the real value of those options is critical to your (company's) good health.
Valuing Your Great Idea
When an idea is nothing more than an idea, many would say it has no value at all. Admittedly, a company with no revenue is worth zero. However, when determining what the value of your company will be in the years to come you need to arrive at some sort of baseline.
Consider what your company would need to be worth in the next few years in order for you to make it worth your while to create anything at all. Obviously if the company was only worth $150,000 in three years you probably wouldn't be dividing up equity today among partners to get there. My litmus test is a value of $2 Million. An idea that can generate $2 Million dollars in a few years is one that is worth my time and energy now. We all know that the price of a failure is zero, so we're far better served by focusing on the value of success.
If you're having trouble convincing others that the value is $2 Million, get used to it. The one certainty is that you will spend the rest of your career at this company convincing people that it is worth more than they think it is! It's good practice.
Stick to Dollars and Sense
If a man showed up at your office with a great idea for a company that he was willing to give you 0.125% of, would you leave your day job and work for him for free?
To most of us, an eighth of a percent sounds like an awfully small number.
But if that man is Bill Gates and that company is Microsoft then its $318 Billion market cap makes your 0.125% worth a little over $397 Million.
The percentage that you're offering your employee, your attorney or your accountant will always sound small and for good reason while you can give someone a piece of a company worth millions, you can never give someone more than 100 percent. And that's a pretty puny number by comparison. The company you're planning to build may have a target of $2 Million, and while strictly speaking it may work out that you want to give an employee 10% of that you're far better to present it as a $200,000 value for their contribution.
Talking in dollars also begins to give you an exchange rate for valuing someone's contribution to the company. Someone who would otherwise be paid $50,000 in cash for their services shouldn't be paid $500,000 in equity. You should certainly consider bumping up the amount to compensate for their risk (after all, we are selling future value here) but a $450,000 increase would be quite extreme.
Get Some Traction Before You Open the Floodgates
Before you're considering the dollar value of other people's contributions to the company, you should be busy increasing your own. Even if your idea is terrific, if you approach others too early their perceived contribution is greater and they're likely to demand a bigger piece as a consequence.
Each piece of infrastructure you build from incorporation to securing customer commitments creates more tangible value for your company and therefore makes the contributions of others slightly less valuable to the whole of a company which is good when you are paying for everything in equity.
Sell Your Kidney To The Highest Bidder
Before you surf over to eBay, let me explain that I'm talking about one of the most important reasons to hold on to your equity.
The early stages of your company may appear to be resource intensive, but often times it's the later stages that require even greater resources and therefore massive amounts of investment capital. When this time comes, if you have little equity left a single round of investment dilution can be devastating. Your stock options, like your organs, are only free until your realize how badly you need them to operate and grow. Treat your options like organs and you'll realize how much healthier you and your company will be in the long term! , often distributed in the form of stock options, is the most valuable asset you will ever part with. They are like the organs in your body you only start with a limited amount and at first they seem like they are free. But like the organs in your body, you only get one chance to give them away, so you had better be real careful about giving them away.


From the GoBIG Network



Regards

Gordon

No comments: