Berberian's Blog

How the Pie is Sliced – My Simple View of Startup Economics

Many years ago, I was discussing with my father the appropriate chunk of equity to give some new partners in my first startup – they were negotiating for equal ownership. He offered this observation: Only man distributes things evenly – God doesn't give everyone the same slice of pie, why should you – if you put in all the money, you should have the largest ownership stake.

That makes since – but as I interact with many new entrepreneurs, I still encounter those that think/hope they can hold on to their precious equity. It is a rare situation where a founder owns the largest piece of pie by the time the company is sold (if they use outside financing).

Look at this very simple table:

Entity	Founding	Angel	Series A	Series B	Series C
Founder 1	50%	35%	21.4%	11.9%	5.3%
Founder 2	50%	35%	21.4%	11.9%	5.3%
Option Pool		10%	10%	10%	10%
Angels		20%	12.2%	6.8%	3.0%
Series A Group			35%	19.4%	8.6%
Series B Group				40%	17.8%
Series C Group					50%

 

There are numerous assumptions with this basic model. I assume that with each round more options are placed into the pool to attract employees. The amount of dilution is not set in stone (green box) – but from where I sit, it's about right +/- a few points either direction. If you need to bring in a CEO expect to give up 5% if it is later in the company life – more if it is earlier (up to 10%) – this may come from the option pool if there are enough shares to accommodate the hire (btw COO 2%-3%, CFO 1% -2%). The investors from one group will usually participate in subsequent rounds to maintain their ownership stake. It is common to get some options from round to round as a reward for a job well done – but usually they do not make up for the dilution from the fundraising.

Dilution and amount raised aren't necessarily linked. Money raised is more a function of the opportunity and investor. A huge opportunity requires an investor that can fund the company to success – a smaller opportunity requires a smaller investor. Each investor, however, needs a piece of the pie that makes sense for their fund. It is unlikely a VC with a large fund will put in a little bit of money early on for a small stake – they need to invest proportionate to their fund size and anticipate future rounds of financing.

So how do you protect your equity? Grow as fast as possible with the least amount of money. If you think you'll need lots of cash – resign yourself to dilution – and raise money when you can. The lowest a founder/CEO will be diluted is around 5% - that is no investor will dilute you to 1% (unless they don't like you) – they will grant options to make your ownership stake interesting to keep you engaged in the business. Other positions will likely fall below the CEO. When I was at Raindance, by the time we went public I had about 4.6%. If you can get to profitability very quickly – do so – it will help with future fundraising, maybe even eliminate the need altogether.

So how do some companies raise gobs of cash with less dilution – it's simple they are having huge success. If you are dominant in your field and you are growing like crazy, you'll be able to give up less equity with each round. If, however, you are doing well but your victory isn't certain –then expect dilution. If you are doing just OK – then it gets harder.

Other ways to protect your ownership: grow slow and use profits to fund expansion, use debt if possible (think credit line, home equity or rich uncle), fewer founders means fewer slices of the pie, go further with less and of course there is always the chance to sell early if the right deal is on the table.

I know there are numerous examples of companies that don't have this type of dilution (those are the ones everyone talks about)– but the bottom line if you aren't on fire – dilution will happen – and from there you'll just have to sell for more to make your piece interesting for you.

 

My Creative Walkabout

For the last three months I've been in a hole thinking about new businesses to start. I've set the bar is pretty high – I want this next business to have the potential to become really big (think several hundred Ms or a B). Many of my ideas tap out at certain revenue levels which make the ideas not that exciting. To spur my creative process, on Brad Feld's recommendation, I scheduled a trip to So. Cal. My purpose: meet some cool folks, hear their stories and become inspired. All the companies had one thing in common – the founders saw the beginnings of a trend in the market, realized it wouldn't hit mainstream for a couple of years and started their company so that when it hit they were ready. Below are the companies I visited:

Mir 3 – Amir Moussavian, CEO/Founder: Out of the five companies I visited - Mir 3 is the most mature. They have real revenue and thousands of paying customers. The trend: When stuff goes wrong people need to know quickly. Notifying them is getting harder as people become more mobile and use multiple devices. Companies and organizations (like schools) will most likely outsource that to a service provider. That was Amir's view eight years ago. It took longer than he hoped – but perseverance is paying off.

Memeo – Hong Bui, CEO/Founder: In 2003 Hong realized that with all these digital cameras, mp3 players, and digitization of videos folks are going to need a way to manage large amounts of data. It seemed obvious to him that people were going to need to backup their stuff on something other than their main machine – like an external drive or a second computer. At the time, external drives were not really being purchased by consumers – but it seemed obvious that eventually folks are going to run out of disk and external drive sales to consumer would pick up. So he did a deal with a hard drive company and now Memeo is well on it's way to becoming a great success.

Net Seer – Dork Alahydoyian, VP Product Management: Net Seer is still in stealth mode but the trend they are focusing on is trying to make advertising within search more relevant by identifying related terms to a search query. Say you search for "scuba" they will be able to associate that term with "vacations, snorkeling, swimming apparel, Grand Cayman, nitrogen narcosis, etc…" They believe advertisers will pay more for ads that can be directed to the user in a contextually relevant manner. Accordingly, search companies will need to meet the demand by using tools that give more meaning to the average one or two-word search.

Topspin – Ian Rogers, CEO: Topspin was started in 2007 when two music-technology visionaries saw something happening in the industry that was odd – major record labels, faced with decreasing sales, are dropping their talent and focusing on just the top acts (they are trying to save their way to success – bad sign – always need to focus on top line growth). Many of these bands have nowhere to go and have to manage their careers by themselves. Topspin is building tools to help bands manage their business. The beauty of Topspin, unlike other music startups, their customers are the bands – not the fans. They don't need to "first get a million users" to succeed – each band already has a fan base that needs somewhere to go.

Oblong – Kwindla Hultman Kramer, co-founder: Since they are in stealth mode I'll refer you to Brad's post. Basically the trend they are seeing is one of inevitability. Like a seismologist that claims a major earthquake will happen in CA in the very near future (1 day to 100 years) – these guys believe that it is high time for a major innovation in how humans interact with computers. It's been 20+ years since the mouse came around. This innovation is going to take some serious brainpower and time – but it will happen and these guys are fired up to make that change happen. Visiting Oblong's facilities and seeing the demo simply blows you away – it's just bitchen. But unlike the others their trend is one that will play out over a longer time and will require both computing power to increase and people to embrace the new way of using a computer. It is a huge idea – they are truly a company of the future.

The net: All companies are focusing on a trend they firmly believe will become reality in the future. They all have incredible passion for their business. They all know exactly what they need to do in the next 12 months. They all have surrounded themselves with really smart people. OK I'm inspired, my turn.

Trip Door

Today I had my first meeting with the founders of Trip Door, they are a TechStars company and I am their assigned mentor (not sure how happy they are about that). Their idea is to create a web service that allows frequent flyers to manage their award miles from all carriers, view available award travel seats and book award tickets all online. I think this is a brilliant idea since my wife, Renee, hates to deal with airline call centers (I, however, love talking to people on the phone for hours on end getting nowhere). They have some challenges, as do all startups, like convincing the airlines to open up their databases to such a service but they also have some interesting angles to get them to the promise land.

I'm really looking forward to working with Krista, Austin, Elliot and Nathan on their cool new business. Go get 'em!

What, Why, Can and How – Picking the Next Business Idea

So now that the Zenie Bottle business experience is behind us – the three of us (Steve, Jim and myself) are spending all our time coming up and evaluating new business ideas. Our evaluation process is pretty basic – we just ask the same four questions over and over again.

What is the business?

We try to describe the business as clearly as possible. Often times we draw stick figures on whiteboards articulating the flow of goods or services identifying who is doing what and when. A common answer to this question starts with, "A dude comes to this web site and clicks…" While this may not embody the big idea or vision, it helps us understand what we need to create to get the business going. Often when I meet with folks and listen to their business, I have to stop them and ask, "OK so describe the process – specifically, step by step…" Many times people get stuck at this question. If this is too hard to answer – move on or keep refining the concept. For some ideas it is OK to be a little vague so long as the cloudy area surrounds something that can be defined later like the UI or interconnecting with a 3^rd party. If there are huge chunks to the flow where there isn't clarity or the process seems utterly implausible, we drop the idea and move on.

Why do people care about this business?

Once we get comfortable with the business concept we ask ourselves, "Why does it matter?" Do people really want this widget or service? This is generally, where we spend a meaningful amount of time hunting down people in similar industries and asking their opinion about the idea. We try to test the concept with friendlies or potential customers. If the idea is great but people are unsure of the value – then it's time to move on to another idea. If we get positive feedback on a concept then we do a gut check – people like to tell you what you want to hear – is their feedback simply them stroking our entrepreneurial egos or is the idea genuinely valuable? With Zenie Bottle we had numerous focus groups and they all said great things – but in our gut we always felt like we had a demographic issue – everyone liked the idea for different reasons. All positive feedback – but different – is a bad sign. It shows that the value proposition isn't clear or universal. If we don't get almost universal, consistent feedback – we refine the concept or move on.

Can we actually build this business?

I can dream up some great business ideas – but for most of them, I'm not the guy to run them. Know your limitations in terms of funding, experience, ability to attract talent, geography, etc… For example, some of my ideas require a tremendous amount of capital – while I have raised money in the past – I probably can't raise $1B for some mega buyout. The other part of the "Can" question is around the technical and/or social feasibility. A couple of our ideas are fantastic but only after they have 15 million active daily users. While building huge social network ideas are possible, we feel that success in those businesses is largely due to luck or extreme skill in social networking – two things we most likely don't have. Other ideas may be wonderful but are on the cutting edge of science and/or require very specialized talent. I'm not patient enough to build a business that requires a ton of research. Still other ideas while not particularly technical or require getting the whole world to visit our web site, require large organizations to change their behavior in fundamental ways – like asking retailers to change the checkout process at the point of sale. Ideas like that the "Can" question refers to the likelihood of convincing someone to change – possible but the value proposition has to be huge. The "Can" question really is about looking inside yourself and knowing what you are good at and what you are willing to tackle.

How do we plan to make money?

The fashion today seems that you really don't need to know this answer at the start, especially if you are a web company. I'm too old school to dismiss this as unnecessary at the founding of a company. If you have the idea that brings value to some group of people, you should have a solid sense of how you are going to make money. Now I'm not saying you need a specific rate card established, but you should be able to identify the points of value in your business. This will necessitate that you understand the fundamental economics of the business and broadly identify how much scale you will need to become profitable. I have to know the numbers before we say yes – fully understanding that early financial models are not accurate – they at least help us identify the key operational and economic metrics. "How you make money" also concerns personal economics. Business ideas that require a lot of capital always mean less equity for the founders. So if my goal is to make $X I need to factor in how big a business we need to build so that when we exit my Y% gets me what I want. Some smaller ideas may actually net us founders more money.

We tend to revisit our answers to these questions for every idea several times (and perhaps even after we commit). Some idea that we tossed to the sidelines a week ago may come back to center stage as we get more information. Anyone going through this process knows that coming up with ideas is the easy part – picking the right one takes a little more time.

Push the Button a Million Times

We're searching for the little magic button that delivers a deluge of food pellets to our cage.  We've been pushing a blue button for six weeks and have only gotten a few pellets.  We think there might be a red button – but we haven't found it.  Or perhaps we simply need to push the blue button harder and longer.  Maybe we need to pull the green lever.  So now starts the Zenie Bottle period of rapid experimentation where no idea is too wacky. Here's what is happening in the next seven to 14 days:

• Opening a retail kiosk in the local mall
• Experimenting with different lists and zip codes to seed the market
• Reaching out to all our contacts to make some connections with celebrities
• Opening up the web site so anyone can buy a bottle or create an account
• Launching our facebook application
• Enabling our text messaging features
• Interviewing experts on our demo to perhaps engage as advisors
• Considering the possibility we are resonating with a different demo
• Start production on our web series
• Reaching out to local media to tell our story
• Brainstorming crazy bottle stunts – like leaving bottles all around a town in every Starbucks or shipping 100 bottles to a radio station

At this point, we are still just a concept.  Once we find out what works with the market and the best distribution mechanism – we'll push that button and become a business.  As a matter a fact we'll push it so fast we might drown in food pellets. Like a rat in a cage – just gimme some positive feedback.

Here is a bottle of our team:

View more Zenie Bottles

What the hell is this and who sent this to me?

Actual quote from a Zenie Bottle recipient. How you respond to these types of emails can make the customer love you or hate you. When we reached out to her – she was elated.

1100 bottles were shipped into the wild last week. About 700 have found homes (45%+ have converted to users so far) – the rest are still in transit. Unfortunately, Mother Nature took a bite out of us this past week and delivered a record cold spell across most of the nation. The Zenie's are designed to withstand temperatures of 15 degrees Fahrenheit. Below that, we have issues. Looks like some 200 arrived frozen. Now this isn't all bad. It turns out it's an opportunity to make these young adults really happy. Check this out:

From user Kristen:

I recieved a free bottle through the Zenie promotion along side a few of my friends. They arrived to us broken with all of contents soaking the box! This is simpl unacceptable. I would like to requesst another bottle free of charge. If you deny me of this I will write reviews about your company's terrible customer service and treatmet. I did surveys and feedback for your company so I hope you grant my request

Our reply:

Kristen,

Thank you for contacting Zenie Bottle, with record lows across the country we have had some of our bottles freeze and break. I'm sorry that your bottle was one of those that broke. Our bottles are designed for a freezing level of 15 degrees but not -10 degrees!

If you're in a cold weather location, we will re-send you a bottle as soon the weather warms up. If you're in a warm weather location we'll send you one immediately. In the meantime ….

Do you have a specific bottle color that you like? Checkout...

Jim and the Zenie Bottle team

Her final response after a few exchanges:

Thank You Jim. You are so great! Thank you for your kindness.

No substitute for great service.

Sponge Castle

Last week my daughter had to make a scale model of a castle for her history project. She wanted to be different. She didn't want to use cardboard or balsa wood. She wanted to use an unusual material. She asked her teacher if she could use rice krispies – but he said no. She asked me for ideas. I had to be careful. If I suggested the wrong material – I'd be the one making a scale model of a castle. We decided to go to Home Depot and look around for ideas. I found the perfect material – sponges. This was a brilliant idea. Soft, flexible, easy to cut and shape and no need for parental involvement (she's in 7^th grade so she needs to do stuff on her own). I thought it was genius and I convinced my daughter to take my advice. We bought a bunch of those cheap rectangular shaped cellulose sponges and Marlo went to town. I asked her if she wanted to let them dry out first since they typically shrink after they are wet. We talked about it and she and I assumed that if you never wet them – they'd say fresh looking like they are when you first open the package.

After two days working on her project she was done – good thing since it was due the next day. The final step was painting the castle – which she did. She left to go to rehearsal for the play she is in and came home late at night. She finds me and asks me to look at her castle. Well between the wet paint and the drying in the open air for two days – the castle was all shriveled up and deformed – it even buckled the glued on cardboard platform. I started to laugh – I couldn't stop – the whole thing was just hilarious – come on a sponge castle. It was my mistake but Marlo was taking the heat. She got upset and started to cry – she became very articulate on why her castle sucked and how it would bring disgrace to her and her family. On top of that, the teacher made a comment in class that morning, "Well tomorrow should be very exciting, Marlo is bringing in a SPONGE CASTLE!" Which really isn't as bad as it sounds; Marlo has the highest grade in the class – and he is a great teacher – but she wanted to show everyone she wasn't crazy. I simply couldn't stop laughing – Marlo ran up to mom asking her opinion of the shriveled up castle. Mom said it was fine. By 1:00am Marlo finally calmed down and went to bed.

My laughter subsided and I started to feel bad – really bad. I was exhausted but I knew my fatherly duty – I had to fix the castle while she was asleep – ugggh (just what I was trying to avoid). I started work at 1:00am – by 1:10 I had the glue gun, cardboard, scissors, paintbrushes and the castle. I went to work and started to cut and glue and buttress up the curving sponges. I'd get one wall set and then the pressure of the curving sponges would force another to pop out. By 1:45am – I made little progress. I started to laugh again. What was I thinking – it was a sponge castle. I finally gave up.

In business, sometimes you just have a sponge castle – no matter how hard you try to make thing go your way – it's still a sponge.

Here are some pics of the final sponge:

P.S. She got an A – I'm sure for originality – but when she brought it home it went straight in the trash – at least she is laughing with me now.

Zenie Bottle Story

One of the unseen elements of the Zenie Bottle experience is the bottles have a story.  This part of the business is a total blast to work on (well really the entire business is a blast).  In about 2 months the story will be unleashed in full force - but here is an early teaser... Enjoy! Oh yeah - buy a bottle, you'll be glad you did - click here to get an invite code:)

Zenie Bottle is Live

On February 27^th, 2007 we founded Zenie Bottle. Today we are shipping out 1,100 bottles to our seed group – teens between the ages 13 to 18 (plus a handful of friends and family). The initial strategy (cuz every startup has an initial idea then changes when they get some market feedback) is to make the site very exclusive (the only way to get an account is to buy a bottle – the only way to buy a bottle is to know someone who has one and they chose to invite you). We'll see if this works – with a group of pre-launch folks we got some feedback that this might be too exclusive. We'll find out soon enough. In the meantime checkout the site – and if you want a bottle – and you know you do – ask me for an invite or click the big green button on the site.

Wind the Frog, Apollo 13, and Jenga

Well we're finally going live with the Zenie Bottle web site (early version – many things still being worked on).  Whenever we had a major launch of software at Raindance Todd Vernon used to say it's time to "Wind the frog."  Which really refers to the scene in Toy Story where Woody yells, "Wind the frog!" to set off an elaborate chain of events to rescue his friend Buzz Lightyear from the evil kid next-door.  Going live with a web site (especially a complicated one) is really an Apollo 13 experience – a delicate set procedures – never before accomplished in real life – that hopefully doesn't blow up as we execute each step in the sequence.  Once executed you feel as if the whole thing is a Jenga tower – a beautiful yet delicate sculpture that can collapse at any time if the wrong piece is moved.  I love moments like this.