Tag Archives: startup companies

TOO MANY FOUNDERS

Seth Temko

A new company is always short on cash and long on tasks. Right from the start an excited pot of people gather together and someone puts a stake in the ground “We’re doing this”. From that point forward a business entity is formed and shares are issued. From this, founders are born.

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I’ve come across a number of startups with 3, 4, 5 and even 7 founders involved in various startups over the past year. It’s always debatable about the right number of founders but there definitely can be too many. Too many founders significantly affects the success of the company, the happiness of the founders and the financial results the founders may achieve personally.

​How so? Read on!

Many founders focus on their percentage ownership in the startup. They tend not to talk about shares but percentage ownership. I own 100%, I own 50%, etc. Usually the more founders the less percentage of ownership each founder will have right at the start. This may seem obvious but think about this in the context of dilution over time.

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Personal Dilution

Dilution Over Time – Assuming you’ll be seeking financial backing and assuming you’ll be giving up equity for money, your share of the company will be reduced with every investment of cash. This effect is cumulative in your reduction of company total ownership unless you intend to maintain personal anti-dilution rights. This means you get to put in your own money along side new investors to maintain your percentage of ownership. Most founders aren’t in a personal financial position to do this. Most founders are “tapped” financially by getting the company off the ground and working for little or no money in the beginning. Even if you can afford to put in money it means your co-founders will get even more diluted and chances are they will not be happy with you.

The percentage you start with is not going to be the percentage you end with. Let’s look at some scenarios so we can get a definitive feel for this.

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Dilution Examples

Let’s say you start a company on your own. You own 100% of the shares.

Investment 1- Let’s say $1 million will be invested for 30% of your company. You will not be handing over 30% of your shares, instead the company will issue 30% additional shares and they will be assigned to the new investor. So your absolute number of share remains the same but you now own 70% of the total shares after the investment.

Result – You own 70% of shares. Investment 1 owns 30% of shares.

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Investment 2 – Now that you’ve successfully grown your business with the first investment you now raise a second round of investment. You get $2 million and give up 20% of the company for the money. This is real progress from your first investment. You’ve double your money raise and give up 33% fewer shares for the investment.

Result A – You own 56% of shares. Investment 1 owns 24% of shares. Investment 2 owns 20% of shares. If you’re scratching your head wondering why investment one is lower it’s because we’re assuming they don’t have anti-dilution rights. This means they lose the same percentage of share you do. They didn’t put any new money in with the second round of investment so they diluted like you at 20%. The net effect is it saved you a percentage of the company. Also, you retain voting control. At 56% of the company you still have the majority of voting stock. This means you control the company.

Result B – Now let’s look at the second investment assuming the first investment has anti-dilution rights. This means they get to put in money alongside with the second investor and maintain their percentage of the company. THIS IS VERY COMMON. Most sophisticated investors will force you to accept anti-dilution rights as a term of their investment

You own 44% of shares. Investment 1 owns 30% of shares. Investment 2 owns 20% of shares. Guess what? You just lost voting control of your company.

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So what happened here? Well, in this case investment #1 said “hey I want to maintain my 30% ownership” so they put in additional investment along with investment 2. So you didn’t bring in $2 million, you brought $2.6 million. The extra $600,000 was invested by investment 1 to not get diluted in the round. So you, the founder, took the additional dilution.

If you wanted to maintain voting control then you’d needed to have taken in less money from investment 2, say $1.5 million, and restrict them to getting 16% or less of the company’s total shares. Then the match from investment 1 would have kept you keeping over 50% of the stock. BUT, some investors won’t accept less than the percentage they want. It’s just not a “meaningful enough” ownership stake. If investment 2 insists on 20% you have a tough choice. Maybe you can convince investment 1 to not maintain anti-dilution rights but it’s highly unlikely.

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Now Bring On the Extra Founders

We saw in the simple example above the dilution of a single owner. Let’s now assume there are five founders and each has 20% equal ownership of the stock to start with.

We’re going to stay focused on you for this set of examples but keep in mind that all the founders are in the exact same boat. I’m assuming here that all five founders are fully vested in their 20% stakes to begin with and none of them have anti-dilution rights or the personal finances to invest additional money with the subsequent investors.

It requires the pool of three of the five founders to have voting majority of the company. 20% times 3 founders = 60% of the shares and therefore voting control.

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Investment 1 – $1 million comes in for 30% of the shares, anti-dilution rights are in place.

Result – You now own 14% of shares. The other four founders own 14% of shares each. Investment 1 owns 30% of shares. It requires four of five founders to pool enough shares for voting majority with the company.

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Investment 2 – $2 million is invested by a new investor for 20% of shares.

Result – You own 7.9% of shares. The other four founders own 7.9% of shares. Investment 1 owns 30% (they invested an additional $600,000 to not be diluted). Investment 2 own 20%. You took in a total of $2.6 million total. The founders now have lost voting control of the company.

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At this point, subsequent rounds of investment dilute you personally even more. If your company hits a problem and experiences a reversal of fortunes you’re pretty much obliterated in your ownership percentage.

Theoretically, on the total value of your shares the 200,000 shares you own keep going up in value. This is a good thing and any general shareholders should be happy. As a founder you may have a very different outlook on things. After all, it’s your baby.

 

Founders Not Pulling Their Weight or Leaving

The romantic notions of a startup and the realities are very different things. If the founders involved have started other companies, their eyes are wide open and everyone should have a good idea of the general effort, stress and dynamic pace they’ll encounter. MOST HAVE NOT.

Those who have not started a business with no other means of financial income are in for lots of surprises. This is not for the faint of heart. Some will abandon the effort. Some will not be adequate for the task. Some will just be impediments to success and must be removed.

What happens to the share ownership of those that prove not valuable and not worthy? Nothing, unless you plan for it. Once stock is issued, they own it. Period. Founders shares are usually very cheap. They may be a penny a share of less. So even if a million shares are issued to the founders only $10,000 is paid by the founders to own the shares. That usually is far short of the capital that’s going to be required to get the business off the ground.

The value to the company is going to be the fruits of their labors. That can be organizing and fundraising, creating operational plans, writing code, leveraging business networking, etc. The impact should be ongoing NOT just one-time. A startup is a marathon, not a sprint. You shouldn’t have someone permanently and significantly benefiting from company ownership for running a short fast “dash” of effort.

Peter Thiel of Paypal founder fame likes to see two founders in a company. No more and no less. In his personal funding he finds that to be the magic number for execution and effectiveness.

​In the groups of four to seven founders (yes, I’ve come across a startup with seven members) it tends to be a democracy, kind of like a band. One or two founders will have the strongest voice and front facing effort but decisions tend to be “group think”.

When one of the principle advantages startups have is being nimble, group think slows things done. Also, quite frankly, it’s a pain in the ass to work with a large group of founders as a coach, adviser, partner or investor. Hassle is friction and no one likes to get burned.

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Resentment Waits for Low Value Producers

Nothing breeds more contention with founders than the guy who “doesn’t pull his own weight”. When a couple of founders are putting in major time and taking on major stress while another founder just isn’t executing with the same passion, commitment and investment – resentment builds.

True Story – A dynamic duo had launched a hosted Ecommerce platform in the late 90’s called Apollo Solutions. These young guys mortgaged their condos and went full steam ahead. The pair felt they needed an MBA involved so they brought in a third partner to write a detailed business plan to present to investors and bring in money. They felt his plan was terrible and he just didn’t fit into the company. They fired him and moved on. They said he didn’t do anything meaningful so they denied his stock grant. Within 12 months along came CNet to buy them out. Guess who came out of the woodwork, yep, MBA guy. He sued which put the sale on hold. This leveraged the founders to pay out a large settlement just so they could sell the business.

Short Timers – What happens when initial founders want out? They leave and they take their shares with them. The guys left are doing a ton of work and usually for reduced or no pay. Most founder shares are very, very cheap so there was no real cash contribution. What happens? They get to benefit from the remaining founders’ efforts.

Some Remedies to Prevent Short Timers from Benefiting – First off, nothing says founder shares need to be fully purchased and handed out on day one. Instead you can carve out all or a large portion of shares and keep them in the “treasury” of the company.

Instead of handing out a big wad of shares on day one, you can divvy up stock options that vest over time. This would be similar to what you’d do with employees. I recommend three or four years to fully vest with a portion vesting immediately and upfront. So for example, if a founder is going to get 200,000 shares in total over three years then have 50,000 share vest immediately and 50,000 shares per year for the next three years. To keep people more on the hook you can have the shares vest equally every month at 1/36th of 150,000.

You’ll have to work out some of the “what ifs”, i.e. what if the company is bought (vest immediately), etc. What this does is allow people who want to leave, to leave, but it keeps a large pool of shares held by the company to give to employees, investors or new founders without having a big dilution effect on everyone overall.

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Phantom Shares and Warrants

For minor partners or those recruited late to the game, sometimes phantom shares are useful although most investors won’t like them. This is a contractual promise to issue shares to people if they meet contract goals and objectives and often there are restrictions. So these persons often get upside financial gain if the company sells for example (phantom shares turn into real shares and are automatically converted into the sale). Phantom shares have no voting rights and no immediate dilution impact. Warrants are similar. They give someone the option but not the obligation to buy shares of the company stock at a set price. Often there is an expiration on this right. They aren’t good forever.

Get it right from the beginning. Don’t have too many founders and put a vesting plan into place for all the founders to start. This will get commitment and best efforts and still allow people to leave on agreed terms if something doesn’t work out. You’ll all feel better about your role as a founder and have better odds of personal success.

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Copyright © 2015 Seth Temko. All rights reserved.

Images from Seth Temko, MS Office.

This article previously appeared in ATTACK PLAN – www.attackplan.com

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Chicago Venture Magazine is a publication of Nathaniel Press www.ChicagoVentureMagazine.com Comments and re-posts in full or in part are welcomed and encouraged if accompanied by attribution and a web link. This is not investment advice. We do not guarantee accuracy. It’s not our fault if you lose money.

.Copyright © 2016 John Jonelis – All Rights Reserved

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Filed under angel, angel capital, angel investor, dilution, Entrepreneur, Entrepreneurship, investor, vc, venture capital

RAW TALENT

Sharks Tby John Jonelis

Ever want to be a Shark on the popular reality TV show? Wish you controlled a billion dollar investment account? Wonder what it’s like? I’m here at Chicago’s 1871 incubator doing it. Emotions run high. Hey, mine are running away with me. That guy on the end keeps grabbing all the deals!

Most of these teams are looking for $100K or so for maybe 15% of the company, but the Sharks seem to want more control than that. Offers meet counter-offers. Investors make hardnosed bids—they team up—steal deals—the usual shenanigans seen on TV.

Negotiations get heated and sometimes abstract. Lance Pressl works a convoluted deal structure in the next room.  No problem—both sides seem on track with it.  But I’m out.  In the long run, any of these companies might produce hockey stick growth or go belly-up.

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Dangerous Waters

Now I’m hearing a pitch from a company called Water Power. I want this one in the worst way. I know the industry. It’s a hugely exciting company with a highly attractive energy product, easily scalable, and a terrific business model.

They’re asking $200K for 20% of the company—a $1M valuation. It’s low. Way low. I tell them they’re undercapitalized and immediately boost the offer for a controlling stake. They counter. Another shark joins me. Meanwhile, that guy on the end is dickering with a completely different set of parameters that sound pretty good.

Ah, but I notice these teams value a strategic investor, so I mention my experience in the industry and that seals the deal. Satisfaction! Victory! Hooray!

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Merchandise Mart

Who Gets to Play

Did I mention these are Junior High Students? Not just any young punks—these are highly gifted, highly precocious, and highly competitive young people. Their pitches rival those seen on TV. Some of these kids are hopefuls for enrollment at the prestigious Illinois State High School for the gifted, the Illinois Math and Science Academy—IMSA.

This entire program is put on by IMSA TALENT. It pits the best and the brightest junior high school students against experienced investors and CEOs at an event that reproduces the popular reality TV show, Shark Tank. Hey, this is a blast!

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Pitch

How it Works

  • IMSA TALENT puts these kids through a fast-paced deep-immersion experience. The school maintains space at 1871, the enormous incubator in Chicago’s Merchandise Mart, so the teams rub shoulders with lots of real startups. That’s huge.
  • Every decision, every action, gets entered into a computer simulation that spits out consequences and makes the process as close to the real thing as you can get.
  • Each team creates an actual product, design, prototype, business model canvas, go-to-market strategy, financials, their pitch—the works.
  • Sharks come armed with unlimited investment capital in the form of Monopoly™ Money and strike cutthroat last-minute negotiations. Think that’s not realistic? Once those dollars get plugged into the simulation, they’re real enough to make or break a company.

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Negotiation

Once again, IMSA proves that, given the opportunity and the right coaching, brilliant children can outperform ordinary adults. Hats off to Carl Heine and Jim Gerry.

Last year I got caught-up in the spirit of the thing, which is dangerously easy to do. One kid was so professional, I forgot myself. I lost my head and asked the team to present before the Heartland Angels. Lesson learned—School first, then business. This year, I keep that straight.

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Deal

Sharks

Lance Pressl, John Detjen, Brian Brandenburg, Jeff Prussack, Joe Guarascio, John Jonelis

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Team

Team Members

Alexandria Cannon, Alp Demirtas, Aman Shah, Ammar Ladhani, Arjun Vyas, Arshia Ajmera, Chandra Gangavarapu, Daniel DeBoer, Dev Singh, Dhruv Nambisan, Ellis Irwin, Erol Ikiz, Ethan Tse, Jacob Conroy, James Raflores, Joseph Tennyson, Joshua Tennyson, Katreena Subramanian, Madeline Drafall, Marc Peczka, Ohm Vyas, Parth Bhatt, Prarthana Prashanth, Shreya Maganti, Shreya Pattisapu, Shreyas Manikonda, Simone Seno, Sydney Elvart, Vismay Vyas, Yuhan Lin.

IMSA Staff

Jim Gerry, PhD

Carl Heine, PhD, Director, IMSA TALENT and Cool Hub IMSA.

heine@imsa.edu Office 630-907-5921 Fax 630-907-5062

Read related article: WHIZ KIDS

Photo credits – Students: IMSA; Architecture: John Jonelis; Shark image: MS Office

Chicago Venture Magazine is a publication of Nathaniel Press www.ChicagoVentureMagazine.com Comments and re-posts in full or in part are welcomed and encouraged if accompanied by attribution and a web link. This is not investment advice. We do not guarantee accuracy. It’s not our fault if you lose money.

.Copyright © 2015 John Jonelis – All Rights Reserved

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Filed under 1871, angel, angel capital, angel investor, big money, Education, Entrepreneur, Entrepreneurship, Heartland Angels, IMSA, Innovation, Invention, investor, new companies, pitch, Public Schools, vc, venture capital

SHARK TANK MEETS THE APPRENTICE

Funding Feeding Frenzy – Part 1

VERBATIM by Loop Lonagan – Investor and man about town,

as told to John Jonelis

FFF LogoLoop Lonagan here. I’m at the Funding Feeding Frenzy ‘n’ there must be more’n 1000 people here and lots more goin’ in and out all day. If you wanna see what’s happening in the Chicago Startup Community, this is the place to be and you can do it all in one single day. But don’t ferget—there’s sharks in them waters and they bite.

This is the place where the judges hold up cards like they used to at the Olympics way back when. They say either FUNDABLE, which almost nobody gets, KEEP FISHING, which I see a lot, or the dreaded GO FUND YOURSELF. Plenty of those too. I watch one company get the thumbs down from the judges but later in the day that same company finds itself an Angel Investor right here at the event.  I’m trolling for a couple good companies myself.   And maybe some fun on the side.

It takes all day before I see any blood in the water. And I’m sittin’ here with a big grin. I always like a good fight.

The Setup

FFF is so big they hold it in this enormous indoor car dealership – almost as big as McCormick Place.  I crawl into a hot new Camaro and ogle the red Corvette.  In past years, with room to spread out, they ran three stages at once.

This year for the first time, the FFF runs just one stage—not the usual three. This poses some pros and some cons. It allows David Culver & Company to put together a large panel of distinguished judges—all recognized Chicago investors. That’s on the good side. I get to see every company that presents. That’s good too. They already weeded out the weak companies and lotsa these presenting here bear a deeper look. I’ll check into those. These companies seem like they’re coached better than ever before and I appreciate the professionalism. All o’ that is on the good side.

But some things don’t work so good on a single stage. You gotta picture the situation. This event goes on ALL DAY. Sure, you can walk around but with only one stage, there’s nowhere else interesting to go. And it’s a hot day. Real hot. The AC keeps going till afternoon, then it gets nasty. But I like investing in startup companies and I like fireworks. I expect to see some of both. So I show up bright and early and stay late. And so do the judges—the whole day. That’s what causes all the trouble.

FFF Corvette

FFF

Just like any good event, they save the best fer last. That means the big show happens late afternoon. By this time I see lotsa shiny faces. The audience gets kinda thin. Most of ‘em are feedin’ their faces and indulging in various liquid cravings and raising a terrific racket in back—so loud it’s hard to hear the panelists. Like I said, these judges been workin’ their tails off all day and barely time for a pit stop. Anybody can see they’re all wrung out. And cranky. For what it’s worth, I figure this thing needs to start at 10:00 am and end at 3:00 pm max. That gives time for a couple two-hour sessions and a nice break.  But that ain’t the way it is.  No it’s every minute all day.

I think it’s crazy to pitch to a buncha investors suffering the miseries, but I see that’s just what’s about to happen. I prick up my ears and lick my chops. I wanna see what develops.

The Donnybrook

After four o’clock, the panelist’s questions are gettin’ kinda testy. They’re attention spans are probably at the breaking point too. I figure some promising offering is about to get chewed up.

Lemme tell you what happens but first, remember my rules:

  1. Tell a good story.
  2. Don’t get the judges mad.
  3. There ain’t no third rule ‘cause three strikes and yer out.

The next company is real special. After hearin’ their pitch over lunch, I believe they’re the real deal. But the guy I talked to at lunch ain’t the same guy givin’ the presentation right now. No, this presenter comes off as a know-it-all. What’s the word? Arrogant. Could be the heat because I meet him later and he ain’t that way at all. But right now, it’s painful to hear. He’s breaking rule #2.

And sure enough, the first judge turns nasty right away.

FFF Speaker

FFF Speaker

“I don’t understand your value proposition.” That’s the opening salvo. Then he starts firing off questions at the poor guy like a machine gun and when he’s done, you can sweep the pieces off the floor. This judge is an investor I respect. He’s the kinda guy I call the sharpest knife in the drawer. Some people think he’s intimidating. This time as it turns out, it’s the kiss of death. No way the other judges are gonna say anything positive after this guy turns vicious. No—they all fall right in line:

It’s like lecturing a schoolboy when the next judge says, “Within the million dollars, how do you see using that money?” Hey, the presentation covered all that stuff. Was he asleep or what? Like I say, it’s late and these guys attention spans are all shot to hell.

They could rattle off the rest of the objections in their sleep:

“You spent virtually no time on the business side.”

“Can you describe in more detail…?”

“How is that justified…?”

“I have a concern…”

Then back to the first judge. “There’s some big players in the marketplace. Some BIG, BIG competitors. One is coming to Chicago probably this year. It’s gonna—they’ll crush you!”

It’s all a buncha hogwash. But now the poor guy is back on his heels. He’s shot his wad.

Here’s the problem: He’s fielding questions all alone—something I like to avoid. He let himself get caught up in details and he don’t recognize these questions is coming at him from an entirely different perspective. Naturally he gets defensive.  Naturally that offends the judges. What he needs is a colleague to observe and step in when there’s a problem. But he’s all on his own.

FFF Speaker

Then we hear objections shouted from the audience.

Can you move so I can see?” Sheesh, I been sittin’ here all day. I’m tryin’ to pay attention to the shellacking going on in front of the big screen. I don’t even need to turn around to recognize the loud, harsh voice of Rong Mayhem. Why’d he wheel himself behind me?

“Somebody make him move.” I don’t budge. Rong can take a flyin’ leap fer all I care. Then he calls out to the speaker—as if the guy didn’t have enough trouble. “What happened to your last venture? I heard it went bust.” I have no idea what he means by this remark. Their last venture is a film that turned out real good.

The moderator interferes before another word gets out: “Don’t talk to him,” he says, meaning the speaker and audience shouldn’t oughta talk to each other. That’s the rules but it seems kinda rude given the circumstances. I like Rong but he gets banned from alotta these events. Can’t keep his mouth shut.

Then there’s a burst of noise from the beer drinkers in back ‘n’ that gets a response from the audience.

“Turn up the speakers. I can’t hear anything,” shouts Rong Mayhem.

“Who cares?” yells Sheldon Tommygun.

“Shuttup Sheldon,” booms Rong.  This delightful interchange leaves me wondering if I’m gonna see an old man and a guy in a wheel chair duke it out. That’d be somethin’ to see.

Another judge goes on as if there was no interruption: “What does adopt the platform mean? C’mon, whaddaya think it means? Then he suggests a major change in the business plan and the poor guy is so beaten down he accepts it—even calls it “smart.”

Time’s up. The presenter limps off.

Next!

This comes as a big surprise – the very next company,  Pallette App, gets a nice warm and friendly reception and takes first place fer the whole event.

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The Winner

I gotta admit, they’re good. Real good. But where’d all that irritability go? Maybe the shark’s bellies are full. To my mind, they just butchered a promising offering and missed a shot at a great investment.

The Happy Ending

I always say: If you tell a good story with passion and don’t personally offend the investors, they’ll gleefully fill-in the holes in your business plan using their own imaginations. Without a good story, they’ll pick you apart like vultures on a carcass. Well it isn’t hard to offend the investors this late in the afternoon. And that’s what just happened here.

So here’s what I do the next day: I run off a transcript of the Q&A. I go to the company’s offices and present it to them. There’s nothing like seeing something in black and white to get your attention. Then I encourage ‘em to show up at a couple other events. And sure enough, the next time these guys present, they do great. And I watch ‘em get fully funded. So this story has a happy ending.

A Promising Company

A Happy Ending

Upcoming FFF Event

So’s I’m goin’ to the next FFF.  It won’t be like this one was.  Probably strictly business. They’re holdin’ it in an auditorium where they can keep tighter control. All the noisy food and venders is gonna be separate. I’m sure David Culver’s got it figured out. It’s his show and he knows what he’s doin’. And I’ll be there ‘cause I’m always ready to pick up another great company or two.  And it’ll be ALL DAY again, so maybe, just maybe, we’ll get some fireworks on the side.  If not, I’ll see what I can stir up.

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Continue to Part 2

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Hey, you wanna know how it actually feels to give a pitch to this kinda crowd? Check out “My Kraken Encounter.” Just click da link.

My Kraken Encounter

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Continue to Part 2

Contacts

Find the Funding Feeding Frenzy at https://www.facebook.com/FundingFeedingFrenzy

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Find Chicago Venture Magazine at www.ChicagoVentureMagazine.com Comments and re-posts are welcomed and encouraged. This is not investment advice – do your own due diligence. I cannot guarantee accuracy but I give you my best.

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Copyright © 2012 John Jonelis – All Rights Reserved

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Filed under Characters, Chicago Ventures, Entrepreneur, Entrepreneurship, Events, FFF, Funding Feeding Frenzy, Innovation, Innovation and Culture, Internet, Invention