entrepreneurship

Roles, processes, and concepts to know if you’re going to be starting your own Internet business.

Internet businesses are the hottest startups around in late 1999. What makes them unusual is that they’re technologically based business, yet the founders come from marketing, strategy, or other non-technical fields. The technology is simply an infrastructure issue, but it’s a big one.

This paper outlines some of the basic concepts for aspiring web entrepreneurs: How does the web site design process work? What are the design and technology roles that need to be filled in a company? And how does the type of your business affect your technology needs? There’s also a resource or two for web design.

How does the web site design process work?

Five skill sets are needed to construct a web site. Sometimes you will have different people for each skill. Less common is finding one person with multiple skills. It’s almost impossible to find a single person who can do all phases of development. (Which is why a site designed by a one-man shop usually looks as if it were designed by a one-man shop.)

Graphic design: the look and feel.

The most visible part of the site design is the graphical look and feel. This includes the color choices, the graphics, logos, and shapes that appear on the screen, and the positioning of the design elements on the screen.

Graphic design is best done by someone trained in graphic design (or has a naturally good eye). Web sites designed by non-designers look that way. And they don’t look professional.

Graphic design is enough for producing great looking print media, but graphic design is not enough when you are building a web site.

User Interface design: the sequence of screens and controls.

Web sites, unlike print media, are interactive. A graphic designer can make the page look pretty, but they may be clueless when it comes to interface design. An interface is the set of controls, links, and buttons that a visitor to the site will use to navigate around the site.

Interface design is all about cuing the visitor how to use the site. Where on the screen will controls be? Where will menus go? How does your visitor know to click somewhere? For example, it would be an interface design question to decide that main menu choices are always visible along the left edge of the screen. And subchoices appear along the bottom. Interface design also includes deciding when to use buttons vs. checkboxes vs. type-in boxes, etc. to interact with the user.

Good UI design involves usability testing, as well. Usability testing tries to make sure that a site really is easy to use, often by having real customers experiment with the site while being watched by the team designing the site.

As a general rule, the only authority on a site’s usability is the your target population. The team that works on the site is far too close to it to know how intuitive it will be to a new visitor.

Information architecture: the path through the site.

While the interface design dictates navigation within a page, information architecture decides how a visitor will navigate around the site. Information architecture chooses the main menu choices—how many, and what they are. Information architecture design uses the business goals of the company along with usability considerations to decide how to divide content across the web site.

During an information architecture discussion, decisions would be made such as whether a site should be organized around constituents or functionality. For example, an information architect could propose the following different ways to organize a travel agency‘s web site. In each case, the site has the same functionality, but getting to the functionality would be a very different experience for the user:

	Organization 1	Organization 2
Business goals	Reduce staff phone time. Encourage people to think about vacation packages.	Provide immediate, quick information. Establish personal relationships with clients.
Main menu	Vacation packages Business trips Personal trips	Make reservations Search for a flight Contact an agent
How visitors contact agents	Three menu clicks: 1. vacation package 2. custom vacation 3. contact agent	One menu click: 1. contact an agent

HTML and programming: the clockworks inside

Once the site has been mapped out and the design finalized, the images and text that make up the design have to be created and put together into HTML (the computer markup language used to create web pages).

If the site is more than unchanging pages of text (“static pages”), then the programming and HTML writing is the site is made “active“ and able to do something more than be a color brochure.

System integration: connecting elsewhere

Often a web site may have to connect to other computers. System integration is the process of establishing the links between your web site and other systems, and making sure that the right data gets sent between the systems at the right time. For example, a web site that does catalog sales may take orders from the internet and enter those into the catalog‘s manual order entry and financial systems.

What are the roles that need to be filled?

The different web site design phases described above are typically done by different people. You can have one person perform more than one of the tasks, however. Or, you can skip tasks to bring your site to market more quickly.

Most one-person or very small web design houses provide mainly graphic design or programming expertise. If you use such a shop, make sure you think about the information architecture, usability, and interface design yourself. With very few exceptions, programmers make lousy interface designers—they aren’t very good at understanding how the rest of us think(1). And graphic designers, while they can create beautiful things, don’t always have a good sense for how a user will move through a site interactively.

You can hire a high-end web design shop such as Zefer, Viant, or Scient. These firms will do a business case analysis and create a site whole information architecture, user interface, and graphic design combine to support your business case. They will also charge as much for your twelve week web design project as it cost to launch the entire company. Of course, they‘ll have it done in twelve weeks, while bringing the expertise in-house will take much longer.

If you do choose in-house development, you will need the following roles filled. One person may fill multiple roles:

Artistic director

The artistic director controls the ultimate graphic design, “look and feel” of the site. An artistic director usually has a background in graphic design.

 

 

Graphic designer

The graphic designer actually creates the design for your pages. It‘s a good idea to make sure you use a graphic designer who is familiar with the constraints of the web. Online design has different requirements than paper design, thanks to considerations like download times and restricted color choice. (See the book The Non-Designer’s Web Book by Robin Williams for more details.)

 

User interface designer

A user interface designer may come from a training or design background. Make sure they understand what makes things easy to use, especially on the web. Ask them what they think of Jakob Nielsen and his AlertBox usability column. If they say “Jakob who?” be skeptical.

 

Information architect

User interface designers will often give a lot of thought to information architecture, as well. A background in writing or editing can be helpful for an information architect, since writing involves organizing information over several pages into a logical presentation sequence.

 

Programmer (Java, JavaScript, C++, etc.)

Whether you need a real “heavy-hitting” programming staff depends on the complexity of your project. If your site interfaces with many outside systems and requires a lot of customer programming, it will pay off to hire some really top notch programmers (and be prepared to pay top dollar for them; every web site builder in the world wants these people right now).

 

If your system has many links to outside databases and systems, look for someone with prior experience in systems integration. If the system will be largely self-contained, you probably want someone with database and programming expertise.

 

Database programmer

I’m not sure this is a separate position. But if you are doing heavy database work (millions of transactions a day), you will be using specialized, high-end databases. These databases often require specialized knowledge to set up and use. While most good programmers can eventually pick up the knowledge, having someone who has mastered them before can be helpful.

HTML coder

HTML coding is a junior job. The trick with HTML however is that it’s tough to get things to look right on all browsers. A layout that looks great on Netscape 4.6 might look horrible on Internet Explorer 5.0. Ask prospective HTML coders about what they do to make their layouts look good on all platforms. If you want to be really tricky, ask them why it’s a good idea to have no line breaks inside a <td> tag in Netscape. If they have an answer, it’s a good sign.

 

System administrator

A system administrator keeps your machines and internal network up and running. They do things like install software, help you when your machine mysteriously crashes, and set up your email system. By the time you have 15 people in your company, you will probably need a full-time system administrator.

 

A common mistake Internet startups make is to have their programmers serve as system administrators. In fact, the two have overlapping but distinct skill sets. And system administration is rather generic, while the building of your web site is unique to you. Get a separate system administrator. You will be glad you did.

System architect

This is the person who has the overarching technical vision for how all the pieces go together, programming wise. It is typically a single person, and usually a senior software engineer. It is rare in a startup to have a system architect who is not also writing code (though it certainly happens).

 

Project manager

Probably the least appreciated technical position is project manager. Hire someone who has run technology projects before, and can also understand the business goals and objectives. Hire someone who has the strength of will to say “Not until our next release cycle” to you when you rush in with a “must-have” feature at the last minute.

 

High tech projects are utterly notorious for being over budget and very late. Several books have been written about the subject and still no one listens, because managers generally don‘t want to accept that something as ephemeral as programming can take that much time. A good project manager will help you balance your optimistic goals with the reality needed to make sure you have a product to ship.

 

A good project manager will be able to tell you about “QA” (quality assurance), release management, where common pitfalls are in technology projects, and how to schedule a tech project.

(You may wish to read the Inc. Technology article on hiring technical people for your business.)

How does the type of your web site affect your technology needs?

The more complicated your web site, the more you will need sophisticated technical people. In increasing order of complexity, here are the kinds of site you might create.

Brochures. An online brochure is the simplest site to create. You will need good design talent, but the only technical talent you will need is an HTML coder.

Off the shelf shopping carts. A simple ordering system created with off-the-shelf software will require a programmer, but probably a junior programmer will suffice.

Your own application. If you’re doing something that involves custom development, you will almost certainly need a project manager and at least one good programmer. Even if you are outsourcing your development, don’t underestimate the need for a full-time person whose job it is to manage the project.

An application that integrates with legacy systems, or systems owned by other companies (your clients’ or partners’ systems). Applications with a high system integration component often require a full complement of technical talent: project manager, system architect, senior programmer, junior programmer, and HTML coder.

What are resources for web projects?

For web site usability, the best site on the Internet may well be Jakob Nielsen’s AlertBox site. It has more research-supported information about how to make your site usable than any other site around. Nielsen also has an article describing how you can do usability testing quickly and cheaply.

For graphic design, check out A List Apart, a site devoted to understanding graphic design on the web.

For usability testing, check out the company User Interface Engineering at www.uie.com.

For HTML tricks and tips, Dave Siegel’s web design page is a good one (though somewhat dated).

Good Luck!

(1) If you’re a programmer, please don’t take offense. I was a programmer for 14 years, myself. I’ve met a couple good programmers / UI designers, but most of us are just too close to the programming to understand what truly is and isn’t easy for other people to use. return to text

Answers to some questions about venture capital

This page contains several different Question & Answer sessions with Venture Capitalists.

• Panel of women VCs, fall 1999.
• Links to two excellent Red Herring interviews on what VCs look for in an investment.

Panel discussion of women Venture Capitalists

Venture Capital is one of the sexiest forms of financing a business. It’s also one of the most expensive. I attended a wonderful presentation last night where a panel of VCs answered questions about their business. Many of the questions were things that people ask me when considering whether and how to pursue venture money. The answers to these questions come from Karin Kissane of TTC Ventures, Marcia Hooper of Advent International, and Vernon Lobo from Mosaic Venture Partners. I am extremely grateful to them for their excellent presentation.

What do VCs look for in a business plan?

VCs are searching for a business opportunity. Your plan has to convince
them that you have what it takes to turn an idea into a breathing,
viable enterprise:

• Management Talent
• A good market
• A product
• Support networks (e.g. other VCs, professional contacts, employees, etc.)

Deal Structure

The biggest convincers for a business plan reader are demonstrations of your competence. If you have a management team with real experience who have successfully launched a company in the same industry, you’ll be credible. If you have customers who have paid money for your product, you’ll be credible. If you have a clear presentation of your opportunity that shows you have a deep understanding of what it will take to make the business succeed (strategically and tactically), you’ll be credible.

If all you have is a good idea, no paying customers (or just letters of intent with no money behind them), no prior experience as an entrepreneur, and a shallow plan, you aren’t likely to make it past the first cut.

But I don’t know how to put together financials. Who knows how much I’ll sell?

Your business plan isn’t a crystal ball. You aren’t expected to predict the future. You’re expected to understand the size of the opportunity. If your product is useful at most to 1,000,000 people, they will pay 10 cents for it, and they only ever buy one, the total the company can ever make is $100,000 with 100% market penetration. Not a terribly attractive opportunity.

That said, decent financials show that you understand how the opportunity will unfold and what it takes to make it happen. By all means, bring in professionals to help you do the financials if you aren’t comfortable doing them yourself.

Should I have someone write my business plan for me?

VCs understand that not everyone is good at everything. When it comes to putting together detailed financials, or polishing the actual writing, bring in help. But when it comes to understanding your business-the market, the customers, and the product-you need to demonstrate that you understand the opportunity. Look for comparables.

I’m a visionary. I don’t have time for all that business plan and market research stuff. I just have a great idea. What should I do?

Team up with someone who has the skill to do all that thinking. VCs won’t invest in a team that doesn’t have time to scope out their opportunity. You don’t need to be the research arm of an investment bank, but you do need to show that you know who your market is, how it is segmented, the size of your opportunity, who your competitors are, and why you will succeed in that environment.

I don’t know who my competitors are.

Then find out. Buy competing products and investigate the manufacturers. Do web searches. Call reference librarians. And think broadly about who your competition is. Rolex doesn’t compete with Timex. Rolex competes with Mercedes Benz. Because Rolex isn’t in the watch business, they’re in the luxury status symbol business.

But we only need 10% of the market to be profitable…why won’t they fund me?

The other 50 funded companies who are developing competing ideas also need just 10% of the market apiece. Unfortunately, that adds up to 500% of the market. Is this a market you want to enter? If so, you need a persuasive case that you have a real advantage over those other companies. Otherwise, you’re just another generic gamble.

How long a time horizon do VCs have for their investments?

It used to be 7-10 years. Then it shortened to 3-5. In recent years, it’s become 1-5. It varies dramatically. One thing is sure, though: as internet time has begun to pervade the economy, VCs are expecting a quicker and quicker harvest.

In part, it is a function of where in the fund cycle the investment is being made. If it is at the beginning, there is obviously a lot more time than if it is the last investment in the fund. Although investors are always impatient, my [Vernon Lobo’s] personal bias is not to have funds come back as quickly as you have described. If I believe additional shareholder value, (in excess of a hurdle rate) can be created by continuing operations, I’d rather wait

How big an investment do VCs make?

Bigger all the time. More people have been investing in VC funds, and they have made huge sums which they are reinvesting. With such large funds, they opportunities to invest $3-$5 million at a time, in order to keep all that money productive. If you need less money, Angel Investors may be the way to go.

In addition, it may be better if the $3-$5 million is is staged in. I find that some entrepreneurs decide to ask for $5 million because they think that is what they have to ask for to get the VC’s attention, when all they really need to get going is $1 million. In the end, it is probably better for the entrepreneur (from a dilution standpoint), to take less up front, and stage in the capital, (as long as they meet their plan).

How big an opportunity do they need?

Many VC’s now are looking for a company that can grow to become at least $100 million (if not several hundred million) in revenue, and hopefully many multiples of that in value! If it doesn’t have that kind of potential it is not that exciting.

What kind of return do VCs need?

VCs need a high rate of return. Remember their business-they have investors that they are responsible to. With NASDAQ producing 50% returns, to be competitive, VCs need to offer their investors 70-80% returns.

But the situation is even worse. VCs have their share of failed investments. Their successful investments have to pay for the failed investments too, driving the returns they need on any single venture even higher.

On the other hand, one VC takes issues with the whole ideas of “target return.“ He writes, “We don’t have a “target” return. We don’t target a return any more than the entreprenuer does. When she/he starts a business, they usually don’t lay out a target return. Our philosophy is to become partners with the entrepreneur, so our objectives are the same…. We hope to make a lot of money!”

What do VCs want in a CEO?

Sales skills, the ability to attract the right team, an understanding of customer and markets, and flexibility. The business plan will change as the business and markets develop, and a CEO needs to be able to spot opportunity and steer the business to a successful (though perhaps unexpected) conclusion.

What’s the competiton for VC funding?

Advent International receives 10,000 business plans each year. They fund 30. You do the math.

What’s the best way to submit a plan to a VC?

Personal connections. One panelist couldn’t think of any unsolicited plans that her firm had funded. Another said some unsolicited plans had been funded, but she couldn’t remember who.

In short, work your network. The impression they gave is that unsolicited plans are virtually a waste of paper. But VCs do talk to each other. If you get your plan in one door, even if it doesn’t fly there, it may get passed around to other firms who will want to invest.

Do I have to tell VCs which other funding sources I’m talking to?

Nope. Keep ’em guessing. Late in the process, they will have to know so they know who their co-investors are. But there’s no need to be too specific in the early discussions.

What if a VC is already funding a competing venture? Will they sign a nondisclosure before looking at my plan?

Nope. You have to trust them. They have incentive to Do The Right Thing; their reputation is all they have. But legally, you’re on your own. They may sign an NDA (non-disclosure agreement) if you have a compelling trade secret, or late in the due diligence process.

An executive summary is a good way to summarize your opportunity without giving away proprietary details. Since a VC isn’t likely to read a plan in great detail if the executive summary doesn’t grab them, spend enough time on the summary and if you can pique their interest without revealing trade secrets, the NDA may be possible later.

How many VCs should I bring into the deal?

More VCs mean more connections and more resources for you to draw on. Two or three is a good number to have on board.

What should I look for in a VC?

Look for personality and fit with the partners who will be on your board. Personality clashes have destroyed companies; it’s better to wait for a good fit than to accept quick money with someone you can’t work with.

It is also perfectly acceptable to ask your venture capitalists for references. Ask for:

• a current portfolio entrepreneur
• a past entrepreneur whose company failed
• a past entrepreneur whose company succeeded
• a past entrepreneur who got booted from their company by the VC

Good Luck!

*****

Red Herring Interviews

Red Herring has published some excellent interviews with Venture Capitalists about what VCs look for in a plan. In addition to VentureCoach VC Q&A, check out:

Benchmark Capital’s Andy Rachleff interview parts 1&2:
http://www.redherring.com/insider/1999/1124/vc-vcps.html
http://www.redherring.com/insider/1999/1201/vc-vcps.html

Divine Interventures’s Mike Santer interview 1 & 2:
http://www.redherring.com/insider/1999/1117/vc-vcps.html
http://www.redherring.com/insider/1999/1120/vc-vcps.html

This page is based on personal experience, and is based on what I know of American tax law. I am not a lawyer, however, and can not claim that this information is currently accurate. Use it at your own risk.

• Terms to know
• Cash flow & liquidity of stock and options
• Tax implications of stock vs. options
• Big “gotchas” of taxes around stock and options.
• What happens if the company never goes public?
• What happens if new stock is given to new investors?
• What if the company gets bought out while I own stock or options?
• How much should I ask for?
• They offered me 3,000 options. Is that a good deal?
• Does the company care if they give me stock or options?

Terms to know

stock	Ownership of part of a firm.
options or ‘non-qualified’ options	The right to buy or sell stock at a predetermined price. For example, you might have an option that gives you the right to buy IBM at $100/share, even if it’s selling for $150/share..
strike price	The price at which an option lets you buy stock. In the above example, $100 is the strike price of the options.
market price	The price at which stock is selling on the open market. In the above example, $150 is the market price of IBM stock.
vesting	You rarely receive stock or options all at once. Rather, you receive shares/options as you meet certain milestones. Stock whose milestones you’ve met are considered “vested.”
vesting schedule	The schedule over which shares or options vest. Often, a person receives a certain number of shares each quarter or each year. A typical vesting schedule might be, ËYou receive 10,000 shares over 4 years. 2,500 shares vest on your first anniversary, and the remaining 7,500 shares vest in equal monthly amounts for the following three years.Ó
dilution	When new shares are issued in a company, it ËdilutesÓ the value of the existing shares. For example, if you own 100 shares of a company with 1,000 outstanding shares, you own 10% of the company. If the company issues an additional 1,000 shares to investors, there are now 2,000 outstanding shares. Your 100 shares are now only 5% of the company. This is called dilution.
registered shares	When a company is public, its shares are registered with the SEC. Private companies issue non-registered shares, which often can’t be sold or turned into money.
incentive stock options (ISOs)	Options which get special tax treatment: they create no tax event when exercised, but are taxed when the stock is sold. if the stock is held for more than a year, they are taxed at the long-term capital gains rate, rather than the normal income rate. When exercised, ISOs can subject the owner to the “Alternative Minimum Tax,” which can be substantial.

You can get paid in stock or in options. If you get paid in stock, you actually receive shares of a company’s stock. If you get paid in options, you receive the right to buy the stock later, at a set price. If the stock is selling on the open market for more than the strike price, you can exercise the option, buy the stock for the strike price, and then sell it immediately for the market price, pocketing the difference as profit. The lower the strike price, the more profit you make.

Options are often issued with a strike price equal to or 10% lower than the market value of the stock at the time the options are issued. That means that the maximum profit the option holder can realize is movement in the stock price after the time options are issued.

Cash flow & liquidity

With stock, there are no cash flow concerns. Once you own the stock, you own it. With options, however, you need to come up with the money to exercise the options. This isn’t always easy. If you have 10,000 options with a strike price of $5, it will require $50,000 to exercise those options and buy the underlying stock.

“But why is that a problem?” I hear you ask. “After all, you’d only exercise options if the stock were selling for more than the option strike price. Can’t you then just sell enough of the stock to cover the $50,000?” Ah, if only it were that easy…

Liquidity

You can’t sell stock in a non-public company. So unless your company is publicly traded, the stock you get (either directly or by exercising options) is just pieces of paper, unless the shareholder’s agreement gives you permission to sell it to third parties. Rarely—and never in a venture backed by professional investors—will you be given that ability.

As I write this (8/99), there is also a holding period on shares of stock in non-public companies. The holding period can range from 6 months to 3 years. Even if the company goes public during that time, the holder of pre-public shares can’t sell until their holding period expires. The intent of this is to prevent monkey business in which insiders are allowed to purchase pre-public shares immediately before an IPO and then turn right around and sell them. In fact, there is currently a strong movement in congress to eliminate the holding period.

[Author’s editorial opinion: eliminating the holding period will probably encourage all kinds of game playing and profit-taking. Philosophically a believer in businesses being value-creators, rather than transient-paper-profit creators, I favor keeping the holding period. Yet as someone who may someday be in a position to benefit from its elimination, I find my principles put sorely to the test.]

Tax implications

To make matters worse, taxes can cause a cash flow issue in all of this. Here’s a summary of how the taxes work:

	early tax hit	later tax hit
options	When you exercise the options, the difference between the option strike price and the market price of the stock is treated as normal income, taxable at your full tax rate.Your full tax rate can be quite high, once state and federal are both taken into account. For example, if you exercise 10,000 options to buy XYZ at $5, when the stock is selling for $7, that counts as $20,000 of taxable income even if XYZ is a non-public company.	When you sell the shares you acquired by exercising your options, any up or down movement in the share price since the date of exercise counts as a capital gain or loss. Capital gains/losses are taxed at a much lower rate than ordinary income. If you later sell your XYZ shares for $9, that counts as a $2 capital gain (the fair market value was $7 when you acquired the shares).
incentive stock options	No tax hit when exercised. Possibly subjects you to the alternative minimum tax (AMT).	When you sell the shares, the difference between the strike price and the share price is taxed. If the shares have been held for less than a year, the normal income tax rate is used. If they have been held more than a year, the capital gains rate is used.
stock	If you are receiving actual stock shares that vest, the moment they vest, the amount vested becomes treated as normal income, taxable at your full tax rate.	When you sell your shares, you realize a capital gain or loss on any movement in share price from the time that you acquired the shares.

The big "gotcha" type tradeoffs:

If you want compensation that vests over time in a private company, stock may be a poor choice. As each block of stock vests, it constitutes taxable income equal to the fair market value of the stock at the time of vesting (not at the time the contract is written). So if the company is doing really well, the 5,000 shares that vest this quarter could be worth $10/share, giving you $50,000 of taxable income. But since the company is private, you can’t sell the shares to pay the taxes. You have to come up with the cash to pay the taxes some other way.

Options are more palatable, but they introduce a quandry. In a private company, you would like to exercise your options as soon as possible. You will start the liquidity counter ticking early, so your holding period will be over by the time the stock is tradeable. And if your options are not incentive stock options, they will generate a normal income tax rate hit. You also want to take that hit (which happens at exercise time) on as low a stock value as possible, and have most of your gains happen as a capital gain or loss.

But on the other hand, you might not want to exercise your options until the company goes public. The shares you receive from the exercise will be fully liquid, and you can trade them immediately. But your entire gain (market price minus strike price) will be taxed as normal income. That can be a huge incremental tax burden.

Whether to exercise options while a company is still private is a complicated, individual question. The answer depends on your regular tax brackets, your capital gains brackets, how long you think it will be until the stock goes public, and how much money you have to pay taxes on the options exercise.

Other Questions

What if the company never goes public?

Well, then you have to find someone to buy your shares if you want to make any money off them. Sometimes the shareholder’s agreement will let you sell your shares to anyone, while other times it only lets you sell your shares back to the company or to other shareholders.

What happens if more stock is issued to give to new investors?

Your shares get diluted. If you are in a very powerful negotiating position, you may be able to get an anti-dilution provision, which lets you maintain your percentage ownership in the firm even when new shares are issued. If this is your first job out of college, don’t bother asking.

What if the company gets bought out while I own options or stock?

This depends on your agreement and the terms of the sale. An IPO or acquisition can drastically change a company, effectively making it a different place than you signed up to work in originally. If you can swing it, the safest thing to do is to require that your options or shares vest immediately upon a public offering or acquisition.

How much should I ask for?

As much as you can get. A few very, very rough rules of thumb: by the time a company goes public, the VCs and investors will own around 70% and the original owners and employees will own around 30%. What matters is not how many shares you have, but what percentage of the company now and at IPO/acquisition time you own.

If you believe that the company will be worth $100,000,000 someday, and you will own .5% of the company at that point, your share will someday be worth $500,000. If you took a $20,000 pay cut for 5 years in exchange for that equity, you essentially exchanged a guaranteed $100,000 salary for a risky $500,000 in stock. It’s up to you to decide if that tradeoff is worth it.

Think this through! I have seen people take a $30,000/year pay cut in exchange for stock that was worth $60,000 after two years. They effectively traded salary for equity without getting enough stock to compensate them for the risk they took or for the fact that it took two years before they saw the money.

Keep in mind that subsequent funding rounds will dilute you. What matters is the percentage you own when the company goes public or is acquired. The percentage you own today may be less relevant.

They offered 3,000 options. Is that a good deal?

Maybe. It depends what percentage that is of the company. If there are 30,000,000 outstanding shares, you’ve been offered .01% of the equity. If the company is the next AMAZON.COM, you’re set for a lifetime if you’re a careful investor. If the company is Joe’s Garage and Fried Chicken Joint, you might want to reconsider. (See the essay on Equity Distribution to get an idea of what percentages are good percentages.)

Remember: it’s the percentage you own, not the number of shares that matters! If they say they can’t reveal how many shares are outstanding, or won’t tell you what percentage ownership your shares represent, run, don’t walk, in the opposite direction. You are investing your time and reputation with the company. Any aboveboard company would instantly reveal those numbers to a monetary investor. If they won’t reveal them to you, it’s probably because they are making a lousy offer.

Without knowing the percentages, you can not evaluate the value of your options. Period. Companies split their stock immediately before going public, or they reverse-split their stock, to adjust the share price. You may have 30,000 options today, but a pre-IPO reverse split of 1-for-2 will leave you with just 15,000 shares after the IPO. (This happens. It’s rare, but it happens. Two companies whose IPOs I’ve been privvy to had pre-IPO reverse splits. One was 2-for-3, the other was 1-for-2 reverse split.)

Once you know what percent you own, find the value by multiplying the expected company valuation by your percentage ownership at IPO. Remember that the IPO itself dilutes all shareholders. Then multiply the result by 2/3 to find out how much you’ll have once you’ve paid your taxes.

I’ve heard companies say, “The percentage doesn’t matter. After all, regardless of percentage, 3,000 shares when the stock hits $100/share, is $300,000.” True. But how do you know that 3,000 shares today will still be 3,000 shares at IPO? And what would the whole-company valuation have to be to justify a $100 per-share price? That’s why it makes more sense to talk company valuation and percentage ownership at IPO.

Does the company care if they give me stock or options?

They may, but if they do, it is only because of the accounting treatment or administrative overhead of giving out stock. Either way, they are giving you ownership or an option of ownership in the company.

How likely are you to go public, anyway?

“We have the greatest e-commerce idea in history. We’ll be the Amazon.com and e-bay of industry X. We plan on raising venture capital in the next three weeks, and we will have our initial public offering within 18 months…by the way, do you know where we could find some good technical people, and maybe a CEO?”
—Several anonymous entrepreneurs

The sentiment I hear from new entrepreneurs is wonderfully optimistic. Incredibly inspiring, visionary, and touching. It’s especially touching in its naivete. Here are some statistics forwarded from a friend of mine in the financial services industry. Think about them before you blithely declare your intent to IPO in the next 18 months…

The number of listed companies is:

NYSE – 3,088
NASDAQ – 4,895
AMEX – 786
TOTAL 8,769

Interesting Fact There are currently 10,719 mutual funds available for investment, almost 2,000 more than there are stocks to buy!!

The number of IPO’s over the last several years:…

This article is continued in the Entrepreneur’s Companion volume 1. Click here to purchase.

Taken from a write-up I did for Wharton’s entrepreneurial community

Rather than attempt a comprehensive write-up of creating a new venture, which would fill several books, here are some practical, immediate tips you can apply. At the end of this article is a URL you can use to ask further questions, publicly or privately.

DISCLAIMER: I’m an angel investor and coach, not a VC. The below is based on my experience reading and responding to business plans. I can’t guarantee that VCs pay attention to all the same things.

• Tips on opportunity recognition
• Tips on writing the plan
• Tips on implementation & life

What investors are looking for in a plan

Investors—whether angels or VCs—are looking for the same things when reading a business plan. They want to know how big the opportunity is, whether this is the right team to exploit the opportunity, who the competition is, what the risks are, and why they can expect this team to implement successfully.

Your job in writing the business plan is to address these questions convincingly and clearly.

Also make sure to check out Notes from a VC Panel Discussion.

Tips on Opportunity Recognition

The size of the opportunity depends on the market

“Opportunity size” is a very rough concept; there is no precise definition. You can think of it as roughly the number of potential customers times the expected percentage who can be captured as customers times their average purchase times their average purchase frequency. You can find huge opportunities by selling small things to many people over and over, by making huge sales to a few people, or anywhere in between. Know why your opportunity is the size that it is.

For example, RenalTech is a company which manufactures filters for dialysis machines. There are 320,000 people on dialysis in the United States. If they know how many filters per year those patients use, multiplied by the price per filter, they can have some idea of the size of their opportunity.

Choose a huge market

Especially in the internet world, venture capitalists are looking more at the market than at the detailed specifics of your financials. Choose a market that is big enough to be an obvious good opportunity.

A business which targets teenage girls who listen to music and has a reasonable chance of capturing 90% of the girls that are online is a huge opportunity. A business which targets net-savvy SAAB mechanics who need prosthetic limbs is not.

Find a business with great fundamentals

Choose excellent business models which have sound business fundamentals:

• lack of competition
• recurring revenues
• low fixed costs
• low asset requirements
• a compelling reason other than “brand loyalty” why customers will stay with you once they join

If your business requires $30 million worth of advertising on an ongoing basis to keep bringing people back to the site, make sure to factor that into your pro formas.

You can think of product ideas as being either candy, vitamins, or pain killers. Candy is fun, but a luxury. Vitamins keep you healthy. Pain killers ameliorate an immediate problem. VCs like to invest in pain killers. If possible, addictive pain killers. People in pain are strongly motivated to buy, which isn‘t necessarily true of people buying vitamins.

If you like risk, ignore the fundamentals

In late 1999, plans don’t need a sound business model to attract capital. Plans with no business fundamentals and inexperienced 27-year-old management are raising money with valuations of $12 million. The IPO market is also going crazy: WebVan just went public on revenues of $395,000, losses of $35.1 million, and they have a market capitalization of $8.45 billion.

The market’s faith is keeping these valuations afloat, betting that (a) losing huge money building a brand will someday turn into much huger profits; and (b) someone will buy the business for its strategic/intangible value, rather than its cash-generating value.

If you’re comfortable making those bets, go for it. And of the 60,000 companies started this year, one or two will likely see those bets pay off.

Know why customers stay

If you show growing revenues year after year, but your customers have no natural reason to stay with you beyond a single purchase or two, think through why you expect the revenue number to grow. Are you somehow encouraging more purchases, or are you managing to attract completely new customers to fill the shoes of old ones?

Prepare to throw several ideas away

Discard non-superb ideas, ruthlessly. VC firms read 10,000 business plans a year to find 20 good investments. Warren Buffet waits years to find a single investment that meets his standards. You’re investing your time, energy, and reputation for years. You own it to yourself to have high standards.

Many entrepreneurs get an idea or two, latch onto them, and then rationalize away any serious holes in their plan. If you don’t go through a couple of ideas before settling on one, you’re either very lucky or your standards for a good opportunity are too low.

Research the competition, even in the pipeline

At the very least, do an internet search for similar ideas and companies. There are few things more embarrassing than presenting a business plan for a “new concept” only to find that concept up and running elsewhere.

And remember, there may be competitors who haven’t launched, yet. Have a plan to deal with the possibility that such competitors will crop up.

You always have competition.

Your competitors aren’t always in exactly the same business; they may not even be companies. Scott Cook, founder of Intuit (maker of Quicken) defines the competition for Quicken as being a pencil and paper checkbook. And using that definition, Scott has built a company that has dominated every financial software market it has entered.

To find your competition, ask the question: if people don’t have our product/service, what will they do instead to meet their needs? That is your competition.

Tips on Writing Your Plan

Let your elevator pitch drive…

This article is continued in the Entrepreneur’s Companion volume 1. Click here to purchase.

Boston Business Journal, Sept. 2003

Stage 1: you have an idea. Stage 2: you’ve developed the business. Stage 3: you’re making money, it’s for real, you’re successful … so why is everything sudden chaos? This article helps you understand that Stage 3 entrepreneurship requires real changes in how you do business.

Read the full article in Boston Business Journal at
http://www.bizjournals.com/boston/stories/2003/09/22/smallb2.html.

Boston Business Journal, Dec. 2003

Thinking of going into business with friends and family? Think twice. It may not be the smooth ride you imagine. Read Stever’s Boston Business Journal article Think Before Mixing Business, Buds, and Blood.