Paths to $5M for a startup founder

 

money_2.jpg

Most entrepreneurs don't do it for the financial reward alone, but it's generally a primary goal in the life cycle. And yet I think many entrepreneurs, especially first-timers, don't pay close enough attention to the impact various decisions have on their personal financial outcomes.

First and foremost, there are co-founders. Mark Suster summed it up great in this Venture Hacks post.

Everyone obsesses with dilution from investors. The biggest dilution comes from co-founders. If you have 2 co-founders, you've diluted 66% before doing any of the hard work. Start by yourself and bring in co-founders for smaller stakes once you've got initial momentum. Unconventional wisdom, but the most economically practical advice you'll ever get. 

Let's put some #s on it. Suppose you want to end up with $5M (gross). Let's say for the moment, after all is said and done, the initial founders end up with 30%. If you have two co-founders (3 people) you'd need a $50M sale to end up with $5M, as you'd get 10% of it personally. With one co-founder, you'd need a $33M sale and with no co-founders, a $17M sale.

Those are huge differences. The universe of companies who can do a $17M vs a $50M sale are greater, and for those companies that can do a $50M sale, a $17M would be of course much easier to swing.

Bottom line, I'd be very wary of taking on a third co-founder from the get-go. And I'd go even farther and consider doing it alone, if just for some time. Yes, there is some real bias against single founders when it comes to fund raising, though it's not impossible. For example, I am a single founder and will fund single founders. In fact, I just did. 

More importantly though, traction trumps everything. Get some traction and funding will flow, if you even want it at that point.

But let's say you want a second founder for fundraising and/or operational purposes. You could consider doing it yourself for a while, and then take on this founder at a less than 50/50 split, e.g. an 80/20 split. That's still an order of magnitude higher than the usual 1-3% the first employee would get, i.e. very attractive. And in this scenario you would have taken some of the risk out of the deal, e.g. by building a prototype, getting the company formed, etc. At that 80/20 split, in the above scenario you'd need a $21M sale, so pretty close to the $17M but with another founder.

Second, let's consider funding. If you do an angel round and then a series A, you're typically down to the 30% founders share I've been using. Here are some ways to get there. 10-20% from the angel round, then 30-50% from the series A and 10-20% from an option pool, which may or may not be allocated by the time of acquisition. So at two rounds of funding you're at 50-90% dilution.

It's doubtful you'll go straight to series A as a first-time entrepreneur and doubtful you'd get 30% unless you've shown a lot of traction. So the original 70% is pretty accurate. If you're in the normal two founder situation, that puts you at that need for a $33M sale to yield $5M personally.

Of course if you raise a third round (or even a fourth), that pushes the needed sale price up further. If you're at 10% founder share with two co-founders, you'd need a $100M exit to get your $5M. And it could be even higher! 

These are the situations where people are shooting for an IPO or a really high acquisition. Not impossible of course, but rare. Only ~15 tech companies are created annually that end up producing 100M+ in revenue, i.e. are viable IPOs.

Now let's suppose you do something that may not need VC. You only take an angel round at 20% dilution and you allocate 10% out of your option pool at the time of acquisition. So now the founders have 70%. At two co-founders you'd need $14M sale to get the $5M. At an 80/20 split, you'd need a $9M sale. If it's just you, you'd need a $7M sale.

Once you get under $10M, the universe of potential acquisition targets really widens. At a 10% dilution (smaller angel round), the #s are $12M, $7M & $6M sales. 

Now let's take it to the logical conclusion.

At no investment and two co-founders, you'd need a $10M sale to get your $5M. At 80/20 that becomes $6.25M. And of course as a sole founder it's just $5M.

Those differences are pretty vast. $5M exit as a sole founder with no investment to $100M exit with several rounds of financing and two co-founders. 

And yet the financial outcome is the same. But the probabilities are not. It's much easier to sell a small company for $15M than it is to IPO.

Update: some comments on HN here and here (repost).

 

If you have comments, hit me up on Twitter.
I'm the Founder & CEO of DuckDuckGo, the search engine that doesn't track you. I'm also the co-author of Traction, the book that helps you get customer growth. More about me.