Using Equity to Build an Awesome Team

Vinod Khosla on How to Build and Manage Teams

We’ve been watching a bunch of the Y Combinator Startup School videos. First of all, they’re great. Second, how is it possible that only 7,000 people on the entire Internet have watched Vinod Khosla talk about “How to Build and Manage Teams?”

Do yourself a favor and watch the entire thing. It’s pure entrepreneur gold!

But if you only have five minutes…here’s a short clip of our favorite part:

Here are the main takeaways:

  1. A company becomes the people it hires
  2. Hire some magnets
  3. Low % equity ownership self-selects for mediocrity

Let’s unpack these and see how to apply them to our own startups.

1. A Company Becomes the People it Hires

“The single biggest reason people stick with a company is because they have people around them who are really awesome that they can learn from, who are better than them. Everyone should feel that way.”

Khosla makes some excellent points, including that “a company becomes the people it hires.”

This means that every founder’s #1 goal is to attract and retain great talent.

Great people are attracted to great people. Khosla says he still spends a big chunk of his time on hiring, so he’s always looking for ways to increase the flow of inbound applications—and he’s always trying to keep the talented people he finds.

So if you build a community of rockstars that everyone can learn from, it helps you attract more rockstars. The résumés come pouring in.

2. Hire Some Magnets

“Think about who you can get who everybody wants to work with. That’s how you’ll hire employees 10 through 50.”

Awesome people are also an effective fundraising tool. Khosla loves to invest in great teams. If he’s talking to a startup he’ll ask himself if he’s impressed enough with at least two of the founders that he would invest in their next companies.

If the answer’s yes then he’ll pretty much always put money into their current company, even if he doesn’t love the business plan. He’ll always pick people over plan.

3. Low % Ownership Self-Selects for Mediocrity

“Anybody you hire who’s exceptional, will a year later figure out they want to start their own company if they’re not a founder. So you self-select for okay people…not awesome people.”

He’s playing the long game, and sacrificing equity in order to get the magnets to stick around.

Once a company grows to 50 people, “the founders should have 1/3 of the common, their 5 or 6 direct reports should have 1/3 of the common stock, and everyone else should have the remaining 1/3 of the common. If you do that, people don’t leave”

Be Generous with Ownership

What’s Khosla’s recommended recipe?

  • 15% equity for each of 3 founders = 45%
  • 5% equity for each of 3 “junior-founders” = 15%
  • 20% option pool

You’ll still want to use a vesting schedule—or Mike Moyer’s Slicing Pie formula—to ensure that team members are actually contributing.

Attracting and Retaining the Best Talent

Most entrepreneurs focus on maximizing their ownership percentage—which is the opposite of what Khosla recommends. His point is that by hiring awesome people you’re more likely to generate enough value that it doesn’t matter if you own less of the company.

Khosla wraps up by pointing out that you also need a big vision to attract superstars. It’s called a massive transformative purpose (MTP) and it’s the key to achieving exponential growth.

It’s the combination of MTP and generous equity that allows you to attract and retain the rockstars—who in turn help you attract more great team members.

Written by Mike Lingle — Find more practical suggestions and free webinars for entrepreneurs at 10xU or connect with me on LinkedIn.

The key slide missing from most pitch decks

The key slide missing from most pitch decks

You’ve just delivered your best investor pitch ever! Now what’s the conversation you want to have with the people in the room? Putting a milestones slide at the end of your pitch deck helps you with three important things:

  1. Show how far you’ve already come
  2. Provide your roadmap at a glance
  3. Frame your “ask”

You can grab our milestones slide template for free. Simply make a copy from the Google Docs File menu and assign a new theme or use View>Master to customize the one we’ve provided.

Constructing the Milestones Slide

The important thing is to show what you’ve already accomplished plus what you’re working on next. Two columns is easiest for people to understand, although it can also be done as a stack like this slide from Buffer:

 

The problem here is that it takes a minute to figure out that some of these Buffer items have already been accomplished—whereas others are slated for future milestones. Can you tell which is which?

The giveaway is the green text.

It’s easier to understand if you split the past vs. future into separate columns and then use checkmarks to indicate completed items.

Here’s the layout we recommend:

Milestones Slide for Pitch Decks from 10xU

1. Show how far you’ve already come

Investors love entrepreneurs who are always hustling. You instill confidence that you’re the right team to reach the next set of milestones by showing how far you’ve already come.

Your ability to get things done is what separates you from the hundreds of other opportunities your investors are looking at—and it’s what convinces them that your startup is the right place to put their money and time.

List the few main items that you’ve already achieved in the first column. These typically include traction, product, and fundraising. You want to show investors that you’re a natural born hustler and that you’re already making the magic happen. Now they feel more comfortable giving you their money.

Here are some examples:

Traction:

  • 10,000 registered users with 3,000 weekly actives
  • $10,000 monthly recurring revenue (MRR)
  • Signed first three enterprise customers for $5,000 MRR

Product

  • Completed mock-up and pricing validation with 50 potential customers
  • Released minimum viable product (MVP) to first 1,000 users

Fundraising

  • Raised $50k from friends and family
  • Completed accelerator and received $25k

You should include everything that shows how awesome you are, but keep the list to five items or less so that people can read it quickly.

2. Provide your roadmap at a glance

Now that you’ve instilled confidence in your audience, you want to lay out your next steps. Start by time-boxing the list with something like, “Next Six Months.” You want to be aggressive, but keep it realistic because you’re making a promise to your investors.

Next, state what you’re asking for, such as “Raising $250k as a convertible note.” You might include the basic deal terms, such “Raising $500k equity at a $2M pre-money valuation.”

One of the most common mistakes we see in pitch decks is forgetting to include the “ask.” We get to the last slide and we still don’t know what you want. Always put what you’re asking for in writing on the last slide. Your audience will thank you. Remember that your ask can change depending on who you’re presenting to, like a strategic partnership, etc.

Scarcity and social proof are like catnip for investors, so if you’ve already closed some of the round you could say “Raising $250k as a convertible note ($80k remaining).”

You don’t need to provide too much detail on actual deal terms here, because if people are interested you’ll be able to talk them through the specifics.

Finally, list the milestones you’ll accomplish with the money. It’s best to focus on what you’ll accomplish (“$10k monthly recurring revenue”) vs. how you’ll accomplish it (“Hire 3 developers and a project manager, release version 2 of the product, ramp our spend on Facebook and Twitter ads”).

If you do want to get that specific then you can do a separate “Uses of Funds” slide with a more detailed list.

This is your promise to investors: “If you give us this money then we will hit these milestones.” So make sure you can do it.

 

3. Frame your “ask”

The goal is to stand out from every other deal these investors are looking at. You do this by spelling out how much you’ve already achieved, what you’re asking for, and what you’ll accomplish in the next phase along with how long you expect that to take.

Putting this all on one slide sums it up for your audience shapes the conversation you’re about to have with them.

You can also work backward from what people would need to see on this slide in order to invest. Then go out and do those things before you start raising your next round.

Expect to have multiple conversations with people before they put any money in. For best results, report new progress every time. Investors want to see momentum in order to feel comfortable putting money into your company.

So make sure you’re always moving the ball down the field.

More Milestones Slide Examples

Here a are a few examples of what works and what could be improved (although it’s true that all of these companies successfully raised money).

> This final slide from Buzzfeed is a missed opportunity because it only has contact info. We’re guessing that whoever Jonah was presenting to already knew how to contact him:

final slide from buzzfeed

> This final slide from Moz is certainly aspirational, but it doesn’t shape the conversation around what they’re asking for and what they’re going to do with the money:

Final slide from Moz

> This final slide from Mixpanel provides incredible social proof. If all of these amazing people have invested, then why shouldn’t you? In fact, you’re probably missing out if you don’t invest!

They did miss a chance to state what they’re asking for and what they’ll do with the money. We also recommend including a logo on all of your slides.

Always have awesome investors!

> This milestones slide from Intercom does a great job of laying out the ask and what they plan to do with the money. The only thing we would add is a short list of accomplishments.

Intercom's milestones slide

Shape the conversation

You’ve just delivered the best pitch of your life. You get to this last slide, the investor looks at both columns and quickly understands where you’re coming from, where you’re going, and what you need to get there.

She immediately starts asking questions. This is exactly what you want!

Putting this milestones slide last in your pitch deck usually starts a conversation focused on whatever’s most important to you.

You can grab our milestones slide template here.

Good luck, and let us know how it goes!

Written by Mike Lingle — Find more practical suggestions and free webinars for entrepreneurs at 10xU or connect with me on LinkedIn.

Valuing Your Startup

Valuing Your Startup with 10xU

It’s an amazing feeling to see $2 million show up in your company’s bank account! Here’s the playbook we used to raise our series A round for SlideRocket:

  1. Build an MVP and get traction
  2. Figure out how much money to raise
  3. Pitch a ton of investors (including strategic)
  4. Solve for % ownership rather than pre-money valuation

(And if you want more info then bring your questions to my free workshop on valuing your startup this Thursday, 6/22/2017 at 6p ET)

1. Build an MVP and get traction

SlideRocket was presentations in the cloud, originally targeted at business users.

I started the company with two other people and all three of us had income from other businesses. We were building the next generation of my presentation company, so I had customers we were planning to bring over to the new system when it was ready. My partners had months of severance from their last startup.

So we were able to self-finance the idea and prototype stages. We talked about raising money via a convertible note, but decided to wait until we had more traction in order to do a larger round and get better terms.

We had the advantage of starting with product market fit because I already had paying customers, so we focused on building what they wanted. We did a pre-announcement on TechCrunch in March 2008 and started getting signups to our waitlist.

We launched six months later in October, and we raised money in December. So our investors could clearly see how quickly users were adopting our service, and we took much of the guesswork — and risk — out of the equation.

2. Figure out how much money to raise

If you’re in the idea stage then shoot for $25k to $50k from friends and family. Or convince your first big customer to pre-pay. Or save up enough money that you can fund it yourself like we did.

At SlideRocket we had a waitlist of thousands of people, both free and paying users (although no real revenue yet), and customers from my previous company ready to migrate.

We built out five years of financial projections and decided to raise $2 million based on projected revenue and headcount.

For companies in our position, Sari Azout — partner at Level Ventures and Entrepreneur-in-residence at Rokk3r Labs — recommends budgeting $15k per person per month for 18 months to cover salary, office space, equipment, general costs like servers, and a margin of error.

So at that rate our $2 million would give us 7.5 people for 18 months, which is more or less what we did with the money. We had two founders at that point and we hired a VP of marketing, a lead developer, a head of QA, an inside sales rep, and a head of business development.

We did, in fact, go through the money in about 18 months.

3. Pitch a ton of investors (including strategic)

Fundraising is a lot like dating, and we had to kiss a lot of frogs (no offense to anyone we met with). The people we talked to fell into two categories: venture capital firms (VCs) and strategic investors.

Strategic investors are larger companies that invest in startups, and we had one big-time Web services firm who found us via our TechCrunch article. That led to a bunch of productive conversations and they ultimately offered to invest.

We were meeting with VCs and other potential strategic investors at the same time. Most of these meetings didn’t go anywhere, and sometimes people were interested but we could tell they weren’t the right fit. One VC wanted us to change both our business model and our behavior — which is a lot to ask of a startup!

We got many of our investor introductions through friends and colleagues. We also hired DLA Piper, a law firm with a big Silicon Valley presence, who helped us with our pitch deck and made a few intros through their startup pipeline program. They cut us a deal where they didn’t charge us until we raised money, at which point we cut them a (big) check plus some warrants that they made money on when we were acquired a few years later.

Sometimes the VCs would introduce us to other potential investors, either because they weren’t interested or because they didn’t want to lead the round. We met amazing people like Tim Draper and Fred Wilson, and we spent a bunch of time on Sand Hill Road.

4. You can solve for % ownership rather than pre-money valuation

When people talk about “valuation” they usually mean pre-money valuation — so how do you know what that is? If you were an established company you could use discounted cash flow — but that’s hard with pre-revenue startups.

The basic fundraising equation is:

Cash Invested + Pre-Money Valuation = Post-Money Valuation

So $2 million of cash invested into a company with a pre-money valuation of $4 million = $6 million post-money valuation.

The shortcut we used was that our VCs wanted to own about 1/3 of our company after the transaction. So that allowed them to solve for the pre-money valuation by dividing cash invested by ownership %.

Cash Invested ÷ Ownership = Post-Money Valuation

So $2M Cash Invested ÷ 1/3 Ownership = $6M Post-Money Valuation.

Now simply subtract the $2M Cash Invested from the $6M Post-Money Valuation to arrive at a $4M Pre-Money Valuation.

The offer the VCs made us was “2 on 4” — meaning a $2 million cash investment on a $4 million pre-money valuation.

We negotiated “2 on 5” — meaning a $2 million cash investment on a $5 million pre-money valuation, which gave our VC 28.57% ownership (their $2 million cash investment divided by the $7 million post-money valuation). So we saved almost 5% of equity.

We were okay with the VCs taking about 1/3 of the company because it gave us cash in the bank plus the social proof of taking money from a firm everyone recognized. One of their partners with operating experience joined our board of directors and was hugely valuable as we grew.

Getting the Best Deal

You’ll get the best deal when you have multiple offers on the table at the same time. We had two VC term sheets in hand plus a $1 million offer from the strategic investor.

Everyone wanted a board seat, so we had to decide between a three-person board (one of us, one investor, and one independent) vs. a five-person board (two of us, two investors, and one independent).

Having three options put us in a great position to negotiate. After some back and forth we ultimately decided to go with a single VC because we were concerned that the strategic investors might restrict our freedom by steering us away from working with their competitors.

Watch Your Exit Price

Also remember to keep an eye on your potential exit price. Your series A investors are looking to get at least 10x their money within 5 to 7 years. That means they’ll want you to sell your company that’s currently worth $7 million post-money for $70 million.

And if your company has a $20 million post-money valuation then you’ll need to sell it for closer to $200 million.

Crunchbase reports that the average acquisition price for startups since 2007 is $155.5 million, so it gets harder to find buyers the further you go beyond that. There are many more companies who can acquire you for $50 million vs. $500 million, so it doesn’t necessarily help you to raise more money.

Keep in mind that Michael Arrington reportedly made more money selling TechCrunch for $30 million than Arianna Huffington did selling Huffington Post for $315 million — because he had raised less money so he still owned 80% of his company.

Next Steps

There’s a lot more to discuss on startup valuations, so I’m hosting a free workshop on valuing your startup this Thursday, 6/22 at 6p ET. You can attend either online OR in our awesome new 10xU learning center in Wynwood, Miami.

I’ll cover additional considerations like:

  • Planning for the option pool
  • Where to find the market rates that investors are paying
  • Avoiding the mistake of self-selecting for mediocre talent
  • And more!

Free RSVP is here: bit.ly/Valuation10xU. Bring your questions!

Written by Mike Lingle — Find more practical suggestions for entrepreneurs at 10xU.com or connect with me on LinkedIn.