2. What is my startup worth?
Google The Berkus Method of Valuation
3. If Exists: Add to Company Value up to:
1. Sound Idea (basic value, product risk) 0 to $500,000
2. Prototype (reducing technology risk) 0 to $500,000
3. Quality Management Team (reducing execution risk) 0 to $500,000
4. Strategic relationships (reduce market / competitive risk) 0 to $500,000
5. Product Rollout or Sales (reduce financial /production risk) 0 to $500,000
Note:
• Used to set pre-revenue valuation for a start-up that has potential of reaching
over $20 million in revenues within five years:
• These numbers are maximums that can be “earned” to form a valuation
• The average value of an early stage startup in US is 1.5m
4. An Example
YOUR COMPANY Value
Sound Idea 300
Prototype 100
Quality Management Team 100
Strategic Relationships 0
Product Rollout 0
Value 500,000
5. 1) What stock options are
• A stock option is a financial instrument which gives its holder the right— but no
the obligation — to buy an underlying asset (common stock of the company) at a
predefined price called the strike price, at a given time (whenever after the
vesting period).
• When granted, their strike price is usually the market value of the common stock.
• The options are at-the-money, their intrinsic value is zero, and all their value is time value.
• You would profit nothing by exercising the options, since the price at which you
could buy and sell the stock is the same (strike price = market price)
• But the options are still worth something because the price of the common stock
might be higher in the future (the time value).
6. What determines their value
1. Volatility of the price of the underlying asset — how much it can change
by time unit — ; and
2. Time to exercise. The higher the volatility and the longer the time to
exercise, the worthier the option (options benefit from the positive
scenarios and are not harmed by the negative ones because the holder
will exercise them — pay the strike price — only if it is worth it).
• For startups
• the time to exercise (let’s say 3–10 years) is very long
• volatility is extreme (the price could easily go to zero or could not-so-easily-but-not-
impossibly go to billions), the combination of both can be explosive
• Hence, the time value of stock options is large.
7. 2) What stock options are for
• To compensate employees economically:
• Market salary
• Cash
• Options to fill the gap
• To align employee incentives with shareholders:
• employees can benefit from the increase in stock value and they can theoretically
influence it with their work, they will be motivated to work harder/wiser/better.
• To retain employees
• vesting mechanisms (e.g. one year cliff and three years vesting)
• employees are motivated to stay in the company at least until the time when they
will be able to exercise the options.
8. 3) What startup stock options are worth
• Value of a stock option is the sum of its intrinsic value and its time
value.
• Stock of an early-stage startup has practically no intrinsic value
• Intrinsic value meaning in this case the discounted value of all future free cash
flows generated by the company
• Since the possibility of the company generating free cash flow is still a very
remote possibility in the far future.
• All their value is time value.
9. EIA Example
• You have an awesome idea EIA and great
• You all work hard for the first couple of months until your partner decides to walk
away for any reason. You really believe in this idea and keep working hard for
more time until things start to work out and you sell your company for a 200
million dollars.
• Next morning your phone rings. It’s your old partner asking for his $100 million
because of the 50% you had agreed when both of you founded the company.
• Wait! What? An exit does not only mean to sell your company, it is also the sign
hanging on top of the door through which your partners can walk away with your
equity.
• If things like this happen, they can really jeopardize the possibilities of success of
the company.
• This is why vesting is so important.
10. 4) Assigning stock
• Determine the market value of the company ( 500,000 )
• Determine the market compensation for the role (e.g. $50k/year).
• Determine how much you can/want to pay in cash (e.g. $20k/year).
• Determine the gap (e.g. $20k/year).
• Determine for how long this gap should be covered.
• 4 hours per day at 10 per hour
• 20 hours week
• 26 weeks in 6 months or 520 hours
• 5200 worth of value or approximately 1% of the value
11. Simple Example
Founder A 5,000,000 25%
Founder B 5,000,000 25%
Founder C 5,000,000 25%
Employee Options Allocated 5,000,000 25%
Employee Options Issued 0
12.
13. What is founder vesting?
• Vesting means that at the very beginning each founder gets his or her
full package of stocks at once to avoid getting taxed for capital gains;
• but, the company has the right to purchase a percentage of the
founder’s equity in case he or she walks away.
• This means that if your partner walks away after a couple of months,
he or she will not be able to claim those 100 million dollars because
the company purchased his or her equity when he or she left the
company.
• In essence, vesting protects founders from each other and aligns
incentives so everybody focuses towards a common goal: building a
successful company.
14. 4 Years with a 1 Year Cliff
• Standard vesting clauses typically last four years and have a one year ‘cliff’.
• This means that if you had 50% equity and leave after two years you will
only retain 25%.
• The longer you stay, the larger percentage of your equity will be vested
until you become fully vested in the 48th month (four years).
• Each month that you actively work full time in your company, a 1/48th of
your total equity package will vest.
• However, because you have a one year cliff, if one of the founders leaves
the company before the 12th month, then he or she walks away with
nothing ; whereas staying until day 366 means you get one fourth of your
stocks vested instantly.
15. Vesting Example
• Company has traction and raised seed round from angels during month 24.
• Equity was divided 35% for yourself, 35% for your partner and 30% for the
angel investors.
• If your partner walks away she will hold 17.5%.
• What happens with the other 17.5%?
• Nothing. It virtually disappears after the company has repurchased it from
your partner.
• When the company was registered, a fixed number of shares- usually
2,000,000- were issued to cover 100% of equity.
• If the previously mentioned example occurs, 350,000 shares vanish
representing that 17.5%, bringing down the total to 1,650,000 shares. All
the other shareholders benefit because now they have a larger percentage
of the company.
16. What triggers vesting
• There is a chance that your company gets acquired before the founders are fully vested.
In this case, your vesting literally accelerates until all – or at least most- of your shares
get vested. There are two types of accelerations: single trigger and double trigger.
• Single trigger accelerates between 25% to 100% of your unvested shares in case your company
gets acquired.
• In case less than 100% of your unvested shares become vested, your vesting period will remain unchanged.
• Double trigger acceleration occurs whenever your company gets acquired and at the same time
your employment at the company gets terminated.
• Usually entrepreneurs include vesting clauses when incorporating the company or raising
a financing round.
• Nonetheless, I recommend doing it whenever you and your partners feel you have all
officially begun working on the company.
• Sometimes there’s a delay between working (coding, planning, etc) and incorporating the
company. I personally recommend doing the not-so-official napkin vesting document so
you are all on the same page from the very beginning.
17. The “Term Sheet Without a Meeting” Team
• CEO had a huge recent exit and wants to do it again
• He or she is joined by a killer group of executives
• They have all worked together and are a proven execution machine.
• Business execution is the biggest risk investors face. Tech is (usually)
the smallest.
18. The Really Strong Team
• CEO has been a CEO, raised capital, and had some success
• Founder/CTO and CEO have a good relationship, they have mutual
respect.
• CTO has great technology and is in market having some success
• If a company is attracting highly talented people, that is a great
indicator.
19. The Sufficient “Backable” Team
• First time co-founder is the CEO. (credible, high energy, etc.)
• Co-founder is a strong tech person recognized in their field.
• The largest business risk point has a seasoned person in place.
• VC investors will take some team risk, but the need to show business
traction increases dramatically with team risk
20. The “Needs Serious Traction” Team
• First time CEO
• Inexperienced Team Underneath
• Lots of passion and energy – high potential.
• The only antidote for this team is serious traction and boostrapping
21. Team Formation Advice
• Let the business risks drive team composition
• Aim high and network furiously.
• Turn a “No” into an advisor.
• Hire A’s who you personally connect with and reference check
relentlessly.
• Don’t hire a jerk no matter how great the need.
• Use prospective investors to help source team members – They are
more likely to fund you if someone from their network joins.
• “It is a bit early for us” actually means “Given this team, we need
more evidence”.