Startup Execution

YADM – Yet Another Dilution Model

Any programmer or Linux gear head should recognize the “Yet Another …” family of tools and frameworks. Stephen C. Johnson is credited with creating the first Yet Another tool when he created YACC – Yet Another Compiler-Compiler. Some currently popular Yet Another tools or frameworks include:

  • YAML: Yet Another Markup Language (later rebranded as YAML Ain’t Markup Language) – a data serialization language usually used to capture configuration parameters
  • YANG: Yet Another Next Generation – a data modeling language related to network configuration
  • YARN: Yet Another Resource Negotiator – a component of the Apache Hadoop framework

Not to be outdone, I decided to create another Yet Another tool: YADM (Yet Another Dilution Model) – an Excel spreadsheet to help founders model the expected equity dilution as a startup reaches typical funding events.

Dilution is near and dear to the hearts founders everywhere. Many VCs, accelerators and incubators publish guidance on the typical dilution events a startup will encounter in its life cycle. Several web sites also provide downloadable spreadsheets that founders can use to visualize their expected dilution. Given this, why do we need yet another dilution model?

Well, simply put, the spreadsheets I’ve seen hard-code the financial terms of each funding event. Because every startup negotiates slightly different terms with their funding events, I wanted a tool that had some simple “knobs” that the user could turn to model their dilution given the terms of their specific investments.

Many startups have slightly different variations down the path of equity investments. Creating a custom model for each specific pathway is beyond the scope of this effort. To keep things simple, I built the spreadsheet with the following assumptions common to most startups:

  1. The earliest non-founder employees paid primarily with equity
  2. One round of angel or seed investment
  3. Three rounds of traditional VC investment
  4. The equity pool for the employees gets replenished based on the pre-money valuation — this just means that the dilution from the option pool is taken before the investment from the VCs.

I’ve provided a sample funding scenario in the screenshot of the spreadsheet (download here) below.

Yet Another Dilution Model (YADM)

Let’s walk through how this spreadsheet captures various dilution events:

  1. Row 2: The user enters their specific data points of their dilution events in the orange cells in row 2. These orange cells are the “knobs” that the user should turn to model their own dilution scenario.
  2. Column B: When the startup is formed, the founders own 100% of the equity.
  3. Column C: The founders set aside 7.5% of the equity to distribute to the startup’s earliest employees.  The founders now own 92.5% of the company.
  4. Column D: 10% of the company is sold to angel investors.  The founders now own 83.3% of the company.
  5. Column E: The terms of the series A investment requires setting aside 10% of the equity for the employees that will be hired up to the next round of funding. Because most VCs negotiate this 10% to come from the pre-money valuation, the spreadsheet calculates the amount of equity required to reach the 10% pool post-money. The founders now own 72.8% of the company.
  6. Column F: The series A investment closes, with the incoming VCs purchasing 20% of the company. The founders now own 58.3% of the company. Note: some might argue that column E is not needed since the series A investment is the primary outcome of the investment round. However, I break this out separately to help illustrate the multi-step dilution that happens as a result of the series A investment.
  7. Column G: As the series B investment comes together, the employee option pool needs to be replenished back to the 10% target. The same pre-money valuation terms apply. The founders now own 56.1% of the company.
  8. Column H: The series B investment closes, with the incoming VCs purchasing 25% of the company. The founders now own 42.1% of the company.
  9. Column I: As the series C investment draws near, the employee option pool again is replenished back to a target amount. This is essentially the same dilution math as columns E and G. The founders now own 40.9% of the company.
  10. Column J: The series C investment closes, with the incoming VCs purchasing 20% of the company. The founders now own 32.7% of the company.

Hopefully, this spreadsheet helps you model your expected dilution scenario. Feel free to turn the “knobs” of the spreadsheet by changing some of the numbers in the orange cells of row 2.

My life is complete now that I too have published a “Yet Another” tool …


Startup Execution

Legal for Startups

We all hate working with attorneys. That is, until you need one. And when you find one that effectively advocates on your behalf, you love them more than you care to admit.

Every startup needs great counsel. But few startups set themselves up to effectively use counsel. Some startups avoid using outside counsel out of fear that their limited budgets will quickly evaporate. Other startups leverage outside counsel, but end up overspending because they don’t optimize their engagement model. I have two simple recommendations – one strategic and one tactical – to optimize your legal infrastructure.

Build Your Legal Playbook

Strategically, startups need to position themselves to be acquired. This involves ensuring that your company avoids any agreements that would introduce unnecessary or unacceptable risks to a potential suitor. Most startups don’t have the benefit of in-house counsel, but that doesn’t eliminate the need for someone to play that role. Your executive responsible for your legal infrastructure should be a capable negotiator with a strong understanding of your legal strategy. Though all contract language is important, founders and executives should pay particular attention to three areas: indemnification, limitation of liability, and termination.

Language regarding indemnification and limitation of liability are closely related. You should work with your outside counsel to determine standard language that articulates your preferred and acceptable levels of risk. Your contract templates should include your preferred language. You should also have pre-prepared backup language for higher risk tolerances when business justifies it. Having this content in advance enables your head of legal to negotiate and structure contracts without constantly having to engage outside counsel and running up your legal bills on routine negotiations. Of course, I still recommend competent outside counsel when engaged in special or non-routine legal negotiations.

Termination clauses represent another important consideration in your agreements. Companies enter into contracts with the belief that they are in the company’s best interests. However, a company’s goals may change over time. A partnership agreement with company X may be advantageous today, but disadvantageous tomorrow if company X’s key competitor wants to acquire you. You need to ensure that your agreements provide you with the right to terminate at your convenience, with reasonable advance notice, and with minimal penalties. This gives you flexibility to pivot as your company’s goals evolve over time.

Don’t Leave Home Without It

Most startups envision an exit at some point in the future. For many startups, the exit will involve an acquisition. As CEO, I’ve led corporate development and the due diligence tasks for two separate acquisition cycles. I’ve also been part of an executive team that consummated an acquisition by Cisco. After driving or contributing to the activities and due diligence behind three acquisitions, I can speak from personal experience that the process flows much more smoothly when you run a tight ship on all your legal operations.

Specifically, one of the most important tools that should serve as the foundation of your legal operations is a contract management repository. The opposing legal team will ask for all of your contracts during due diligence. Having a tidy contract management repository enables you to deliver every agreement to the opposing counsel in minutes. I’ve seen companies spend weeks hunting for a few remaining agreements because of poor document management and controls. Combing through file servers and individual laptops for the latest contract templates and the fully countersigned version of agreements wastes time and money. Sloppy contract management ultimately results in delays and higher legal bills. More importantly, it injects unwanted concern into a suitor regarding any potential exposure from acquiring your company. Finally, another potential pitfall of failing to accurately track all of your agreements is that you will miss an agreement and fail to hand it over, exposing the founders or the executive team to legal jeopardy. Due diligence is a fast-paced, pressure-packed time where you don’t want to be pulling your hair out chasing down every last agreement, or creating any inhibitors to your company getting a clean bill of health.

A good platform such as DocuSign or Adobe Sign (formerly EchoSign) will not only provide you with a comprehensive contract management repository, but will also automate the process of contract revisions and digital signatures to fully execute the agreement. Clerky is an innovative startup that helps automate some a startup’s basic legal operations and forms. Regardless of which solution you choose, make sure to use the contract management platform for every agreement including, but not limited to:

  • Articles of incorporation or organization
  • Corporate bylaws
  • Operating agreement / founder’s agreement
  • Shareholder agreement
  • Non-disclosure agreements (which may include non-solicitation and/or non-compete clauses)
  • Job applications and offer letters*
  • Intellectual property assignment agreements*
  • Asset ownership agreement*
  • Employment contracts*
  • Financing agreements
  • Stock option program*
  • Restricted stock agreement
  • Sales contracts
  • Purchase agreements
  • Master services agreements
  • Consulting and professional services agreements (statements of work)
  • Partnership agreements
  • Lease agreements
  • Insurance documents
  • Workplace safety / liability release forms*
  • Employee handbook, code of business conduct, etc.*
  • Board documents (meeting announcements, minutes, resolutions, etc.)
  • Advisor agreements

Items marked with an asterisk are often included in a job offer package.

Closing Arguments

Work with your outside counsel to determine your risk tolerance. Then establish baseline preferred and acceptable language for your contract templates. Then develop a playbook to guide the negotiations with prospective agreements. As you negotiate the agreements, make sure all contracts are stored in a repository to facilitate easy access when needed. Implementing these best practices will ensure a smoothly running legal infrastructure that enables instead of hinders your startup.


Startup Lifestyle

Not Your Baby

Founders are a rare breed. They are driven by a vision of what can be to take risks. Founders often invest years of blood, sweat and tears to build and grow their startup. Given the amount of energy, effort, and sacrifice required, it’s not surprising that many founders consider their startup their baby. Some founders use this metaphor casually. Others use it quite literally. In light of the huge commitment required by a startup, founders have to be careful to maintain perspective and balance: a company is not a baby.

The Fun Toddler Years

It took a leap of faith for me to start my own company back in 2001. It was exciting to watch the small seedling that was my company germinate, take root and grow. The volume of work quickly exceeded our capacity and we began to hire employees and sign multi-year contracts. We nurtured and babied every customer. With a strong focus on providing technical expertise with phenomenal service, we soon grew to several hundred customers.

The Challenging Adolescent Years

And that’s when things got hard. Not every employee was the perfect hire. Not every customer was reasonable, nor did all of them pay their bills on time. As both the Chief Architect and CEO, I split my time designing highly available data centers while also securing financing and lines of credit to fuel the next stage of the company’s growth. We counted several top-15 e-commerce web properties and online marketing companies among our customers, including several with millions of daily transactions and billions in revenue. We grew faster than expected, meaning employees often bravely accepted responsibilities that they weren’t completely prepared for. Good employees rise to the occasion, but it certainly was turbulent at times.

As a first-time CEO, I include myself among the list of employees with more responsibility than ever before. I had to drive corporate strategy, negotiate legal terms, monitor cash flow, analyze markets, deal with angry customers, and ensure that we didn’t over-extend our resources. There were many pivotal moments where the company’s success or failure hung in the balance, and with it, the immediate livelihood of the employees and their families. During these times, stress and anxiety were off the charts. I found myself easily agitated and moody. I worked all the time. I wasn’t enjoying my family. My wife and friends wondered if I suffered from depression.

The Epiphany

Thankfully, I had a great support network. It was through this circle of friends that I got help. Several seasoned gray-hair types gave me perspective. I always considered my company my third child. This was my core mistake. A company is an asset, not a child!

A child is a person, with a beating heart, emotions, and the ability to feel both pain and love. A child is special and needs care, feeding, and connection. In return, a child gives wondrous joys and brings years of fulfillment. Every parent feels this – or at least felt it at one time.

A company is an asset – just like a car, a house, or a stock. Sometimes the asset serves you well and provides a fine return on investment. Other times, the car breaks down, the roof leaks, or the stock you bought loses value. When this happens, you either fix it or you replace it. Though many people spend hundreds of hours building up their car or perfecting their house, these assets don’t love you back. They serve you and we all need them, but they are inanimate objects and can be replaced.

I struggled with this concept at first, but I soon came to realize that life moves on even if your company doesn’t succeed. My wife and kids wouldn’t love me any less. Nor would their love be dependent on the size of our house or the material things in the house. Once I understood and accepted this concept, I was able to install healthier boundaries. I felt liberated. Don’t get me wrong: I still worked very hard to make the startup successful. I still shouldered the same weight, but I was now unencumbered. It was still a significant burden to bear, but I found much more peace and satisfaction with my daily life.

What to Do

We eventually sold our company, so in many ways it was a success. However, the business world is littered with stories of entrepreneurs who amassed small fortunes, but failed to find satisfaction or worse, lost their family in the process. A Google search on “deathbed regrets” is sobering. Click through the search link. Read several of the articles. Though death may seem far off for most, you shouldn’t wait until the end of your days to start living life to the full. Drawing healthier boundaries produces a harvest that you can enjoy now.

Every situation is different. Every founder has different skills, values and motivations. Every company has different strengths and weaknesses. But every employee in the company, from the largest stockholder to the entry-level new hire is a person. And every person needs to establish the right priorities to guide their life and their decisions. My advice to every aspiring startup founder is to seek a trusted group of seasoned and successful counselors to guide not just your company, but to guide you as a person first and an entrepreneur second.