Posts tagged ‘Paul Graham’

September 23, 2012

How to allocate the Option Pool?

The only currency a startup has other than cash which you need to run the daily experiments to find the Product to Market fit and to build a Minimum Viable Product is Equity. I find that many founders and technical team members struggle with understanding Equity believe me it took me a while to figure this out, however once you understand what Equity is and how it can be used, one stumbles on how you should allocate the equity.

As founder(s) I presume there is more than one, you own majority of the equity in your business although it is worthless at this time and you own all of it. If you are successful in raising money ie cash, the investor substitutes his cash for equity in your business, typically when companies are formed you have a said number of shares… in Iceland it is 500.000 (five hundred thousand shares) and usually you are suppose to post cash against it and show it in your Balance Sheet when you register the company or file with the company registry. The company can issue more shares and each share is valued either by the cash that you can generate operating the business or if an investor comes in with money and values the shares at a certain rate. If you have followed me so far, then you are doing much better than how I felt when this was explained to me a long time back.

Anyways, moving on… now you have equity ie. shares in your business and you need to hire a top talent, you want to conserve your cash because you are still iterating and have not yet reached break even i.e your expenses does not equal your income. You use the next currency to attract talent, i.e equity or option pool. You can either take a portion of the equity and allocate it to the role that you plan to hire as part of the compensation package or you can allocate a certain percentage of the option pool. Option pools are formed when the existing share holders decide to take a percentage of the equity and set it aside as a pool to attract talent into the business. The actual pool size depends on the shareholders etc me and my partners in AIP usually are generous with this allocation, we don’t scrimp on this because we believe in order to hire top talent you need to provide top potential upside for their time and effort. So, how do you determine the pool size or allocation within the pool? I have not found a better explanation than Paul Graham‘s post on “Equity Equation“, it is a long post but it is worth every word a read and a re-read. Here are some excerpts, all the answers to allocation comes to a simple equation:

1/(1 – n)

Whenever you’re trading stock in your company for anything, whether it’s money or an employee or a deal with another company, the test for whether to do it is the same. You should give up n% of your company if what you trade it for improves your average outcome enough that the (100 – n)% you have left is worth more than the whole company was before.

For example, suppose you’re just two founders and you want to hire an additional hacker who’s so good you feel he’ll increase the average outcome of the whole company by 20%. n = (1.2 – 1)/1.2 = .167. So you’ll break even if you trade 16.7% of the company for him.

Let’s run through an example. Suppose the company wants to make a “profit” of 50% on the new hire mentioned above. So subtract a third from 16.7% and we have 11.1% as his “retail” price. Suppose further that he’s going to cost $60k a year in salary and overhead, x 1.5 = $90k total. If the company’s valuation is $2 million, $90k is 4.5%. 11.1% – 4.5% = an offer of 6.6%.

And more generally, when you make any decision involving equity, run it through 1/(1 – n) to see if it makes sense. You should always feel richer after trading equity. If the trade didn’t increase the value of your remaining shares enough to put you net ahead, you wouldn’t have (or shouldn’t have) done it.

You can see how this can be plugged into a performance management process within your team. The above equation and method is very effective. You allocate the options based on the level of contribution the team members make and if you make the measurements simple and visible, it makes the compensation system transparant, aligns and motivates the team as well. I have a philosophy when it comes to recruiting and compensation, all the benefits, salary, options etc is only for the team members to show up… in order to build a winning team everyone needs to volunteer their hearts and minds. The simple parts of making the team to show up is easy the hard part is to find a purpose or cause that is so important and bigger than each of us that it makes the team aligned and enables them to volunteer their most valuable resource which their hearts and minds. How are you making your team volunteer their hearts and their minds?

September 14, 2012

Picking winners in a farm of Black Swans

I love probability and statistics, yes I am weird. The whole notion of me starting to invest in Startups and Entrepreneurs started when I was mindlessly searching the Internet for Power Law examples and bumped into Fred Wilson’s blog post about Power Laws and returns in VC investing. I wrote a paper a while back on how every Aggregate Economic Variable more or less follows a Power Law like distribution and I took the case of the Icelandic Krona. There is no revelation there for

those of us who have been looking at this but for the mainstream this is news. Nassim Taleb wrote a book on this and it did quite well. Now Paul Graham has written about “Black Swan Farming” and at the same time Nassim Taleb is advising anyone wanting to go into the Investment Management business to stay away! This is all very interesting given our Icelandic context. I meet investment manager and VC investors all the time and I am just dumb founded when I hear them talk about how they can pick winners and they are doing a great job at capital allocation… what a bunch of crap! No-one knows, this is a crap shoot and I am happy that Paul Graham came out and said it. So what does one do? I wish I had enough capital to take bets on all the startups and entrepreneurs being formed in Iceland because there is no magic bullet to pick a winner, as Paul says in post:

The probability that a startup will make it big is not simply a constant fraction of the probability that they will succeed at all.

The fact that the best ideas seem like bad ideas makes it even harder to recognize the big winners. It means the probability of a startup making it really big is not merely not a constant fraction of the probability that it will succeed, but that the startups with a high probability of the former will seem to have a disproportionately low probability of the latter.

Wait, it gets worse. You not only have to solve this hard problem, but you have to do it with no indication of whether you’re succeeding. When you pick a big winner, you won’t know it for two years.

Meanwhile, the one thing you can measure is dangerously misleading. The one thing we can track precisely is how well the startups in each batch do at fundraising after Demo Day. But we know that’s the wrong metric. There’s no correlation between the percentage of startups that raise money and the metric that does matter financially, whether that batch of startups contains a big winner or not.

There is only one way to build a startup ecosystem, winners from the previous generation in the community need to invest back into the community. I wish more of Icelandic successful entrepreneurs would invest back into the new generation. Maybe the problem is that there has not been a big enough exit for that to happen or maybe it has, but I see a huge potential for Venture Backed investments in Iceland because every Entrepreneur I meet could be a winner, I wish I could pick a winner. I know I cannot, I am at peace with that… I pity those who think they know better.

September 7, 2012

What does it mean to Execute?

I was very impressed with the blog post by Ben Kaufman titled “What Raising Money Means to Me“. I believe personal stories tied to the ups and downs of building a business are always fascinating to read. Ben is young, went through the Paul Graham’s Startup Curve and I believe has had his awakening. You can see it in his passion and language About Team

My grandfather called me to congratulate me on building a successful company. We still hadn’t done shit. We just got some dude to write a check.

Things I have learned from closing rounds & announcing funding:

  1. Be bigger than your round: If the press is only writing about how much money you raised, it’s because you haven’t done anything bigger. That’s on you and your team. Work your ass off to make sure the money is not the news. You should be really fucking uncomfortable if the money you raised overshadows the work you’ve done. It scares the shit out of me every night. Still does. Don’t rest on your round. Fight your round, be bigger than it. Make people forget that time you raised money.
  2. Lead through it: The way you carry yourself through the announcement of a financing has a huge effect on your team and community. If you pretend it’s the coolest biggest deal in the world- they will too. Suddenly, all the hard work they are putting into launching a new product is out-shined by the fact that you got someone to write a check. As some illusion of success is felt, the collective level of hustle will naturally wane.
  3. Be insecure: When I sign a term-sheet, I get angry and uncomfortable. “Shit, ok no excuses anymore–I gotta do this.” There is an immense sense of responsibility. Let your team feel your stress, your angst, your hunger. The passion of all around you will go through the roof. People won’t just throw money at problems, they’ll work with the same scrappiness and drive that got you this far. You don’t have to pretend you’re a big fucking deal. You’re not (yet). Be insecure.
  4. Congratulations: Don’t congratulate people for raising money. That was never the goal. The goal is building a successful and meaningful business. When people raise money, instead of congratulating them, wish them luck. Their work is just getting started.Congratulating people for financing perpetuates a problem that has plagued the startup world. The problem is that that it’s easy to focus on the hype surrounding a company, and lose sight of the fundamentals. This is why our industry is flooded with what I call “startup fuckers.” These are people whose only ambition in life is to raise money, and then sell their company. They have no real interest in building a meaningful and enduring business. If we let startup fuckers dominate, we all lose. Read TechCrunch and any other “deal blog” and you’ll see countless companies boasting about how much money they’ve raised and how great they are as a result. It’s bullshit. They’ve done nothing (yet). Don’t fall into the trap of congratulating them. This is my favorite startup quote of all time (although I don’t know who said it): “Congratulating an entrepreneur for raising money is like congratulating a chef for buying the ingredients.” That says it all.
  5. Put your ass on the line. Lay out clear goals for your users and staff as to what you hope to achieve with this round of funding: why you’ve raised the money, what you’ll do with it, and how the collective performance of everyone involved can be measured. Even if the money is news in the short term, you’ll have something to point to. “Judge me on this.” Some say under-promise / over-deliver. That’s fine. But do promise something, otherwise everyone will make up their own mind about how much your round should let you accomplish.

The above 5 points says it all. I have written a lot about not putting emphasis on raising money, it is distracting and gives a wrong sense of accomplishment. I think every startup should be focused on building something of value, solving a tough problem, don’t give into the hype of TechCruch or the Media although I think the Media and everything else comes to you when you are able to really Execute on the solution to the problem that your startup was founded on. Being an Entrepreneur is always about juggling priorities and ensuring that you are making slow progress but one cannot take the eye from the ball about Executing on the promise to your customer, your partner or your investors. That is what I saw in the post by Ben. Having the discipline to Be Bigger than Raising Money is hard when you are 25, I really take my hat off to Ben Kaufman. I wish all entrepreneurs to learn the same wisdom.

July 29, 2012

Framework to build Great Companies

Source: Good to Great by Jim Collins

A framework is more like a guide, it does not tell you how to walk the path but gives you guideposts on what you should focus on. Building great teams is the bedrock of building great companies. I have mentioned many times that when you are investing in a startup, the team matters a lot. Building great teams that execute is an important necessary condition. All other things you can change but the team dynamics is critical, it is hard to encapsulate and constant changes in team members and structure always leads to confusion and delays progress.

I believe the framework build by Jim Collins in his Good to Great book clearly articulates what I mean. The first stage in all great companies before they became great was the build up of disciplined people. Without disciplined people all other things falls apart, what do I mean by disciplined people? I can sum this up in one sentence, disciplined people are those who Make and Keep Promises. It is as simple as that. If you one can build a discipline to do that one can get disciplined in anything. There are a number of qualities that are required to be disciplined, I like :

  • Relentless
  • Resourceful
  • Resilient
  • Responsible
  • Respects other opinions

This is by no means an exhaustive list of attributes that comprise the winning team, however it is a good start. Paul Graham wrote a very interesting post about being relentlessly resourceful, he was of course referring to startup founders. I think the concept can be applied to anyone. I would like to be in a team that is relentlessly resourceful, that is resilient ie. when adversity hits the plan the team has a way to stand up and keep moving forward. Responsible is another word that I really like Dr.Steven Covey talks about this a lot in his books, the word responsible can be broken into Response-Able ie. have the ability to respond. Respecting others is not a nice to have but a must have quality. No-one knows everything if you want to win in the market place you need to bring people together who can compliment each others weakness. Thats the way winning is done! I wanted to leave this blog post with words of wisdom from a very famous philosopher Rocky Balboa.

The world ain’t all sunshine and rainbows, it is a very mean and nasty place and I don’t care how tough you are it will beat you to your knees and keep you there if you let it. You, me or nobody is going to hit as hard as life… but it ain’t about how hard you hit, its about how hard you can get hit and keep moving forward, how much you can take and keep moving forward… Thats how winning is done!

March 22, 2012

SXSW update – 8th Lean Startup Meetup

Cover of "Minority Report [Blu-ray]"

Cover of Minority Report

Kristjan Freyr Kristjansson was at SXSW2012 and he gave a brief talk about the show and more importantly shared his thoughts on attending many of the Lean Startup Panel. The summary of the SXSW update was:

  1. It is very noisy, crowded and advertisements everywhere – it would be impossible to get your startup noticed or even to meet someone and follow up on the conversation. It is a fantastic place to get connected for the first time through the parties hosted by various brands, Kristjan particularly liked the one hosted by Startup Weekend, TechStars and Google.
  2. Have a plan with regard to what you want to achieve when you attend SXSW, and it is something every startup/entrepreneur should experience once
  3. There is an opportunity to have a big Icelandic contingency in the next SXSW, as the planners of the SXSW really liked the Thojdfunder National Assembly that was organized in Iceland and they would like to tap into the crowd of brilliant entrepreneurs and people focused on solving challenging problems attending SXSW next year and apply the same approach that was applied in Iceland. Gudjon Mar and Gunnar Holmstein were the instigators. I fully support the initiative lets see if we can gather enough people in Iceland to support this initiative and show some strength from Iceland next year in SXSW.
  4. There were some very exciting interactive advertisement focused software that had face recognition software and based on your online profile was able to display ads that were targeted. The technology is here and it is just a matter of time before it becomes mainstream. The advertisements on the subway in Minority Report when Tom Cruise was running is going to happen sooner than you think.
  5. There were many formats for the Lean Startup sessions, some of them were led by Eric Ries, but there were others where different startups shared their examples of applying the Lean Startup Principles. Kristjan, thought it was so incredible to be see so many startups starting to apply the lessons and are learning fast and pivoting into valuable solutions. It is amazing to me why this has not caught on sooner here in Iceland, we have a long way to go here.

The general discussion centered around how we can experiment and validate hypothesis, Kristjan shared the link to the Lean Startup Experiment website The 5 minute corner was taken by Helgi þor Jonsson, Helgi has been following a blog site and how he has taken the first step to becoming an entrepreneur. He has started working on a prototype of a Project Management Platform for volunteers and non-profit activities. His insight working with this blog site is the concept of 30 x 500, which is get $30 from 500 people then you have a business or $500 from 30 people. He has been taking the online course which is almost over and he would be ready to move on to the next stage of launching his product.

We discussed a lot about how to raise the bar on Startups being created in Iceland. Of course there were many suggestions, Gudjon Mar was of the opinion that we need to have big wins to establish a precedence that successful and profitable startups can be created out of Iceland. I feel we need to go one step further, successful and profitable startups need to created in a faster pace. We need to accelerate the process to actually make an impact and change minds in Iceland. I believe that if we can focus the entire startup community to pick topics from Paul Graham‘s Ideas that YCombinator will invest in and basically build companies for those problems we will get somewhere with the culture here. We need to make it attractive for someone to invest in, nothing against someone wanting to start a coffee shop it just does not create a buzz for Angel and Venture Investors to get excited about.

March 8, 2012

How to make your startup survive

photo of Paul Graham

Image via Wikipedia

The post is motivated by the answer I saw in Quora to a question that went like this “Where is this startup hype going to end?” The author went on to describe why he wants answers to the above question. His premise was that everyone and their mother is starting a startup and that is a clear indication of a boom and even people who know nothing about Internet are working on something. He was more interested to learn about How is this trend going to evolve, how is it affecting our society and where will it end up? All valid and relevant questions but these should be the least of the worries of any startup. The biggest worry should be how well you are iterating the Build-Measure-Learn cycle to improve your Product-Market fit and how quickly are you scaling up your customer base, market share and revenue, in addition, how efficient are you with the cash in the bank so that you can continue to extend you runway. Remember the biggest challenge a startup faces is Running Out of Money! the usual stuff.

I really like the top answer on the topic as well. If you have time go read it, it is insightful but I don’t really agree fully with the assessment that Interest Rates drives the engine of the startup world, sure it helps a lot when the cost of capital is low to be able to raise money but the biggest value while building a company is how cheaply you are able to run the business. The author to the answer refers to Paul Graham‘s Cockroach Essay. It is one of the classic essays from Paul Graham. I could not agree more to that essay, the reason a startup succeeds or fails is 99.99% dependent on the quality of the founders. This means “what matters is who you are, not when you do it. If you are the right sort of person, you’ll win even in a bad economy. And if you’re not, a good economy won’t save you.” The second point that Paul makes is how to make your startup recession-proof, it is “exactly what you have to do anyway: run it as cheaply as possible“. The most important lesson in building a startup is getting into the discipline of bootstrapping and Paul puts it “be the cockroaches of the corporate world. The immediate cause of death in a startup is always RUNNING OUT OF MONEY. So the cheaper your company is to operate, the harder it is to kill. And fortunately it has gotten very cheap to run a startup. A recession will if anything make it cheaper still”. Paul wrote this in October 2008, It is even cheaper today to run a company.

I distinctly remember those days in October when the whole financial system in Iceland had just collapsed and I got fired, one of the most liberating and conflicting experiences of my life. I need to thank the one who decided that I am not worth being part of the “team”. I did not do the conventional wisdom thing of either going back to school or trying to get another job. I did what Paul recommends that is be an Investor when the times of tough. I had no money, but found ways to raise the money convinced my partners that we should be building equity when the times are bad. The jury is still out on whether the decision was right or not. But we run a very tight ship with our operations, our partnership in my opinion has the lowest cost to run, it is about 0.6% of the capital we have invested. I know that we are cheaper in running our investment company than even Vanguard. This last couple of years has been a humbling lesson in building my discipline to endure the pain and sacrifice. I don’t have any sympathy for anyone who wants to do a startup but does not want to sacrifice. Like they say it is like running a Marathon, there is no short cut.

March 6, 2012

Incubators vs Accelerators

There is a fundamental difference between an Incubator and an Accelerator. Here is a video interview where Brad talks about the difference between Incubators and Accelerators. 

An Incubator gives you real estate i.e table, chair, meeting room and power socket, internet connection, a coffee machine and/or a foosball table in exchange for rent. This has been the traditional model, and I believe the economics of this model does not work. You are trying to get rent from an Entrepreneur who is struggling to get his economic engine going. Some incubators actually take Equity + Rent for providing the above, that is just wrong!

Image representing TechStars as depicted in Cr...

Image representing Y Combinator as depicted in...

Image via CrunchBase

TechStars Result

To make a point, Iceland has a bunch of Incubators but no Accelerators! Most Seed/Angel investors when they invest in a Startup fund for all the above. I think that increases the risk to the Entrepreneur and the Investor. Think about it, every Entrepreneur needs to build a network, tinker with the Product-Market fit and build a business when operating in an environment of extreme uncertainty. This is what I believe increases the chance of failure. When I bring this topic up in Iceland, everyone comes to the defense of all the support that exists for Entrepreneurs, I don’t doubt that or challenge that but the help is in the wrong direction. I want to bring attention to the successful Accelerators of TechStars and Y-Combinator. Lets look at the numbers:

Companies selected through the program: 104
Failed: 8
Acquired: 8
Total Capital Raised by Companies: $126,392,305
Number of jobs created: 645
Timeframe: 5 years
Y-Combinator is by far the most successful Seed Funded Accelerator out of Silicon Valley. Paul Graham the founder has blogged about the results. He looks at the result differently. The total value of the companies that have gone through Y-Combinator according to Paul is $4.7 Billion.
I think Iceland needs an Accelerator and we are working on establishing one!
December 15, 2011

Strategy execution – Reboot Iceland

I have written about My vision for Iceland and why some of the current strategies being explored in Iceland will not work. How do we restart the entrepreneurial system? I have been doing a lot of thinking about this since I started working with Entrepreneurs in Iceland. So what do Icelandic entrepreneurs need?

  1. They need organized Seed/Angel investors and capital to help them through the valley of death
  2. They need active Mentoring
  3. They need a bridge to a bigger market
I have been making the rounds trying to convince institutions in Iceland that in order to reboot Iceland we need new companies that are solving the problems of the future. We need an active privately funded Venture Capital company that helps entrepreneurs through the above stated 3 challenges. I have been working with the two incubators in Iceland Innovit and Klak, to partner with and launch a Tech Stars model through them. The biggest problem has been making people/institutions believe that something like this can be done here in Iceland. So what is new? every entrepreneurs goes through many nay sayers until the nay sayers are wrong.
The private VC company will fund the running of the Tech Stars program, and will fund 10 startups each year for a period of 3 intense months of mentoring, training and getting their idea formulated into a Minimum Viable Product (MVP) or an invest-able business plan. At the end of the 3 months, each company will pitch to an audience of accredited investors and get funded.
Image representing TechStars as depicted in Cr...
Image via CrunchBase

Why Tech Stars? I believe it has the right ingredients for making this model work in Iceland. Tech Star is a mentorship driven accelerator that brings the local community into the fold. The track record of companies coming out of the Tech Stars program is incredible and odds defying. The mentors are volunteers and they are solicited based on their experience, success and on being entrepreneurs. I have spoken to a bunch of people in Iceland who qualify to play the role of mentors and most of them have shown a lot of interest to participate. A Tech Star affiliated program provides the network needed to bridge the gap from Iceland to the rest of the world and the company will also have a stamp of approval to the VC community at large.


Get every new post delivered to your Inbox.

Join 3,812 other followers

%d bloggers like this: