The best part about being in the start-up community is watching other start-ups. Almost every week, I learn about a new company that stops me in my tracks and makes me say, “Damn, that is so obvious. ABC company is going to forever change the way we do XYZ.” Here are three companies that have given me this reaction.
Venture capital was created 56 years ago. Before Eugene Kleiner’s shot-in-the-dark letter that landed on Arthur Rock’s desk, there was no institution for funding smart people with new ideas. That changed when Rock connected Kleiner and 7 other colleagues with Sherman Fairchild. Fairchild invested $1.5 million into the 8 transistor scientists to create Fairchild Semiconductor. Fairchild Semi was a success, at first, but soon the founders left because they did have enough equity. Two Fairchild employees - Robert Noyce and Gordon Moore - went on to found Intel. (To learn more about the fascinating history of VC and The Valley, check out this interview and the movie Something Ventured.)
Venture capital was a tectonic innovation in finance. But in the last half century, not much has change: VCs raise money from Limited Partners and invest in young, un-established companies with mountains of potential. In fact, the major innovation has been the rise of secondary markets like SharesPost and SecondMarket. These exchanges give shareholders of private companies liquidity, which is great. But these markets have not changed the fundamental way in which early stage ideas get funded.
The way that VC offered equity financing for early stage companies, Kickstarter offers working capital finance. This is huge. Before Kickstarter, working capital finance was restricted to established companies that had good relationships with banks. Now, a company with a novel product idea can create a Kickstarter campaign and pre-sell units. Since the company receives the money before shipping the product, they have capital on hand to deliver the promised product.
In short, Kickstarter gives early stage entities a form of finance that did not previously exist for them. The key question is will Kickstarter launch a billion dollar business? Naysayers say no way; Kickstarter is for crafts and movies. I say, if Kickstarter was around in 1976, Jobs and Wozniak would have created the “Apple 1” campaign.
Look at the data. Texting is on the rise; voice calling is on the decline. Recognizing this, TalkTo created an app that allows anyone to text any question to any business. Want to know if Whole Foods has your favorite microbrew? Launch TalkTo, select Whole Foods, and shoot off a text. Running late for a dinner reservation? No worries; TalkTo has your back.
I was in New York City this weekend and used TalkTo half a dozen times. It worked flawlessly. I was able to get a restaurant reservation, change said reservation, and double check that we would be seated outside.
Within one day, TalkTo inserted itself between me and every business that I interact with. In other words, TalkTo -- not the restaurant, bank or hotel -- owns the relationship. This is incredibly powerful: owning the customer relationship is the holy grail in business. In the insurance industry, for example, brokers and underwriters constantly struggle to own the policyholder relationship. Owning the relationship enables companies to better understand customer needs and ensure quality interactions, leading to customers that stay longer and buy more.
By building a simple app that delivers as promised, TalkTo is poised to change the way that people find information about and interact with companies. What company recently did that? I’ll give you a hint. It starts with a “G” and ends with an “oogle.”
I love services that create marketplaces. The two most recent examples are Airbnb and Uber. Airbnb looked at the world and said how can we connect supply (people with spare beds) with demand (people looking for an inexpensive place to stay). Uber did the same thing, connecting underutilized Town Cars with people seeking reliable and convenient car services.
GigWalk is connecting businesses that need market research with people looking to make a few dollars. A brand - think Colgate, P&G, etc - needs to understand (or audit) how its products are being placed on the shelf at retailers. The brand could send in a dedicated “secret shopper,” which is costly and logistically challenging. Or, the brand could use GigWalk to push an alert to anyone in the area and ask them to simply take a photo of the Dental Section.
I particularly like GigWalk because it is an everyday product. A simple trip the grocery store or Starbucks or a restaurant could net a GigWalker a few dollars. In short, GigWalk looked at the world and said how can we use existing tools to mobilize people to solve a business challenge.
Splitting equity is typically the first business challenge that founders face. The first hours, days or months of a start-up are exhilarating - intense brainstorming sessions shape the product and market research reveals the size of the nut you're cracking. You and your partner(s) are excited and decide to take the leap and start a company. How will the equity (or ownership) of the company be divided? Most founding partners simply split the pie evenly, so two partners own 50% each, three own 33.3% each, etc.
Recently, a friend came to me with this problem. He was working on a mobile application with two people and they had not yet decided how to split the equity. He also needed to attract talent, so keeping equity on the side was necessary. For the first hour, we just threw numbers out there and framed everything from the vantage point of "what would my friend be left with." We eventually drafted a structure but it just did not feel right. It was formed from a hunch and WITHOUT any analysis. It could not be defended.
I thought about the meeting for a day or two. There just had to be a better way to split the pie. So, here is what I came up with. It is a two step approach that, first, weights the functions of the company and, second, applies a percent score that each founder brings regarding that specific function. I have shared the template on Google Docs, so feel free to use. (If you have trouble finding it, the title is: Framework for Calculating Equity in a Start-up.) Here are additional thoughts on this approach.
In terms of my friend's start-up, I defined the functions/components as the initial idea, technology, business development and business operations. I applied a weight to each component. Since ideas are, well, just ideas, I gave that a 10% weighting. Technology got a 50% weighting due to the fact this was a mobile application that would live or die by the design of the product. Business operations and business development were equally weighted at 20%. It was then up to my friend to figure out what percent of each function the founders brought to the table. Using my friend as an example, he had the initial idea and was going to be responsible for for all business development and half of business operations. Thus, his stake should be worth 40% (100% of idea @ 10% + 100% of biz dev @ 20% + 50% of biz ops @ 20%).
This approach creates a defensible split based on analysis of the company and the strength of the partners. It is important, however, to not simply accept the end number as gospel. After all, we cannot forget the last time analysts put full-faith into models (see Rating Agencies 2008). So before you go use this model, here are a few key notes:
First, the founders should decide together what each function of the company is worth. Doing so, increases buy-in to the process.
Second, remember that there are subsets for each function. Take technology, for example. There is a need for user interface talent, database talent, Android/iOS talent, etc. If need be, use the template to calculate the value for specific subsets and then use a second template for the full company view.
Third, use the modeled number as a starting point. I suggest being creative and using milestone approach to divvying out equity. Take for example a company that needs to fulfill 30% of technology talent. It would be crazy to recruit a partner and give that person 30% from the start. Instead, give him 5% and a plan to obtain the additional 25% by hitting two or three milestones. This way you are protected from an under-performing partner controlling a disproportionate amount of the company. Here is a great article about this very topic.
I'm the Founder and CEO of Peak Support. This blog is my take on early-stage companies and innovation. Every so often, there may be a post about culture, networking, family -- you name it. After all, what is a blog if it isn't a tad bit unstructured.