The Equity Equation

The math equation is correct, but the likely outcomes are nearly impossible to estimate. I have been on the management team of 5 startups and advised many others. There are some "norms" and guidelines for how much to raise at each stage, how much equity to give up, and even how much stock to grant employees as you grow the company.

I wrote an in depth blog on these questions, too long to detail here, but Paul is on the right track. For more details see How much Equity for Investors and Employees?

http://dondodge.typepad.com/the_next_big_thing/2007/08/how-m...

http://www.nosnivelling.com/Paul Graham equity formulas.xls

If all I am looking for is financial independence (say $3M), why would I trade an 80% probability of success for a 5% probability of achieving 100 times that by selling out to VCs?

Sure, my expected return is 6 times greater, but now I need approximately 31 (=log 0.2 / log 0.95) bites at the cherry to guarantee an 80% probability [1] of success. That's 6 lifetimes of startups for a serious serial entrepreneur (most of us have energy for one, maybe two, startups).

Unlike VCs, who invest in a portfolio of companies, I don't have a portfolio of lives.

[1] This assumes only two outcomes from a VC-backed company: zero return or $300M exit. Obviously there are a range of returns, but this is a reasonable approximation since VCs have no interest in seeing low returns - they'd rather kill the company than waste their time.

"The reason Sequoia is such a good deal is that the percentage of the company they take is artificially low. They don't even try to get market price for their investment; they limit their holdings to leave the founders enough stock to feel the company is still theirs."

If Sequoia took ordinary stock for their money that argument would have some legs. But otherwise, it is self-serving (for the VCs). Once you take their money at valuation X, liquidation preferences and control clauses guarantee that you're not getting anything until the company is worth at least 10X. It doesn't matter whether the founders still have 95%, they've given up control over the outcome that matters to them.

Angels are a different story. I have angel investors myself, carefully chosen, and with a term sheet that is much fairer than anything you'll get from VCs (they can't screw me; I can't screw them).

I used to have some deference for VCs, but after hearing their self-serving arguments and witnessing their arrogance for years, I don't waste my time (being profitable also helps).

Don't get me wrong, we could grow faster with VC money, and I'd do it on the right terms. But these days, if a VC contacts me I always ask them within the first 2 minutes whether they'd invest on similar terms to the existing angels. The answer is always "no". They never have a good response to the obvious question: "how do your terms make sense for a founder?".

As for language, I apologise. I have not used the expression "self-serving tripe" in person with a VC, but I've been close. They need to hear it sometimes.

"Many VCs, including Sequoia, will let founders sell some of their stock on the way up"

How very generous of them. They may deign to "let" you sell some of your stock. Come hither dumb hacker, trade that unencumbered stock for paper you don't even have the right to sell. And just to prove how generous we are, we'll let you keep 70% of the paper no one is allowed to sell (of course, we reserve the right to do whatever we please with our 30%).

Be in no doubt that they 0wn your ass, regardless of the percentage of your company they have. Hence why discussion of equity percentages makes no sense unless we're comparing the same class of stock.