The Farmer and The Suitman

Have you ever dreamed of launching your own DotCom and be rich? Consider this. It's it's too long, skip to the end.

The Farmer

Let's say you are the farmer. You work hard for the money you earn.

Let's say you have a small piece of land and you grow wheat. One day you realize machinery would increase productivity. Without it, you'll always stay at the same point. With it, however, you'll prosper. You could deliver quality, on time. The largest distributors would pay you well. You’d still honor your word and be an even greater provider.

The Suitman

Let's say one day someone, ‘the man’, proposes a deal. "I'll give you the 400K worth of machinery you need. I believe your farm is worth $1 million." A million dollars? You thought your farm was only worth 300K and was making 50K a year in profit. Interesting!

Then ‘the suitman’ says, "I will only do the deal if you can prove you'll make $5M a year in 5 years." Looking at it this way, it becomes more difficult. But after considering, you realize you can be creative and rent your equipment to other farmers or, better, use your equipment on other farms for a part of their production.

You can sell part of your production to other distribution channels, with higher margins. You can sell overstocks for construction material. The more you look at it, the more you realize the $5M a year is possible…if only you had the machinery.

Finally, ‘the suitman’ concludes: "Since I put in 400K, and your company is worth 1M, I'll take 30% of your company."

The formula: 400K + 1M = 1.4M…and 400K is 29% of the total.

Makes sense! Fair deal.

The Typical Venture Deal

Shall you ever consider launching your own startup company, that is the deal you'll receive. It is standard and it might slightly change but not that much. That is the way DotCom companies get started in the US. You can look for something else, but it will always come down to that deal.

In 2008, deals were 500K on a 1M-3M valuation for 33% equity with a 10 time return over 5 years.

During New York Internet Week (two weeks ago) and at Startup2Startup on the West Coast (4 weeks ago), Angels/VCs were looking to inject 300K on a 1M-2M valuation with a 30 time return over 10 years. This deal is standard with all Angels and VCs. As they say, they show themselves more flexible under difficult times and look more over the long term.

The reality is that they won't make a deal unless you have a working prototype and that you break the ice with the first sales. Which means that you work unpaid for one or two years, that you make people work unpaid for equity so they don't leave, that you use all your credit margins and all your resources. Angels and VCs will wait until the last second. When they come with the proposal of agreement, you don't refuse.

They will own 30% of everything that you have done. They will own 30% of everything that you will do for the rest of your working time within that company. At least until something happens.

In the case of the farmer, it means that the man would own 30% of the farm, 30% of the machinery, 30% of the stocks and 30% of every year profit of the $5M income. All this with a 400K check.

Where it Doesn't Work!

The deal could still be fair shall the man help you grow the business after signature. Let's say on day 1, both have injected money/work according the their shares. It's normal than shall the entrepreneur brings work for his 70% share, the angel/VC brings money/work for 30% for the years to come. The company is still growing - And money doesn't grow by itself.

Money doesn't grow by itself. Back to the farmer's example, it would be nice if the man could introduce the business to better distributors, amazing workers, negotiate with the mayor and the local deputy, bring TV station to cover the amazing products; basically bring to the table important working assets to help to grow the business. At least, provide 30% of the value for the years to come after the transaction. That would be a fair deal.

Unfortunately, most VCs and Angels will jump immediately to the next transaction. Feeling that they are better off to diversify their portfolio and that anyway, their company will give them better commissions on transaction rather than on growth. Their effort will be put in monitoring the financial activity of the company. They'll work the phone not to keep you too discontent.

And It's Not Over

The 2000 DotCom crisis was a financial crisis. It was not an Internet crisis. Internet usage never slowed down during that period. It kept its steady growth.

The crisis we are in right now is, again, a financial crisis. The DotCom startups suffer actually not because of the behavior of previous startups. But from behavior of financial companies.

It would be nice to hope that Angels/VCs will change behavior/expectations by themselves. But as long as entrepreneurs will accept their deals, the deals will remain the same.

Advices to Entrepreneurs

Be aware:

1. Give 20% of your company to an institution that will bring 20% of work value every year after the transaction.
2. Give 30% of your company to an institution that will bring 30% of work value every year after the transaction.
3. Give 40% of your company to an institution that will bring 40% of work value every year after the transaction.
4. What ever the amount will be, it will be standard anyway. Right now, it's between 300K-500K.

Also look into people:

1. Nice personality and great personal values
2. Good working ethic (stay vigilant of all the little sentences that could shed a light on this)
3. Knowledge and experience in your industry
4. Great personal network within your industry at all levels

Shall your Angel/VC is not successful with all his companies, ask him questions he would ask you. You are partners after all, you should be able to say everything to each other:

1. Why does he invest in industries where he does errors of judgment?
2. Why does he invest in industries where he doesn't bring value?
3. How much time did he spent per week with his unsuccessful companies creating value, as opposed to monitor financial results? How much time does he plan to spend with you per week?

Dear Angels and VCs, your comments are welcome. Maybe there is some truth I haven't found yet in the standard agreement.

Comments

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