Tl;dr: You do a startup to make everyone money at an exit. You need to know how much you want to sell for and be able to communicate that to staff, investors, and even your parents. This blog is going to teach you why and provide you some exercises to help figure out that magic goal in a specific figure.
A decade or two ago I went to Queen’s, Cambridge to do a course on entrepreneurship. For a total n00b, it was very useful in building up foundational knowledge in entrepreneurship. The only exercise I remember from it is decidedly monetary.
“How much money is enough? When you factor everything you would buy and all the expenses, how much money would you have?”
That’s clearly my wording after so long, but it’s the short version.
We were all given 10 minutes to figure this out. I came up with $122m as the most I would spend on houses, cars, private schools, and the like. I didn’t think too much about philanthropy as a 19-year-old, so that number is too small, ha!
Whether or not that number is accurate is not important. The order of magnitude was. If I wanted to achieve the goal or entering the 2 comma club, I would have to do specific activities.
It largely meant that I couldn’t have a job, I would have to excel and not compare my efforts to those around me, and I’d need to take risks on something large enough to generate that level of return.
I had no idea what and how I would do that. I knew I would have time to figure out what would create that wealth. Key was keeping my ears and eyes open for opportunity when the opportunity came.
I had a goal though. $122m.
The goal of a startup is to exit
Many people have built companies that they live well on, buying houses and the like. But at some point, every company needs an exit as the founder wants to retire. For your normal mom and pop business that may mean a generational pass-on with their kids taking over, but not all kids want to work in that stationary company pops built.
For large companies, the founder will exit in the private or public markets.
This is to say that every company needs an exit at some point, but family-owned ones have little pressure on when.
Investor funded companies are very different. They are a ticking time bomb. VC funded startups have at the absolute theoretical maximum, 12 years to exit. When you take money from a VC you are doing so in the expectation of providing a fat investor return.
Whilst there are many factors at play as to why people want to build a startup which may include “changing the world”, empire building, ego, and such, the true drive is to get really fricking rich!
Denying this is actually detrimental. All the people you are hiring may love your vision, but what they really are signing on for is the big paycheck.
If you are signing up for the VC funded startup game, you need a paradigm shift to internalize making money is good and it is your primary goal.
Which is what confuses me so much.
98% of founders that I’ve asked have no idea what they want to actually sell their startup for?
Founders don’t know what they want to sell for
If you accept your company is being funded, you are taking a crazy risk with your time and savings, and staff are working for an exit, isn’t it really peculiar that you don’t know what you want to sell for?
I mean, what is it?
I’ve never actually had a founder tell me “I want to make $122m”.
The closest was a founder in Singapore who told me he wanted to make enough to buy an island and not crash the company he spent so many years building. There’s still no numerative goal there, and a lot was grounded in fear.
Having a number is very important. It informs you of the kind of business you have to build an insight into the path you take to get there.
Why picking a number is important
If you have no idea what you want to sell for, how do you even know that this startup has the potential to achieve any of your financial goals? Will it buy the wife that house you promised? Will you be in a Tesla, or end up in a beat-up Hyundai?
Dilution is real
It costs $70-100m to build a SaaS unicorn. How many rounds of dilution do you think are involved in that? Yes, every time you raise the money you are losing 10-40%!
That billion $ exit sounds fab if you want to make a billion-dollar exit, but if investors own 90% of your company, you have $100m left at best.
When thinking about your exit, you need to factor in your fundraising strategy and the effect it will have on dilution.
Startup sucks and you need to stay motivated.
Your time has an ROI
If you start a company, earn no salary, and then realize the market for socks for hippies is smaller than you first thought, then you are unlikely to be able to sell your company for much, if for anything at all.
In this case, working at Chuckie Cheese with a guaranteed $15 an hour as a manager would have, in fact, been a far better decision.
Let’s say you are a hotshot and are a product manager at Google. You have a base salary of $300k, options which will probably pay out a few million dollars if you stick with it, and frankly, free lunches aren’t terrible. Why exactly do you want to do a startup?
All the benefits of freedom to make decisions and the like need to ultimately come down to what your relative payout is.
If your startup takes 7 years, then you make $2.1m, plus say $5m in options, whatever perks, so call it $7m.
Now a startup. You’re likely to flame out so 10x that number. It wouldn’t really be worth it unless you would take home $70m at the end (ignoring tax etc). If your startup might return you $20m, then you really would need to prioritize non-financial factors to warrant making this decision.
Your time has an “ROI” aka Return on Investment. There are many things you ‘could’ do to make money, what ‘should’ you spend your time on?
I think about this all the time. There are so many things I could do, but what has the highest return? Whilst helping people is a huge driver for me, ultimately what I do needs to have a payoff.
What is the pay off for you of what you are deciding to do? Does this motivate you?
The night is dark and full of terrors
Startup sucks and fundraising is a bitch. That’s sort of my motto for my educational work.
Thinking about setting up a new startup actually stresses me out. I know what is involved.
People calling you a loser, firing people, being lost all the time but not wanting to let anyone know. The list is endless.
If you are going to enter the hell that is a startup, you really need to have a guiding light- A lighthouse to always guide you back on to your path when you are immersed in darkness and depression.
A big fat check is how you justify the emotional turmoil. Only that exit needs at least a number if not a name. I call mine Chantelle, what’s yours?
Staff hiring and motivation
Everyone likes, needs, and wants money.
That vision and dream stuff works great, but when people are really pissed off, do you know what they use to rationalize when things get dark? How much they are being paid now and how much they will make.
You’re trying to hire that Google dude. “Hey Vijesh, come work for me for $40k a year! You’ll get to democratize carrot delivery!”
“I make $300k a year and will net $7m over the next ten years. Why would I work for $40k?”
Vijesh doesn’t care about your $40k salary, and whilst your mission sounds enticing, he doesn’t care.
But, but, Vijesh… what do you say to him now?
Vijesh may like carrots, but this is a financial decision before he can care about the ancillary benefits of being the one to emancipate the carrot.
If you know what you want to sell for, what you are giving him, you can use math acrobatics and explain the risk-return profile could yield him so much more!
Clarity on exit can be communicated to staff to help them rationalize their opportunity.
Carrot delivery is going to make you rich is the rallying cry!
Pay staff less than market
Quality staff is expensive and in short supply. That’s why their rates are high. Other companies want them just as much as you do. There’s just one problem with startup budgets.
You can’t afford to pay market rates. In order to pay less, you need to spit some game.
A startup exit payment to staff is effectively just their future salary plus a balloon figure to adjust for the risk associated with joining your startup. In fact, if they get paid more than that figure, you gave them too much equity.
The fact your business has high exit potential, which you can define is a part of the reason you will be able to pay staff less.
Just as you lose your path on the way to exit, so will your staff.
As you engage in a motivational monologue, you will espouse all sorts of talk, but how much money Vijesh will make is why he’s going to stay in on Saturday night coding rationalizing it will all be worth it at the end.
Quality staff have options. Everyone else is just a pain to retrain to replace a role if they are lower level.
Real equity is for your game-changers, especially once your company is worth something on paper. Giving up those options when trading for a new startup is a real consideration for retention.
Investor valuations are just paper, but they are a touchpoint (if communicated honestly, if at all) that your talk of the homeland big exit you pitched when you hired them has hit a milestone and is on track.
The fat check at the end really is why Vijesh is going to ignore any offers to poach him away.
You know you are a VC candidate
If you want to sell for $500k, you are not a VC candidate. You need to be thinking about a minimum $100m, depending on how much you plan on raising.
By knowing what you want to sell your company for, you can actually ascertain if your startup is something that is fundable by VCs in the first place.
This may sound obvious, but it is not to a lot of people. Before you decide you want to raise money from investors, pause and figure out if your company actually is VC fundable. If it is not, then you are going to waste a tonne of time trying to raise, keep getting rejected, and get deflated.
If you realize your vision is too small to be a VC candidate, then that’s great! Not you know you just need to think bigger. That’s almost always possible. Figure out that new vision and decide if you want to raise again.
Don’t raise if you don’t have to
I don’t know why folks got it into their head that raising money from investors is cool? I actually think it’s just an easy way out from being resource-constrained. That’s myopic thinking. Yes, you’ll have money from investors but you’ll be expected to achieve a whole lot more with it. If you couldn’t hit your goals with no money, you won’t have an easier time hitting bigger goals.
If you don’t have to raise I’m advising you not to. You need a compelling and logical rationale to raise. Investors aren’t giving you money if you don’t have a logic either.
Spend time on traction and actually making money instead. Traction will only increase your options for raising money in the future.
Don’t face rejection if you don’t have to
You are more fragile than you know and fundraising is grueling.
It’s tantamount to being a nerd in high school and walking up to the pretty girl in the lunch hall and asking her out, with everyone listening, and getting shut down. Only you’re going to do this 100 times or more.
I know a lot about raising and I hate doing it. It exhausts me to think about it. I’m currently being asked to help a great startup raise and I’m really thinking if I can be bothered to deal with the stress!
Gain confidence through clarity
If you’ve figured out that your business could be the next big thing, you can build confidence in what you are doing. Startup is hard and you need to be sure that what you are doing makes sense and then to put the blinkers on and your head down and work.
A 50 year old immigrant from India to the USA emailed me worried VCs would look poorly on him and he would have trouble hiring younger people. In short, I told him to figure out if he really believes in what he is doing and then to shut out those negative thoughts and just go for it and not look back. You’ve too much to do than to worry about those imaginary demons.
If you can be the next big thing then you know you are fundable. When you go pitching investors you are confident about why you are in the room and that what you want makes sense. Your confidence makes everything you say more powerful.
I recommend reading this blog: Founder confidence. How you answer investors’ questions matter
Of course, you’re going to have a lot more confidence if your startup is legitimately fundable in the first place. Don’t go raising if you are not fundable.
I recommend reading this blog: Fundable startups are fundable
How do you pick a number
You hopefully get why knowing why what you want to sell for is important. The next question is how do you figure out what that number is.
Focus on the order of magnitude
The first step is to pick a ballpark number. The specific number doesn’t matter now. You’re looking for a number in the right range or order of magnitude.
Start with how much money you want to make. Is that $10m or $10b? Maybe it is $100m?
What feels like the right amount?
The next thing you need to do is figure out how much that implies you have to sell your company for. You are unlikely to own 100% of your company unless you bootstrap all the way or are an evil genius and screw people all along the way.
Since you plan on raising money, you can be absolutely certain like death and taxes you are not going to own 100% of your startup. You are going to sell 10% to 40% in every fundraising round, ignoring funky stuff like venture debt.
How much are you going to have to raise to get to your exit? How many rounds is that?
Do the math and then you need to gross up your personal take-home number. If you want to raise 3 rounds and get done for 25% each time (Ignore the actual math here for simplicity), You are giving up 75%.
This means that you need to sell for $400m to make $100m.
But hang on, what about the staff and advisors you want to take on board? If you give 20% of the company to staff and 5% to advisors, that exit number needs to be larger.
Again, for simple math, let’s assume you are generous to your team and your total dilution is therefore 90%, which means you now need to sell for $1b to make your $100m!
What number is worth your time?
You’ve figured out one way to set the max number you need to sell for to hit your goal, now what about the minimum number you want to sell for?
Simply put, what’s worth your time? For Vijesh, he needs to make $70m to justify joining you. So what is your number?
There is a lesser-known VC in the USA that has an algorithm to help them make investment decisions. I read their fairly nerdy blog where they share some insight into how the algorithm works. What I ascertained is that founder salaries are a large constituent.
Founders who give up larger salaries to do their startup are taking more risk and therefore would have higher conviction in what they are doing.
If you are working minimum wage for $12 an hour, your opportunity cost is effectively zero as you can always get a job again and you’re not losing to much in salary compared to an exec who makes $10m a year organizing meetings no one wants to attend.
If you make $25k a year than anything more than $25k a year is a bonus. Frankly, if you are one of the lucky ones to get to series-a, your salary is definitely going to be more than that anyway. Any exit is a cherry on top.
On the other hand, if you are a 45-year-old exec who has hit the big time, leaving to do a startup may have serious consequences on your job prospects in the future. You need to figure out what the minimum number is to justify this insanity!
If you are making $10m a year, the startup will take 7 years to achieve your vision and exit, then you need to apply a risk factor to your salary. Let’s say you think you have a 5% chance of making it happen, then you believe 20 x $7m is $140m is the minimum number to make worth quitting your job make sense.
In the context of your exit goal, adjusting for dilution, is that possible?
What is possible in your market?
You know what you’d like and what the floor is to justify your startup, but is that reasonable?
You need to understand your industry and the future market for acquisition. If you need to sell for a $1b is that even possible? Sense check this.
A startup is outsourced corporate innovation
Very few companies IPO. Despite it being an unlikely option, many investors put a section in your definitive documentation for that eventuality. I would not let this be a primary exit opportunity when doing this exercise unless you have a rationale.
So if you are not going to IPO, what are you going to do? You are going to sell to another company. Which begs the question then, why is someone going to buy you?
The way I think about startup acquisitions is that startup is just outsourced corporate innovation. This is quite important to understand.
Companies will buy you in the future for a reason. What is that reason? There are typically two categories for acquisition if you are a success:
- Financial: You make money and a public company is traded at a higher valuation which is typically 30%, called a liquidity premium (Let’s ignore the fact many private startup valuations have been inflated in the late 2010s). They trade at 10x revenue, you make $100m revenue so they could add a $1b to their market capitalization. Alternatively, a private company buys you, but this is more likely if you messed up something.
- Strategic: You’re doing something a bigger company needs. One motivation could be defensive, such as Facebook buying Instagram so someone else can’t have it. Another reason could be for a company to remain relevant. There are many reasons, but the point is that there is a reason!
Why are you going to be bought in the future? The next question is how much are you going to be acquired for?
The more you want to sell for the fewer acquirers there are
It’s all very well to say you want to sell for $1b. Ask yourself, who is actually going to buy you?
The more you want to sell your company for, there are exponentially fewer companies to buy you. There might be 50k companies that could buy you for $1m, but there could be 5 companies in the world that could afford to buy you for $1b for a compelling reason at the time you are selling.
If you are gunning for a huge exit, you need to have a compelling rationale for that acquisition, and ideally a reason you will create a competitive bidding situation.
Are there people in the market that will be able to afford the price you want to sell for?
How valuable is the problem you are solving?
The more valuable the problem you are solving, the more people who might want to acquire you and for a larger amount.
If you are doing some social media app, then why is someone going to buy it for a wad of cash? Is it really solving a huge problem? You might argue the market is huge as everyone uses social media but is it really going to get people off Facebook? Are you going to be a threat to their growth engine in Instagram?
If you’re fixing healthcare or finance in the USA, you have a huge market, but is your solution going to realistically be able to disrupt it through disintermediation, etc? Can you capture a huge section of a latent market?
If you disrupt the market how much is that worth and does it meet your exit goals?
What has been done before?
The easiest way to figure out what the exit potential is is to look at what has been done before. Who was sold for what?
What companies have been sold before and for how much?
If you know your industry, you know it’s history. So what is the biggest acquisition in the industry’s history? Was it anything near the number you want to sell for?
If the number is larger cool, if it is far smaller then you might have a problem. Why will you be the largest acquisition in your industry?
Startups either do something better than currently exists or they create something new.
Frequently it is the former which is easier. Just do some research if you don’t know. You could hire someone smart on Upwork to do this for you.
If it is the latter, you can always find a tangential established industry to compare yourself to. The goal is to just to see what was sold for before and for how much. If you can ascertain their logic for the why, that is also useful.
What were the multiples?
When a company is bought there are standard metrics such as revenue and EBITDA which become industry benchmarks. You divide the acquisition price (simply put) by the revenue and EBITDA to figure out the multiple they were acquired for. For example 10x revenue.
If you’ve figured out what you want to sell for you can divide that acquisition price by 10x to figure out the revenue you will be generating at acquisition. If you want to sell for $1b, then the revenue needs to be $100m.
Interesting, $100m revenue is what is needed. Ok now, back to what is possible in your market. Is the market large enough to generate $100m? What market share would that be? How fast is the market growing if it is small presently?
Unfortunately, these numbers are rarely if ever shared publicly. If a public company acquired a large company you can go to the investor relations section of their sit and check investor presentations. Some times they share the numbers there. Anyway, this isn’t an M&A class.
If you can figure out the acquisition multiples you can triangulate what might be possible for you. You might say ok actually $75m is the max market share I could get in 7 years’ time. So if you 10x that on the multiples you found, you know your exit potential is around $75m.
What number is fundable?
The final exercise you can do to figure out what your target exit number is to think about what investors will actually fund.
Whatever number you might decide makes sense, is possible in the market, motivating to you and staff, etc, if it’s smaller than what meets the requirements of investors, you are not fundable by smart investors who know venture capital math.
Now, to complicate things, different investors require different exits to make their business model work. Let me explain. The goal of a VC is to return 3x to its investors. I’m going to ignore the details and make this simple so you understand the principle.
If a VC has a fund of $50m, they need to give their LPs $150m back in say 10 years time. If they assume that their whole portfolio will fail and one company will be the ‘fund maker’ then they will only do an investment if you can return them $150m.
Next, understand that the VC doesn’t own you 100%! They own say 25% of you at the exit. In which case you need to sell for $600m for them to make that $150m. Big numbers right?
Now you might have lofty goals and want to raise from mega-funds like a16z. Again with simple assumptions, a16z has a fund of $1b. They want to return $3b. If they own 25% and you are the only exit, you need to sell for $12b to make their business model work!
In reality, the math is far more complicated and I would need to make a spreadsheet to explain it. One simple rule many VCs say is that you need to return the size of the fund, so 1x the fund size.
For your purposes, I’m going to give you a simple min/max.
- Min: The size of the VCs current fund they are investing out of is the min amount they need back. If the fund is $50m then they need you to return $50m. If they own 25% you need to sell for $200m.
- Max: If you are to be the fund-maker for the investor you want to raise from at this round of fundraising, then you need to 3x that number. So that $50m micro VC needs $150m back and if they own 25% you need to exit for $600m
You ideally want to sell for $600m if everything goes great, but if you sell for $200m on the downside, then you are still sort of fundable.
We’ve gone through some simple exercises and some complicated ones that might have you totally lost. If you do only one thing from this guide, it’s picking a number you want to sell for, commit to it, and tell it to everyone!
If you are capable of doing a bit more work, then make sure that number actually makes sense! It will be a lot more credible.
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