Hard Truths

Let’s start with two truths that are difficult, but important for entrepreneurs to hear:

  • Only 1 out of about every 10 startups goes on to become a functioning company.
  • The biggest reason that startups fail is because they build something that no one wants

The Nature vs. Nurture of Market Building

Almost anyone who has been involved with a startup has felt the frustration of having a “great” product, but not being able to get the attention of the market. The classic answer to this dilemma was to mount massive “Maddison Avenue style” advertising campaigns. The thinking process is that markets don’t naturally exist, consumers have to be TOLD what they want and how they want to consume it.

For decades this kind of—let’s call it the “nurture” approach to market building—was the exclusive domain of big brands with big advertising budgets. Many advertising and marketing agencies still sell the promise of “if you get your message right, the world will beat a path to the door of your unicorn factory”.

Enter social media: the great leveler of the messaging playing field. Now everyone could get their message out without any kind of budget, and they did. The result: noise and confusion … and a lot of misinformation.

But something even bigger happened. Consumers started talking to each other. They shared their joys and frustrations about the products and services they used. Smart brands pay attention and aligned their emerging and self-selecting customer cohorts.

Savvy brands discover and play to the nature of the groups that buy their products and services. This does not mean that they ask their customers what they want—that’s a rookie mistake. Rather they spend time getting to know their customers:

  • What are they trying to accomplish?
  • How are they doing things now?
  • What are their frustrations with the way things are?
  • What gives them joy and a sense of accomplishment?

So What’s a Startup To Do?

One of the most effective things that any startup can do is invest in DISCOVERING its business model. This is the process of documenting all of your key assumptions about your customers, how they want to interact with you and your product, what it will take to reliably build and deliver your product, and how cash will flow through the organization.

The biggest value of business model discovery is not getting your initial assumptions right, but recognizing that your initial assumptions are most likely wrong. It’s the process of testing, modifying, and validating the assumptions behind your model that lead to business success.

Full Disclosure

Logika is a presenting sponsor of The Indy Startup Challenge. A business model discovery boot camp and pitch competition in Central Indiana. We believe in the process and have seen the results it can produce!

 

Photo credit: Market by Flickr user Mike Knell

One of the many talents that successful entrepreneurs possess is the ability to use what they have to get what they need to start and sustain their businesses. Since early-phase entrepreneurs often lack cash, some variation of the question “can I pay for this with equity?” often surfaces.

Unfortunately, there is no one ‘right’ answer to this question. Here are a few of the challenges and issues to consider:

Equity is not cash

The value of your equity is unknown. Common wisdom is that 90% of startups never become sustainable businesses, so the equity results in nothing. On the other hand, maybe you are hatching the next unicorn. In which case, equity is a very expensive way to pay for services.

You can’t make more equity

The total amount of equity is 100%. I’m frequently surprised by the number of people who are ready to offer 10, 15, as much as 20% in equity for everything from accounting services to a ‘full-stack’ programmer. In the same breath these entrepreneurs declare “I will never own less than 51% of my company”.

The difficulty with these positions is a matter of simple math.

Equity Dilutes

Just because you receive 20% in equity doesn’t mean you will have 20% of the company when the equity can be converted to cash. Since total equity can only be 100% — though early equity deals can sometimes feel more like a remake of The Producers than a business transaction — bringing on new investors means dilution for current equity holders.

The challenge here is at least twofold:

  • Dilution does not always occur uniformly. Services-for-equity holders may feel that they are being taken advantage of.
  • Services-for-equity may perceive their equity as collateralized debt and may see their dilution as an unfair reduction in pay.

The volatility and risk of early-stage equity makes for ample opportunity for misunderstanding and disappointment. This can lead to hurt feelings, damaged reputations, withheld services, and fails deals.

Equity is not debt

Having equity is no guarantee that you will ever be paid.

Equity is Worthless

You can’t pay your rent, buy a car, or get groceries with equity. Equity only becomes valuable when some kind of conversion event occurs. But what will trigger that conversion?

Generally, equity converts on the influx of some cash. But there are a few challenges: If you are an investor, do you want to see your investment go to building new capabilities or paying off old debt?

About 80% of the companies on the INC 5000 are completely self-funded (no external investment). When and how will there equity value be calculated? convertible?

There may be better options

Working with limited funds is always a challenge – doubly so in early startup phase. Handing out equity can lead to a confusing and unattractive (to future investors) cap table. At best this can lead to contention over dilution rates among current equity holders. At worst it can completely scuttle a deal.

Convertible notes have long been a staple of the startup world, but they can make the balance sheet unattractive to investors.

The folks at Y Combinator have developed the safe note as a means of overcoming many of these difficulties.

In the end, funding startups is difficult – and one size never fits all. The point is, it’s probably best to avoid a ‘knee-jerk’ “will you do this for equity” and consider all of the options – then make sure you have adequate input from financial and legal professionals.

Photo credit: SHARING by flickr user Lena