martin zeman's blog

I had a great colleague – she is excellent at work but not enjoying it that much, often feeling bored. On the other hand she always lights up when she is talking about her nights out, what and how much she drank, how smashed she got and how awful she felt the following day. It seems to me like all she talks about is drinking .

It seemed ridiculous to me and to tease her I declared a launch of a global campaign called “Drinking is not cool”. Our marketing strategy relies purely on word-of-mouth and although it creates a great buzz – the number of active members remains stable – i.e. one (update: I wrote this article a couple of months ago and now it actually seems like there are some new comers to the club – welcome Rachel, Samson and James).

The original strategy was not to drink any alcohol for a month. But – firstly, it has been scientifically proven that small amount of alcohol is healthy, and secondly I was just about to attend my high school reunion. So I modified the strategy – instead of no alcohol I set a maximum of two drinks a night and to make up for that I changed the one month period to indefinite one.

It’s been over six months now and I must say that I can not speak highly enough of it – I used to have really severe hangovers on the days following my nights out. I used to wake up around noon feeling sick for the rest of the day. That’s gone now and that’s the biggest reward for me. People often muse about the money I must have saved but for me that’s just a small bonus. I hadn’t been spending too much on drinking before anyway, avoiding shots and preferring to get home by tube rather than by taxi.

Warning: Reducing drinking is not for everyone, it can lead to a sharp conflict with the reality with far-reaching consequences. The less you drink, the less fun you seem to have in pubs. Others are discussing things you don’t find interesting and they are laughing at stuff you don’t find funny. Are you wondering how come I haven’t returned to drinking because of this? Well, I can’t go back – my brain is convinced that what happens under the influence of alcohol is not a true reality and however nice it looks, it’s fake – it seems like I live my own personal Matrix from which there is no way back – the red pill has absorbed long ago.

PS: As for the rules I am not too strict about them, sometimes when I have a really good time I even have three beers. A small flexibility makes a big difference when aiming for consistency.

I have been describing to a friend how we distribute equity in elexu and I thought it might be interesting for others as well so I decided to share it here.

what’s the problem?
Imagine you have a great idea for a web startup and you realise you can’t do it on your own. You start looking for a co-worker. You obviously start with a person you need the most – if you are a business/marketing person you search for a developer and vice versa. As you don’t have money to pay them right away you reward them with equity. But how much do you give them?

Let’s say you believe it’s a really great idea and the person’s contribution won’t be worth more than 10% but your first coworker will very likely see it differently – she will see that there are two of you, both spending roughly the same amount of time so from her perspective it should be more like 50-50 or at least 75-25. You agree with that and start working.

It all goes well until you realise you need more human resources. So you find new people and offer them equity but that means that both you and your first colleague have to give up a part of your equity which as you can imagine usually doesn’t go down well. You can easily end up arguing about whether you need new people at all and why you have to give them so much equity. And this gets worse with every new person coming on board as you have more people with a stake in the company whose share you want to dilute.

how we do it in elexu?
We work for sweat equity which means that the salary we would have earned is converted into equity. Each of us has a set salary level. As we don’t pay ourselves any cash at the moment we can afford to set the salary levels relatively generously. Rather than setting the salary based on previous experience of a person we can look at it from the future perspective – either elexu achieved success which in itself justifies the higher salaries (we had to be quite good to suceed) or it didn’t achieve success in which case the higher salaries are irellevant as the equity is worth nothing.

Great feature we use is a deferred payment bonus – in order to make up for the fact that money are not being paid out immediatelly we put a premium of 50% on top the basic salary. The beauty of this is that we can use the same approach for external collaborators (contractors, key advisors, etc.) – if they are willing to postpone their reward until the company can afford it (i.e. after the first investment round) they will get a 50% bonus.

The key ingredient to all of this is the valuation of the company. This is the value stakeholders (founder, employees, investors) believe the company has at a certain point in time. A typical startup doesn’t set their valuation until a meeting with the first investor. That’s too late. It gives too much power to the investor to impose a valuation benefitial for her (as low as possible). What you as a founder should do is set a valuation of your company yourself on the first day you start working on it and then review it with after every major event (e.g. team expansion, demo version created, product launched, first paying customers, etc.)

Here are some ideas how to evaluate an early stage startup:

• Ask yourself: “If an investor would come today and wanted 20% of my business how much would she have to pay me?” Take into account the current stage of the startup.
• Or you could be more scientific about it and calculate it from bottom up. Estimate how much work (in monetary terms) has to be done by your employees before they will stop earning sweat equity and start being paid normal salary (e.g. first investment round). Set a sufficient buffer for unexpected circumstances. Decide what percentage of shares you want to own at the time you will start paying your employees (the rest will be owned by your employees). And now just calculate the valuation as (work to be done + buffer) / % to be owned by employees.

It is important to set the valuation right. You have to be able to justify the valuation in front of your colleagues and investors, if the valuation is too high they won’t work with you. On the other hand if the valuation is too low you might run out of equity for distribution before you reach your goal.

Now, going back to sweat equity – the salary gets converted into the percentage stake in the company by using the valuation of the company at the time the money was earned. I created a simple illustration.

The table shows an employee who worked two days a week (40% of a work week) between July and September, when the company had valuation of $1 million. And jumped on board full time since October when the odds of success increased (which is demonstrated in a higher valuation). Although the employee worked for only two days a week in the first three months she earned a bigger stake (1.2%) than in the second period (0.6%). The monetary value of the sweat equity from the first period copied the increase of the valuation so the $12k worth of sweat equity from the first three months are now worth five times more, i.e. $60k.

what are the benefits?
The key benefit of this method is that founder doesn’t have to give equity away cheaply. By operating with real monetary figures (as opposed to using only percentages) it’s easier for coworkers to see the value of their stake.
This gives the founder higher flexibility to get more people involved which subsequently inreases the likelihood of success of the startup.
There is one more perspective I’d like to mention. This approach sends a strong message to your potential investors. It demonstrates that you really value your equity. In other words, if you’ve just given 30% to a developer for 3 months worth of work, why should an investor pay hundreds of thousands of dollars for 20%?

I really like this approach, it is transparent, easy to understand, it increases the chances of success and reduces chances of internal arguments about shares and allows people to focus on what really matters – getting work done.

what do you think?
Please let me know what you think. Do you see some key aspect I have overlooked? Do you have any ideas how to further improve this? Have you successfully used a different approach? Was the article helpful or at least interesting?

The past is not dead, it is living in us, and will be alive in the future which we are now helping to make. (William Morris)

When I look back at year 2011 there are two things that stand out.

Firstly a decision to leave my employment career and join David at elexu – an ambitious startup that aims to help people achieve their dreams. When I joined elexu I thought we would launch in a couple of months but those were very naive and unrealistic expectations. Although it went slower than I had hoped we have been moving forward. Our main activities involved clarifying elexu’s concept and specifications, networking and strengthening our team.

What I found personally quite distracting was working part time in Cogent Law, even though it was only for two days a week – an undivided focus is extremely important. So I left Cogent Law before Christmas and now I am fully focused on elexu as is the rest of our team. January and February will really show what we are made of – I am very enthusiastic and optimistic about elexu right now.

Secondly the year 2011 was a year of learning for me. Apart of learning a lot about the world of startups, especially from David, I’ve read a fair amount of books. I’ve read mainly business books and books about personal development (I maintain my reading list on Linkedin). The book of the year for me was Awaken the Giant Within by Anthony Robbins.

Probably the most valuable experience for me last year was recruiting an analyst, my replacement, for Cogent Law. The lessons I’ve learned will definitely come handy.

Looking forward to 2012 I have one goal – launch elexu. I expect an eventful year full of new experiences and learning on the go. I will surely meet a lot of new people and probably go through some emotionally challenging times but I am sure it won’t be a boring year – I am looking forward to the adventure.