martin zeman's blog

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?

‘Build it and they will come’ is a dangerous assumption for a startup.

Why Startups fail?
I am reading The Four Steps to the Epiphany by Steven Gary Blank (retired serial entrepreneur teaching enterpreneurship at several major universities). The book starts by describing a scenario of an ambitious startup which raises a lot of money, prepares everything (product, advertising and PR) for a glamorous launch only to find out they are significantly missing their revenue targets. In an attempt to attract new customers the startup starts burning through the cash ever quicker ultimately ending up in a bankruptcy. According to Steven this is a very common scenario.

Steven suggests that startups don’t fail because of bad products but because they don’t allow enough time for learning and discovery about their respective markets and customers. He suggests a typical startup needs two or three attempts to figure out their market to get it right but most of the startups don’t plan for that. Instead believing they will get it right the first time they follow a very risky path of all-or-nothing, scale up their operations prematurely and end up in a disaster because simply ‘Build it and they will come’ is a myth.

Market Type
Steven stresses the big difference between introducing a new product to an existing market (this is what mature companies do) and introducing a new product to a new market or a resegmented market (this is what most of the startups do). In the first case customers and their behaviour are fairly well known and that’s why mature companies often succeed with new introductions. On the other hand in case of resegmented markets (introducing niche or low cost products) and especially in case of new markets the reaction of customers is unknown or at least very uncertain.

The two types of markets respond completely differently to the same impulses. This has very sound practical consequences and requires a special consideration when hiring staff for startups. Steve argues that people always tend to apply successful strategies from their past but should the majority of their experience be from mature companies operating in existing markets, their actions applied in a startup will not yield the expected results, in fact the actions can seriously endanger the new company.

Another great insight that’s vital for startups to understand is the process of technology adoption by a market. Startups need to realise that customers differ based on their product needs and buying habits, they can generally be divided into early adopters (customers eager or willing to try a new technology and products) and late adopters. In the first phase of a startup the available market for a startup consists only of the innovators and early adopters which is circa 16% of the size of the overall envisioned market. This needs to be reflected in the financial forecasts otherwise a startup won’t be able to hit their revenue targets.

Customer Development Plan
The book provides an easy to follow guide on how to avoid the fate of the company from the aformentioned scenario. The approach is quite simple, it says that in addition to Product Development Plan a startup needs to prepare and follow a Customer Development Plan. The goal of Customer Development Plan is to understand in detail customer problems and needs, discover a market for the envisioned product, develop a sales model which can be easily replicated, create and drive end user demand and then transition the organisation from one focused on learning and discovery to one focused on execution.

Although I have only read the first part of the book it has significantly boosted my confidence in success of elexu. I have always been a strong believer in elexu as a product I could see very clearly how it will work and what value it will deliver but I used to feel a bit uneasy as I couldn’t picture clearly the process of customer adoption. I could see elexu before the launch (beta version) and I could see elexu three years after the launch but the period in between was covered in a haze for me – it is not any more – thanks to Steve Blank and The Fours Steps to the Epiphany.

Now it’s time to start working on the Customer Development Plan, I can’t wait.

A few weeks back I had another short period of feeling a bit down and stuck. I thought about it and spotted an interesting thing. I noticed that I had been behaving quite seriously lately – at elexu, at Cogent Law, even at home or when outside with friends.

I assume it’s caused by elexu, feeling the pressure and trying to prove to everyone that it is a serious business. But it’s not the seriousness of employees that makes business serious (I wonder how I will translate this into Czech ).

Actually humour and fun were the most powerful tools of the best managers I have had the opportunity to work with and they have been achieving some serious results with those tools.

Following their example, I am going to have fun – entrepreneurship is a game, life is a game – time to play!

I have always found it very funny when people were showing off with their fancy titles – being it a job title or a university degree. That’s why I felt quite hesitant to accept a title of a director in elexu. How can one be a director in a company which hasn’t made a single penny yet?

When I met new people I even felt a bit ashamed that my business card said ‘Director’ and I tried to explain what I actually do so I wouldn’t look like one of those people I used to laugh at. But that has changed. I have changed.

It started when I changed my main status on Linkedin to ‘director at elexu’ it is a big thing when all your business contacts see it but what really pushed me was a comment from my friend and coach saying that it is really important to know what we are. And that’s when all the dots connected.

In several books I’ve read this year (Influence by Robert Cialdini or Made to Stick by Chip and Dan Heath, Awaken the giant within by Anthony Robbins) the authors explained that often when people make decisions of what to do they don’t think about what they want to do or what would be the best thing to do but instead they ask themselves what would a person like them, or a person they would like to be, do.

Here is a nice little example about hotel towels. Another typical example might be selection of a college – where do people like me apply to?

While reading those books I thought this doesn’t apply to me as I rarely do what others do and quite often I do exact opposite but when I think about it now maybe that’s why I behave that way – because I see myself as an outlier, person that would do exact opposites than others.

It is without a doubt that the image we have about ourselves heavily influences our behaviour. All you need to do to change your decisions and behaviour is to change the way you see yourself. This is a very powerful weapon and I am now using it to my advantage.

I am Martin – Director at elexu.

PS: It’s also good to know the above works both ways – you can’t make a lasting change in your behaviour without changing the way you think about yourself. Anthony Robbins illustrates it well on people who try to lose weight or quit drugs.

What is the root of the UK riots? Is it greed, ‘professional’ criminals, bad parenting or bad economy? Bit of everything, really – but I guess the determining factor is grim outlook for the future for a lot of people and especially youths.

Imagine you have just finished high school, you can’t go to university (it’s too expensive), you can’t go to work (no jobs for people without experience), money you get from the government are likely to shrink, so what do you do? Live off your parents, hang out with your friends who are exactly in the same situation. If you could at least hope it will get better, but how could you?

With governments having less money to spend and with companies cutting jobs down it’s hard to see the light ahead. But I believe there is a hope – all we need to do is to change the way governments and companies spend money.

Instead of spending money on big and costly projects in case of governments and means-to-an-end advertising in case of companies we should distribute the money among big number of small projects. Big investments come with big expectations which requires costly experts to deliver them.

Small projects on the other hand don’t require big investments therefore they don’t carry a high risk (respectively the risk is distributed among a high number of projects which makes it safer) but they represent a high opportunity for big success. Even if such a project is not successful in financial terms the experience it gives to people involved is extremely valuable and makes it worth it.

The difficult part is to show companies and organizations that it’s worth spending money that way. And that’s what we are going to do with elexu.

Check out Live UnLtd – they fund great ideas of young entrepreneurs. There are more companies and individuals with similar agenda. These people know how to use money efficiently – we need to discover them, give them funds and let them do their work.

Last week I have attended a Mini Lean Camp – informal mini conference about lean methodology. It was an inspiring event attended by a lot of great people. There was one presentation that in particular grabbed my attention. It was a talk about solving arguments by Benjamin Mitchell – he is, among other things, a team coach who helps SW development teams work smoother and faster.

Benjamin said that when people argue they often focus on their ‘positions’ (what they want to happen) instead of their ‘interests’ (why they want it to happen) which reduces chances for a win-win solution and generates a lot of ill feelings and stress.

How to solve arguments in three simple steps

Benjamin suggested these three simple steps to resolve arguments:

1. Ask the other side why they like their solution.
2. Tell the other side why you like yours.
3. With the the knowledge of each others interests, rethink your options – isn’t there a solution that would suit both sides’s interests? And while looking for it consider what would happen if agreement is not found.

Bejamin challenged us to role play an argument on the spot with people sitting next to us. During those few minutes the difference between positions and interests became absolutely clear. It’s one of those things that is invisible until someone else tells you about it and then you are like: “Well, that’s obvious, isn’t it? Normal common sense.” The challenge is to remember it during an argument and act on it.

Put into practice at elexu

I have applied this advice at elexu right away. We had been arguing with David for a while about our approach to elexu site development. While I was pushing for lean approach (starting with the minimal viable product and growing it gradually based on users’ feedback) David wanted to launch it with all the core features he had envisaged (in other words his vision of minimal viable product was much bigger than mine). Neither of us was willing to step down from our positions and even if we agreed on a compromise one day, exhausted from trying to persuade each other about our truth, a week later we appeared to be back at square one – the compromise forgotten.

So last week we sat down and talked about the reasons why we push in our directions. David was concerned that it is very difficult to add new functionality successfully into a product later on especially during a time of big growth. My biggest concern was wasting time and effort on developing something that users will not use. We both understood each other’s interests but it wasn’t yet clear how to fulfil both of them.

The real golden nugget of the discussion came when David mentioned that when I push for something he is not convinced about it’s just my word against his which is not strong enough argument to do it that way and then he said that in such cases we need to listen to potential elexu users to validate our hypothesis. Which was exactly what I thought would be the best as well. We’ve just never brought it up before and fought blindly on behalf of the users based just on our assumptions as if our design should be the final one.

This discussion really helped us align our direction and I am more motivated than ever. All we needed was to stop fighting about positions and discuss our interests instead. It’s wonderful how such a small change can be so helpful. Thank you for it, Benjamin.

My first thoughts about startup life? It’s a crazy emotional roller coaster.

One day everything looks perfect, future is bright and clear, nothing is a problem and I just want to get on with the work. But then, another day, I feel down, almost depressed asking myself what the hell I am doing and wondering if we are ever going to launch.

I am starting to see patterns in this though which I hope will help me reduce the bad times and multiply the good ones. Here are the things that help me:

Take a step back – Look at the big picture. Ask: What is really important? What we need to focus on?

Do the work – A feeling of moving forward is absolutely crucial. We can talk for ages but unless we do something tangible it feels like wasted time to me. Even when I know that the discussions are vital – they feel worthless without a tangible end result.

Don’t take arguments personally – Recently we spend a lot of time arguing about elexu – both me and David feel very passionate about it and while we share the top level vision our views on how to get there sometimes differ which leads to heated discussions. Knowing that we both want the best for the company helps us find compromises and remain cool on a personal level – but it helps to remind ourselves every now and then.

If you have any tips or your own experience, please share in the comments. Cheers.

“You must be the change you wish to see in the world” (Mahatma Gandhi)

My friend, Botanicus aka Jakub Stastny, is working on a start-up project and he is sharing thoughts about enterpreneurship on his blog: http://blog.101ideas.cz/. Get inspired. I did.

Inspired by Jakub’s post about Managing Motivation, here is my answer to the question:

Why do I work on Elexu?

• Big Challenge. This is a challenge I have been looking for for a long time, one that will test my abilities to the maximum. This can ultimately show me what I am capable of as there are almost no limits to a start-up success. Am I good enough?
• Making World a better place. I know this will sound silly but I’ve always felt like I should try to make the World a better place. The world seems to be far from perfect and people who could do something about it often focus on making money or having fun. If they will not change the World, who will? Elexu is a huge opportunity for me to do it, probably the best opportunity I will ever get so let’s not waste it.
• Elexu needs me. David has created an excellent vision, he is great at selling it to people and he knows how to run a company. But he needs someone to help him with IT related stuff. Someone who would understand him perfectly as well as IT. And that’s where I feel I fit in like a piece of puzzle.

• Doing what I love – Innovate. Times I liked the most in my previous jobs were when I was changing ways things had used to be done there before. Innovation that’s what I am about. A start-up offers massive opportunities for innovation and much better environment for it as well without corporate politics or employees scared of change.

I went to another session of Eclub – entrepreneurial club which educates, inspires and empowers entrepreneurs. This time we talked about the importance of vision and people for the success of our ventures.

Guys from Eclub asked us what we think is the main reason behind the success of people like Richard Branson, Alan Sugar, Jamie Oliver, the entrepreneurs’ role models. They suggested it’s the visions they had which were so powerful or with which they were so obsessed that they dragged them towards success.

My answer to the question about the main reason of success was different. And after I have been thinking about it for a few days I still believe there is more important reason behind success of the successful. While I appreciate the importance of vision – I believe it’s not what determines your success – having a vision is easy, the difficult part is being able to realise that vision – ability to execute is what makes the difference – that’s the scarce skill. There is plenty of dreamers – well almost everyone is a dreamer – but only very few people can make their dreams make come true.

The second part of the session was about importance of people for the success of a company. We agreed that it is impossible to achieve a big success alone. Then we have discussed how many people we think we need to achieve success. My view was (and by looking at my first blogpost about Eclub it had been for a while) that having three really close people is the best.

Eclub guys suggested that a bigger group is better – they call it a Success Family – having circa 10 or so cooperators, supporters with whom you can discuss your progress and ideas, brainstorm your future steps, share experience, people from whom you can get open and honest feedback. Above all success family can help you sort your own thoughts.

These people don’t have to be working officially or directly on your project. In fact it might be better if they don’t, they might be more unbiased when they are a bit more distant from the project than you are.

I really bought into this idea. It makes a lot of sense – every person has different specialities, different skills and knowledge – so it seems better to utilise everyone’s strengths rather than hoping to find people who would be able to advise on everything.

I liked the idea so much that I have started to think immediately whom would like to be in my Success Family for Elexu. I need to think about this a bit more, give it a clearer shape but I will surely share my thoughts and experience in another blogpost.

I was going to hand in my notice last Friday, I had my plan nicely crafted (handing notice on Friday the 13th, starting my new life on 13th June – my wedding anniversary), all was nice and bright. On Thursday I came to work and saw an email from our HR which informed me that my replacement who was going to start in ten days had been given an offer from his current employer and decided to accept that. I was quite disappointed – mainly because it made my perfect plan no longer perfect…

…but after a few minutes I remembered this simple and powerful excercise from a great book Awaken the Giant Within by Anthony Robbins. The excercise is really simple – whenever you feel bad about something, when you wonder “Why me?” – ask yourself: What’s good about it? and write your answers down. It really helps. This is what I came up with in this case:

• I get more recruiting and interviewing experience.
• Several great lessons learned for the future:
  • always expect things to change – anything can happen – this is life.
  • it’s worth asking why a candidate wants to work at your company – it might help the candidate realise the benefits of your company/role.
• [we are in a process of building a new BI/reporting tool at work which will make analysis much easier and significantly reduce effort we put into building and running reports, so...] This is another reason to implement the BI solution as quickly as possible which is what I was recommending all along.
• Opportunity to make my boss and the company a favour by delaying a bit with handing in my notice.
• Something is happening => I feel more alive.
• Adam, my would-be-replacement, will get a better deal for himself.
• Someone else will get a job. And others will get a chance to get it.
• Then I thought about Elexu and tried to find something good about the fact that I will start dedicating most of my time to Elexu a week or two later. Surprisingly enough I did find a very good answer. I started wondering what would be the key Elexu tasks that would get delayed thinking that I could put more effort into them during evenings and weekends. And then it struck me that I have already been delaying some key tasks to the time after I would leave my full time position, giving myself an excuse that I will have more time to dedicate to them then, but then I realised that I have enought time to start with them right now and I should and I am going to do just that.

This little exercise completely changed the way I was feeling about the situation and pushed me from pity to action – amazing.