Author: Ron van Bijsterveld

An investor wants to give you money for a certain percentage of your startup. Should you take it? You’re about to hire your first employee. How much stock should you give him?

These are some of the hardest questions founders face. And yet, according to Paul Graham (YS founder), both have the same answer:

1/(1 – n)

Whenever you’re trading stock in your company for anything, whether it’s money or an employee or a deal with another company, the test for whether to do it is the same. You should give up n% of your company if what you trade it for improves your average outcome enough that the (100 – n)% you have left is worth more than the whole company was before.

For example, if an investor wants to buy half your company, how much does that investment have to improve your average outcome for you to break even? Obviously, it has to double: if you trade half your company for something that more than doubles the company’s average outcome, you’re net ahead. You have half as big a share of something worth more than twice as much.

In general, if n is the fraction of the company you’re giving up, the deal is a good one if it makes the company worth more than 1/(1 – n).

Venture capital

Suppose a VC offers to fund you in return for 7% of your company. In this case, n is .07 and 1/(1 – n) is 1.075. So you should take the deal if you believe we can improve your average outcome by more than 7.5%. If they improve your outcome by 10%, you’re net ahead, because the remaining .93 you hold is worth .93 x 1.1 = 1.023.

One of the things the equity equation shows us is that, financially at least, taking money from a top VC firm can be a really good deal. A top VC likes to take about 30% of a company. 1/.7 = 1.43, meaning that deal is worth taking if they can improve your outcome by more than 43%.

For the average startup, that would be an extraordinary bargain. It would improve the average startup’s prospects by more than 43% just to be able to say they were funded by a top VC, even if they never actually got the money.

Why? Because a top VC gets hundreds if not thousands of business plans a year and funds only a few of them. The companies that make it through are not average startups.

Of course, there are other factors to consider in a VC deal. It’s never just a straight trade of money for stock. But if it were, taking money from a top firm would generally be a bargain.

Employees

You can use the same formula when giving stock to employees, but it works in the other direction. If i is the average outcome for the company with the addition of some new person, then they’re worth n such that i = 1/(1 – n). Which means n = (i – 1)/i.

For example, suppose you’re just two founders and you want to hire an additional hacker who’s so good you feel he’ll increase the average outcome of the whole company by 20%. n = (1.2-1)/1.2 = .167. So you’ll break even if you trade 16.7% of the company for him.

That doesn’t mean 16.7% is the right amount of stock to give him. Stock is not the only cost of hiring someone: there’s usually salary and overhead as well. And if the company merely breaks even on the deal, there’s no reason to do it.

In order to translate salary and overhead into stock you should multiply the annual rate by about 1.5. Most startups grow fast or die; if you die you don’t have to pay the guy, and if you grow fast you’ll be paying next year’s salary out of next year’s valuation, which should be 3x this year’s. If your valuation grows 3x a year, the total cost in stock of a new hire’s salary and overhead is 1.5 years’ cost at the present valuation.

Let’s run through an example. Suppose the company wants to make a “profit” of 50% (if you’re a hot opportunity, you can charge more) on the new hire mentioned above. So subtract a third from 16.7% and we have 11.1% as his “retail” price. Suppose further that he’s going to cost $60k a year in salary and overhead, x 1.5 = $90k total. If the company’s valuation is $2 million, $90k is 4.5%. 11.1% – 4.5% = an offer of 6.6%.

For those of you who want to do an actual calculation, I suggest you use this online calculator by Steve Trambert.

Note: notice how important it is for early employees to take little salary. It comes right out of stock that could otherwise be given to them.

Organic growth

While Graham’s Equity Equation gives a growth rate that gets a founder back to what (s)he had, it does not account for what (s)he could have had. The equation assumes that the company would experience no growth if a VC does not invest.

Logically, a zero-growth assumption does not make sense and thus it makes sense if we add an organic growth term “g”to Graham’s equation. Organic growth can be thought of as the growth that the company is likely to achieve absent a subsequent investment.

Let’s take Graham’s original scenario where a VC takes 7% of your company and add an organic growth term of 3% to it. The equation becomes 1/(1-n-g)-1, or 1/ (1-0.07-0.03)-1, or 11.1%. This is the breakeven growth rate when taking into account a company’s organic growth projection.

Entrepreneurs should ask themselves the following: do we believe that an investment from this particular VC will allow the firm’s value to increase by at least 11.1%?

Final comments

Obviously, stock grants cannot be reduced to a formula. Ultimately you always have to guess. But at least know what you’re guessing. If you choose a number based on your gut feel or a table of typical grant sizes supplied by a VC firm, understand what those are estimates.

When you make any decision involving equity, at least run it through 1/(1 – n) to see if it makes sense. You should always feel richer after trading equity. If the trade didn’t increase the value of your remaining shares enough to put you net ahead, you wouldn’t have (or shouldn’t have) done it.

An important business lesson from Ross Geller and an essential entrepreneurial skill that can be identified based on 4 character attributes.

When we listen to entrepreneurs pitching their vision and path towards success, we ask ourselves if they will be able to pivot to get there.

The world is shaping businesses increasingly unpredictable and fast. The likelihood that any of us will have an unwavering path to entrepreneurial success is less and less likely. Winners will be those who adapt and learn from their mistakes. People need to be nimble in order to increase their chances of success dramatically.

Unfortunately, many entrepreneurs think discussing potential pivots will limit their chances of getting an investment. They limit themselves to selling their path towards success which actually decreases their chances to land an investment.

A pivot is a change in strategy without a change in vision. It’s simply an alternative way to be more successful and achieve your vision. I believe pivoting is a very important skill that increases the likelihood of success.

Character attributes

We try to predict a person’s ability to pivot before the need to pivot occurs. We look for four important attributes: intelligence, self-awareness, empathy, and modesty.

Intelligence

Intelligence is the ability to perceive or infer information and retain it as knowledge to be applied towards adaptive behaviors within an environment or context. You can’t adapt if you are not able to process and analyze the vast amount of information that comes your way.

Self-awareness

Self-awareness is the ability to look outside of oneself, and see yourself as others see you. You can’t act on new information effectively unless you can see its effect on you. Self-awareness is the core to adaptation – unless you understand why you act in a certain way, you cannot act differently.

Empathy

Empathy is the ability to perceive how your actions affect those around you. It creates a feedback loop, where you measure your actions and subsequent reactions. For example, the concept of understanding your customer and making something your customer wants, relies heavily on this cycle.

Modesty

Modesty is having a limited and not overly high opinion of oneself and one’s abilities. Modest people are more likely to listen to others, value opinions, collaborate, and learn. People with big egos tend to lose sight of the bigger picture. They cannot connect with other people and a collective purpose. Without a collective purpose, businesses are not able to pivot.

Conclusion

When we encounter people with a purpose who are open, willing, and able to pivot towards success, we are more than happy to consider an investment and discuss important topics like:

• target audience(s);
• tweaking products and services;
• pricing;
• streamlining processes;
• etc.

We founded Creative Capital Studio, based on a human capital approach towards investing. We recognize the importance of creativity which was already emphasized by McKinsey and World Economic Forum in 2017 and 2018 respectively.

Like all other investors, this will require us to make investment decisions. We investigated many traditional investment decision-making frameworks (e.g. the 4 Ts: Thesis, Team, Traction, Timing) and concluded there was a need for change. Almost all frameworks are based on gathering (financial) evidence and the historic performance of companies and/or individuals ignoring the fact that historic success doesn’t guarantee future success. We wanted to adopt a people-centered, forward-looking model and thus we created the “˜P-score’ decision framework based on 3 Ps: People, Purpose, and Potential.

Inspiration

In a creative capital studio, everything starts with creativity which requires inspiration. To understand our thinking, we would like to share some of the quotes of people who inspired us to use a different approach when making investment decisions:

Bill Gurley: “Being “˜right’ doesn’t lead to superior performance if the consensus forecast is also right.”

Andy Rachleff says: “What most people don’t realize is if you’re right and consensus you don’t make money.” It is a bit strange that most people don’t realize this truth and yet it is common sense: you simply can’t be part of the crowd and at the same time beat the crowd, especially after fees and costs are imposed.

Jeff Bezos: “You just have to remember that contrarians are usually wrong.”

Bucking the crowd’s viewpoint in practice in the real world is not easy since the investor is fighting social proof. Robert Cialdini said: “social proof is most powerful for those who feel unfamiliar or unsure in a specific situation and who, consequently, must look outside of themselves for evidence of how best to behave there.” Great investors have acquired skills in knowing when to be contrarian.

Andy Rachleff: “Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.”

Buffett puts it this way: “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”.

Howard Marks: “To achieve superior investment results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently or do a better job of analyzing them “” ideally all three.”

Peter Lynch said once: “To make money, you must find something that nobody else knows, or do something that others won’t do because they have rigid mindsets.” This search is best done by people who are curious, imaginative, and hard-working.

Marc Andreessen: “If something is already consensus then money will have already flooded in and the profit opportunity is gone. And so by definition in venture capital, if you are doing it right, you are continuously investing in things that are non-consensus at the time of investment. And let me translate “˜non-consensus’: in sort of practical terms, it translates to crazy. You are investing in things that look like they are just nuts.” “The entire art of venture capital in our view is the big breakthrough for ideas. The nature of the big idea is that they are not that predictable.” “Most of the big breakthrough technologies/companies seem crazy at first: PCs, the internet, Bitcoin, Airbnb, Uber, 140 characters. It has to be a radical product. It has to be something where, when people look at it, at first they say, “˜I don’t get it, I don’t understand it. I think it’s too weird, I think it’s too unusual.'”

Being willing to intelligently take this leap of faith is one of the main differences between the venture firms that consistently generate high returns “” and everyone else. Or like Plato says: “Courage is knowing what not to fear”. The ideal startup business is a combination of half-crazy and great convexity (big upside and small downside).

Geoff Lewis: “The best time to invest in a company is when it’s most in violation of a popular narrative.”

In 2010 the popular narrative was “Cleantech is dead”. Who would have imagined the success of Tesla? Narrative violations are highly idiosyncratic, so unearthing them is admittedly more art than science. It is the search for companies that cannot be easily categorized at all. Violating the narrative today will come to define profound new truths tomorrow.

Simon Sinek: ” We should invest in people not ideas. A good idea is often destroyed by bad people and good people can always make a bad idea better.”

It’s a well-known practice that if you invest in a talented team and give them the freedom to create, they will be able to test, experiment, and build something successful. You might even invest in a team and give them the freedom to experiment with multiple concepts for a company, instead of focusing on just one.

Steve Jobs: “Get closer than ever to your customers. So close that you tell them what they need well before they realize it themselves.”

Get to understand your customers’ desires and motivations, without losing sight of the fact that you are the expert. Pushing for small efficiency gains and incremental changes based on passive data may help your margins initially, but truly understanding your customer is what incites a revolution.

Albert Einstein: “Imagination is more important than knowledge. For knowledge is limited, whereas imagination embraces the entire world, stimulating progress, giving birth to evolution.”

Imagination is required to construct insightful theories to explain observational data. Most of the theories we can think of turn out to be incorrect, but through a process of examination and refinement, we eventually weed out the incorrect theories and arrive at the best surviving model we can come up with. We need both imagination and analysis to carry this process forward.

Dwight D. Eisenhouwer: “In preparing for battle I have always found that plans are useless, but planning is indispensable.”

In reality, most plans are rendered useless almost as soon as they are put in motion. There is still some value in the original plan, however. It defines the goal or the outcome we desire. And that’s the most important part of the original plan “” that the destination is clear; the reason, the purpose you’re on a journey in the first place.

But, this doesn’t take away the need to continuously have at least a high-level overview of the plan (objectives, key results) and spend sufficient time on planning; people should always know why but also need to know what, how, and when.

“Times change, technologies change, markets change. To survive, the best leaders realize that their businesses must change as well.”

There is no bigger destroyer of creative potential than the misguided decision to persevere. A company that cannot bring itself to pivot in a new direction on the basis of feedback from the market can get stuck in the land of the living dead, neither growing enough or dying, consuming resources and commitment from employees and other stakeholders but not moving ahead.

Startup productivity is not about cranking out more widgets or features. It is about aligning our efforts with a business and product that are working to create value and drive growth. In other words, successful pivots put us on a path toward growing a sustainable business.

Every startup should have a regular “pivot or persevere” meeting. In my experience, less than a few weeks between meetings is too often and more than a few months is too infrequent. A startup that never had such a meeting is probably not the right investment opportunity.

Nike: “Strong alone, unstoppable together.”

What makes a successful startup team? The common answer is prior startup experience, product knowledge, and industry skills predict the success of a new venture. We tend to disagree: stellar teams have the right combination of hard skills and soft skills. Experience and expertise only lead to better performance if team members share their knowledge and have a common vision for the company.

Guy Kawasak: “Ideas are easy. Implementation is hard.”

Successful implementation is all dependent on the team. It does not matter how great the idea is if you cannot pull it through. Actually, it often is better to have just a “good enough” idea and a great (or promising) team as a starting point than the opposite.

Mahatma Ghandi: “A burning passion coupled with absolute detachment is the key to all success”.

Passion is one of those intangibles that drives an entrepreneur, gets them through the good times and the bad times, and ultimately dictates the success of any startup. If you are not passionate about what you are building, you might as well pack up your bags right now, as your startup will never work.

Result

Creative Capital Studio is a gathering of creative minds. Our views do not reflect the consensus of the crowd and thus we are likely to outperform a market since a market by definition reflects the consensus view.

We are less focused on “pain” and frequency of use. The combination of painful and frequent might seem like the holy grail but it also attracts relentless competition. We rather envision the future and determine if there is room for a big idea (blue ocean). We rather fail unconventionally than succeed conventionally.

We strongly believe a passionate team of creative people with a purpose and persistence will be able to continuously come up with the right plan to generate profit in the end.

We are humble and love to learn, connect and create together. We make our investment decisions based on 3 key aspects of an early-stage company: People, Purpose, and Potential.

It may be true that software eats the world. It may also be true that money feeds the world.

But software and money don’t change the world. Creativity does. Passionate people with purposes do. And perseverance does.

We are with those who want to change things for the better. Who keep on trying and are not afraid to fail. Who set a purpose and pursue it. We will support them, think with them, create with them “” and stay with them as long as we create value.

Let us explain why.

Creative

There are several sides to the start-up and scale-up game. On the one hand, there’s the side of venture capitalists, who offer funding to early stage companies, normally in exchange for shares in the company. On the other hand, incubators will help you out with your idea, offering services and bringing ideas to the market. Most of the times, the relationship between the early stage company and the VC or incubator is based on the mutual trust that we will all gain by it. Bottom line, everybody is aiming for a profit.

Then, there are entrepreneurs. People with “˜ideas that might just lead to something’ and the willingness to take a risk. In the last decades, these ideas have become more and more digital, data based, and algorithmic. Most start-ups nowadays offer platforms, more than actual content. They are not about creativity and find their disruptive strength in the business model “” not in their transformative value. Bottom line, everybody is serving what’s already there.

But there’s a specific party that seems to get lost in this game. We are talking about the people that want to create something really new, not only to make a profit, but also to make things different, valuable, hopefully better. Who see unsolved needs of other people in markets and in social areas, and are ready to pivot their answers those needs into something sustainably valuable. Who want to make a difference, consider what is possible and start with defining a purpose. Who know that success begins with the right mix of people involved. And who are willing to persevere, and not aim for the quick win.

VC’s and incubators are not able to help these people; they simply have a different business model based on a one-dimensional view: ROI within a limited period of time. Restricting themselves to a role as shareholder, they might just not be able to understand the real goals of this kind of entrepreneurs: the purposes that they try to serve, instead of the business that they will generate with it. VC’s and incubators are set up to create businesses, not impact. They simply have a different perspective.

This is where Creative Capital Studio steps in.

Capital

Creative Capital Studio aims at purpose and a long-term perspective. We are triggered by ideas, epiphanies, inspirations, possible impact. We try to deeply understand entrepreneurs and their purposes, and estimate what would be needed, what could be added, what could be different; in short, we will look at possible pivots to make ideas, purposes and entrepreneurship successful. We deliver creative human capital that will bring success. We will support you to make the miracle happen.

The capital we deliver is impact based: purpose first. Business will adapt itself: we treat business as a condition for the purpose; not the other way around. To deliver our value, we do not think in boot camps, temporary commitment, standard models; we are part of “˜our’ companies, for as long as needed and in a way that is necessary and valuable. We will enhance their ideas, investigate their significance, find their format, help scale them up “” always together with the relevant team of the company. We will deliver opportunity, feasibility, desirability, sustainability and creativity in all aspects: by working on the actual purpose and its conditions.

Our main capital consists of topic experts. The partners in Creative Capital Studio are all very experienced, top professionals in their domain: strategy, human resources, marketing, technology and operations have no secrets for them and mirror and complete the expertise of companies. They deploy their knowledge and their creativity as part of their own commitment to the purposes of “˜our’ companies and partner up with the entrepreneurs in our Studio in a co-creative setting to pivot their businesses.

Of course, we know that entrepreneurs also need financial capital; funding to scale up. And we connect “˜our’ entrepreneurs to this capital, but not to earn it back as soon as possible. We demand a long-term commitment of investors, in exchange for value-driven returns. We demand commitment to the purpose.

Studio

We call ourselves a Studio to make clear that we co-create and co-innovate. We offer a setting for ideas to grow, businesses to develop, purposes to be understood deeply, values to be delivered. The Creative Capital Studio is a meeting place for passionate, purpose-driven entrepreneurs, to create the next steps together by connecting the dots.

We think that companies with a purpose are looking for product/market fit and need creativity to realize their potential; which we will deliver in return for equity. We gladly include venture partners that seek impact and will deliver their creativity to support the success of our companies. And we bring the desired social ROI to limited partners by offering them the possibility to invest people-centered, instead of opportunity based, ensuring them that people-driven purpose will remain central in their investment vehicles.