Salary of a startup enterpreneur

Had the pleasure of meeting a very passionate entrepreneur recently on my trip to the capital. A highly experienced professional in mid-/late- forties, the ex-CxO of at least two large professionally managed Indian groups. And, a first time entrepreneur. A rather passionate one at that, I must add. Lets, for the sake of this discussion, refer to her as Naina (not her real name).

I listened intently to the story of her career progression so far and what prompted Naina’s journey, and the pain point that the new business/start-up was going to address and so on.. Incidentally, a prelim Excel of the projections related to the business model had also been worked upon, and so I happened to glance thereupon as well. Almost the first thing that I saw made me fall out of my chair, literally!

The total team size that the business was looking at was about 27 persons, with total annual salaries of over Rs30million; yes over Rs30m, on a turnover (which always is iff) of under Rs20m. That too, for a tech-driven co with IPR-driven business model. The problem was not that the persons to be hired were NOT for the further development of the products (which, if it had been the case, would have been fine from an investor’s perspective as it would potentially lead to additional IPR accretion). The problem was also not that the number of required persons was too high to digest for a bootstrapping startup. The problem was that Naina wanted to hire top-notch professionals at top-notch salaries (quote “in order to lure them into a start-up” unquote).

These professionals for the top management team of over 6 people, and the role to be played by them were all till date being played almost singularly by the entrepreneur! Uh oh! While its only understandable that once the funding comes in, a startup can afford to hire some good talent. This enables the entrepreneur to concentrate on value building, a luxury until the funding comes in. But, this was surely going overboard!! On two counts: one, number of people to be hired, and two, the salaries to be paid to them. She wanted to hire a COO and CMO at an annual compensation of over Rs4m compensation each, and a few others at anywhere between Rs2.4 – 4.0 million. This, of course, was in addition to the Rs6m compensation for herself as was noted in the Excel sheet.

I tried to reason out with her, that these are not the salaries that startups can afford to pay. She retorted that these salaries are still just about half or thereabouts (one-third in her own case) of their last-drawn salaries. And that any investor who comes on board and does not understand the kind of sacrifice that has gone in over the past couple of years to the get the business where it has reached and who is not willing to pay her even one-third of her last drawn salary is a moron and hence unwelcome to the party! Ouch!

It took me a lot of time and effort to explain to her that a startup needs to be run as a startup. And, that one doesn't go and hire so many professionals the moment the money comes in! And, even if they are hired, they are hired for their skills as well as passion to be a part of something potentially big!! Hence, the salaries paid to them are not necessarily in tune with their last drawn salaries; that is why we have ESOPs and MSOPs. The figures she was asking for were way high from the normal trend and accepted norms in startups. The only thing that should motivate the top management of a startup is the potential huge upside that they can get in case when it turns into a successful story. A market-linked salary would kill the very hunger that investors wish to see in startup entrepreneurs/management team.

Of course, investors don't expect the promoter to work on ‘nil’ salary, but what is provided for is just about a sort of sustenance allowance, which is more in tune with the age profile and familial responsibilities that the promoter may have to take care of. The real remuneration would come only at the time of a meaningful and profitable (again, iff) exit at a much later stage.

At this point, I was almost inclined to give her the example of how a lion is just about part-fed, and not fully fed, before a gladiator fight; the hunger keeps the lion motivated to kill his prey for food. A fully fed lion would hardly make for a meaningful gladiator fight. Given the high-running passion and temperaments at the point, I chose not to so mention!

Albeit, I did use the example of our common friend, who himself was a highly acclaimed CxO of a very large telecom co, who has founded and was now running a funded social enterprise, and was drawing a salary which was a fraction of what his successor was currently drawing. She snapped by saying “I am not like him!!”

I vehemently kept trying to explain to her re the necessity to treat a startup (including a funded one) as a startup, and to keep bootstrapping. And she diligently kept trying to highlight the absolute necessity, nay indispensability, of the team that she proposes to hire and the salaries that they would have to be paid. Ultimately, we agreed that it was a deadlock! One that was big enough for us to finally end our long discussions (we fairly overshot the time, but could hardly progress on meaningful discussions). Picked the tab and bid her a sweet good bye.

Got me thinking – if I were to wear the hat of an angel investor, I would never feel comfortable about giving anything more than decent sustenance to the entrepreneur. Having your own company is not what you do when you want to protect your own salary; its what you do when you want to create your own legacy. And, for that, as an entrepreneur, you definitely need to compromise on short-term gains. Lest, they take your eyes away form the long-term goals.

And, oh, by the way, never got a chance to look at Naina’s entire Excel model; we just couldn't get around to that!

Valuation in case of a Start-up

Ah, Valuation!!

Valuation is a rather tricky exercise. Regardless of whether you are a buyer or a seller, and no matter what value you do the transaction at, you will always feel the right value was a little different. In case of startups, this conundrum only compounds itself!

Valuation: More art than science, more so in case of a startup

Valuation, in itself, poses enough procedural and technical challenges that in spite of all the various valuation methodologies, which are technically robust in their own rights, valuation is regarded more of an art, than a science.

In case of a listed or a larger entity with established record of profitability and/or cashflows, especially in cases where comparable industry data is available for benchmarking, the science of valuation plays a prominent role. But, in case of startups there is little, if any, history and a very wide open canvas of what it can grow to be. It is not unexpected to assume that in case of startups as the actual performance of the company will substantially vary from the projected one. Hence, DCF approach, which may be relevant in certain cases, will not hold water in such cases where the degree of certainty of projected cashflows is highly circumspect. Hence, any value ascribed to it might as well be arrived at by rolling the dice; the odds are pretty much the same!

Nevertheless, it cannot be ignored that the biggest test of valuation is common sense. If the valuation methodologies throw up a figure which either defies logic or which sounds too good to be true, it most probably is!

Rule of thumb

As investors move along the learning curve, having invested in numerous startups, they tend to form a feel and hence thumb rule of what kind of valuations DON'T make sense. Of course, with time and euphoria, these rules of thumb also tend to change. This may sound arbitrary and a highly subjective methodology of valuation. Albeit, there is enough empirical evidence to prove that any investment in a startup at a value of higher than the US$ 1m to US$ 2m has a thin statistical chance of making for a good investment for the investor. Hence, the early stage investor will always be wary of investing at a value higher than this range.

Would be useful to always bear in mind another golden rule of valuation of startups: he who has the gold makes the rules! So, it doesn't matter what the entrepreneur think his business is worth. What the investor thinks as the businesses worth is what matters. After all, a business is worth only as much as what an investor is willing to write a cheque for!

Pre- and post-financing valuations

The pre-investment (a.k.a pre-money) valuation is the value at which the new investor comes into the business. It is the value of the business before the new investment is taken in. As a corollary, the post-investment valuation (a.k.a. post-money) valuation is the value of the business after the new round of funding/investment has come in.

Say, for e.g., a VC fund invests $500k for a 20% stake in a company, then the existing shareholding would amount to being 80% of the company. If 20% is valued at $500k, then the balance 80% would be proportionately valued at $2mn. Thus, the pre-money valuation of the company is $2mn and the post-money valuation is $2.5mn. Instead, if the VC fund had invested $500k for a 25% stake in the company, the pre- and post-money valuations of the company would be $1.5mn and $2mn respectively.

Albeit, it is pertinent to note that the pre- and post-money valuations are both an implied derivative of the amount being invested by the investor and the stake acquired by him against that investment.

Conclusion

From an entrepreneur’s perspective, valuation indeed is important, as it will determine what stake of his/her company will need to be diluted in favour of the investing stakeholders. But, its importance is oft-times over-rated. Its better to have a small pie of a large cake than be saddled with a very large pie of a rather small cake.

Would like to sign off with a small word of advice to all startups. If you have the right investing partner (smart money), focus on ‘value’ rather than valuation! Rather, if you are very confident of your business’ ability to grow, settle for a lower valuation if you have to for the sake of the fund-raising, but ask for milestone-based MSOPs. This will enable you to increase your own value, without compromising that of the investors. Of course, it would not be out of place to mention here: the value of the promoter’s holding is also a misnomer of sorts. In almost all cases, the promoter will be bound by legal restrictions to be able to cash out his position, unless all others have been given an opportunity to exit first.

Why must monsoon play a havoc with Mumbaikar's life every year??

Who is responsible for this madness every year. Yes, of course, BMC is the first name that comes to the mind. But isnt there more to it?

• Shouldnt the ordinary citizen be blamed for blatantly littering, which in turn blocks the sewages and hence the flow of water?
• Shouldnt our teachers be blamed for not teaching the students that littering is not just illegal but in absolute defiance of civic sense?
• Shouldnt the contractors be blamed for poor upkeep and maintenance of the roads, leading to slowing traffic?
• Shouldnt our drivers be blamed for ignoring not just traffic rules, but even inasmuch as civic sense and common courtesies to fellow travellers by parking indifferently, by not stopping before the zebra lines - clearly hindering the flow of traffic, without any benefit to anyone?
• Shouldnt the traffic police be blamed for allowing such nuisance on the road?
• Shouldnt the builders be blamed for gobbling up our free spaces and blocking the nallahs that take the water out of the city?
• Shouldnt the buyers be blamed for buying such flats from such builders?
• Shouldnt the slum dwellers be blamed for the same reason - blocking the water outflow?
• Shouldnt the political parties be blamed for shielding and encouraging these slums for political reasons?

The list can go on. But, there has to be a stop somewhere. and, before that stop, there has to be a start somewhere. Lets us pledge to be that start. Let "I" be the change i wanna see in "YOU". If each one of us can do that, this city, nay country, would be a much better place to live!