Category Archives: Investor Wealth

Fold The Company vs Doing Everything You Can

Twitter Summary: Happy to report there is still “No Magic” in how to fund and keep a start-up going.

Repeating the obvious, to keep a startup alive you need to bring in more money then you spend, and you need the determination to keep up that effort. I recently received documents from a two year old start-up summarizing the steps the company has taken to keep itself alive. In the past year the company looked to raise another round of funding, but with issues surrounding raising money for advertising based startups, they were not able to get a valuation the founders and the seed round investors deemed reasonable. Rather than dilute themselves or run out of money, they chose to: a) Eliminate staff to just the founders, b) Reduce and eliminate compensation to those founders, and c) Take consulting opportunities that are related to the company’s mission but not directly to their goals to sustain the business.  These consulting opportunities relate more to the expertise of the founders, rather than the goal of the company.  They acknowledge that this is not the original long-term plan, but fortunately, the consulting clients are potential future customers of the company’s product.

In reading  “between the lines” of the documentation, I could see that there have been opportunities for the founders to just call it a “good try “and move on to other startups, jobs, or consulting without the overhead of funding this venture.  However, the team is determined to keep on with their mission, and found a revenue source that was “good enough” to help bridge and get to their eventual goals.

Paul Graham’s essays about startups is one of my favorite reads about how start-ups succeed and fail. More important than brains is the commitment to deliver on the goal and to do everything it takes to support the startup. The decision is actually easy: If the money truly runs out, and there are no consulting opportunities, revenue or additional funding, then it really is time to shut the company down. If revenue can be assembled then the next most necessary element is the determination to continue to deliver on the goal.

Patents — Continuous patent reform

Twitter Summary:  Why the patent system should be continuously reworked to reflect innovation.

The rationale for patents is exchanging explicit information for how something is done for an exclusive right to do it that way until the patent expires.  This appealed to me as a software developer. As an open source software supporter, and a life-long student I have always appreciated reading algorithms, source code and processes to figure out how something is done.  Given that we are all standing on the shoulders of giants, it seems only right to share as much as we can to further advance the development of better software and systems.  Developers should be paid for their work, and the companies that invest in sharing how they do something should be given the opportunity to benefit for their contribution.

Unfortunately the perceived and actual misuse of patents in the software industry are legendary. The GIF patent issue in 1994 suprised many developers that a widely understood algorithm was patented and that anyone who used a common image rendering software owed Unisys a usage fee. The Alcatel-Lucent patent infringement lawsuit which is still under litigation generated a $1.52 billion judgment against Microsoft in 2007 for its use of the MP3 encoding/decoding technologies.  Even more tragic are the patent issues for HIV/AIDS related drugs, where  patent protection has made it difficult for poor countries to afford the drug for their populations. India recently rejected the patent applications so that they can provide the drugs at a more affordable price to their citizens.

Given the value created by the patent system in encouraging the sharing of information, a continuous review process would improve the agility of the patent system to reflect the changes and innovations all people would like to see. Microsoft would like to see the patent system be unified into a global patent system.  I think this is an excellent idea on three levels:

  1. It would compel a conversation and hopefully create a unified standard about what types of inventions should be patented and for what duration they should be patented.
  2. It would compel people, organizations and countries to think globally about the impact of their inventions and create a standard that they should achieve if they want patent protection.
  3. All these conversations and standards would have an organization committed to examining and re-examining if it is achieving the desired goal of increased innovation, increased information sharing, and adequate time for inventors to recoup their investment.

Such a patent organization could periodically re-align itself to achieve inspirational goals like the XPrize Foundation and support innovations that would benefit society.  It could offer a 100 year patent to the first organization that creates a cure for cancer, or creates an affordable non-polluting vehicle that can travel thousands of miles. It could create shorter patent durations for software or other technologies that have a short life-span. Given the many approaches to patent reform, it should all be with the end goal of encouraging the sharing of information, providing a standard for establishing the uniquness of an idea, and allowing the inventors enough time to benefit from the exclusive ownership of the patent.

Alternate Compensation Models

Twitter Summary: Examples of alternate compensation models that focus on fairness in compensation.

In my continuing research on compensation models, I was led to two different articles that offered interesting models on how to structure compensation. One article focused on how to structure compensation for a legal firm’s partners and the other was  “The Hacking Business Model”, which offered a compensation model and complete structure for creating a company for distributed software development.

The Partner’s compensation plan primer is an interesting read. It highlights that compensation is tricky because employees desire a sense of “fairness,” but people’s definition of fair is different. The recommendation for legal firms is for them to decide  compensation plans a year ahead of the compensation review, and support decisions with records that are comprehensive, reliable and available.  Basic questions that need to be addressed are: (1) Who makes the allocation decisions? (2) Are allocations based on percentages or units of participation? (3) Are distributions allocated based on prior work or when current the year is complete? (4) Will profits be distributed and how much will be allocated for overhead? (5) Are there principals that get compensated regardless? The article re-enforces the notion that whatever model you choose,  a) you need to create the expectation among the employees that the plan will change for continuous improvement and b) you will communicate the changes ahead of their implementation.

The “Hacking Business Model”  is a model focused on creating a worker owned company and implements an open compensation plan. When I first showed this to some of my friends, their initial reaction was to quote Monty Python and the Holy Grail:

“We’re an anarcho-syndicalist commune.
We take turns to act as sort of an executive officer for the week.
But all the decisions of that officer have to be ratified
at a special biweekly meeting
by a simple majority in the case of internal affairs.
– But by 2/3rd’s majority …”

Despite the similarities to humorous sketch, I like the Hacking Business Model’s attempt to lay out not just a compensation plan  but a documented philosophy and approach to how the business is focused, how it is structured and how it is allowed to change. The compensation model it advocates is vague on salary and simply states that pay is competitive, but does focus on the goal of the company being to generate bonuses. Bonuses are a function of hours worked (units of participation) and a VIP multiplier based on their relative importance to the company. Although I am not sure how many companies have been successful using this business model, it certainly is open and understandable.

Companies strive to have a “fair” compensation model.  Since being “fair” is subjective, a better plan is to be clear as to how you compensate your employees, have a documented way to decide how compensation is determined, and the process for how it will change from year to year.

Giving the company away

Twitter Summary: To grow a business, you have to give pieces of it to others who also will benefit from its growth.

In my continuing research on alternate equity plans, I spoke with the founding member of a real estate company that originally started with 6 partners, and has grown to an 80 partner firm. The founding of the company was that each partner bought 1/6th of the company and any future distributions would be divided equally among the members.   At the inception of the company, there wasn’t enough revenue to actually have any distributions, but everyone was providing sweat equity and the real estate sales model comes with a well defined commission structure.

The biggest hurdles for the company was when the 6 original partners had to make a decision of whether to keep the company small or to broaden the ownership to include more of the associates and employees.  The two times the company had to make the transition it almost destroyed the company as you had to deal with partners who didn’t want to grow the company bigger or dilute the equity they have created within the company.  The majority of the partners argued that by broadening the equity participants you could get even larger returns.  The company ended up choosing to broaden the number of participants in the equity plan, which fortunately also coincided with a growth of the business which brought greater returns for everyone. In retrospect, the founder thought that Bill Gates, Jeff Bezos and many of the internet startups got it right from the start by starting off with an options and equity plan so that the incentive to help everyone participate in the growth of the company was broadly distributed throughout the organization.

The hardest part about building a business is that if you want growth you end up having to give your business away. You have to give ideas, equity, incentives, and successes to people you have enlisted to help you grow the business. By broadening the base of the number of people working to make your organization to grow and flourish you increase the probability that you will be successful. The transition from growing “my idea” to “an organization of ideas” is likely to be the biggest issue in managing the growth of an entrepreneur started organization.

Why do we have businesses anyway?

Businesses are created and run for many reasons beyond “to profit” or “to make money.”  My favorite write up on this was done by Richard Feld’s “What is the purpose of business?” who argues that businesses are created primarily to provide goods and services to a population. Profits are important as they are useful to keep the company continuing, but not the purpose of a business. The quest for profit outside of the purpose of an business risks the loss of direction for the company and the loss of the business itself.

Profit for profit sake contributed to the downfall of several large financial institutions throughout 2008.  Banks and investment organizations provide loans and high quality investment advice to sustain themselves. Many of these organizations took larger risks in lending what people now realize were lower quality investments for the sake of an increased rate of return.  These organizations bankrupted their purpose in offering poor quality investments, which ended up bankrupting themselves and their investors along the way.  Surprisingly, banks also increased service and usage fees, for which there was no tangible benefits, and further alienates customers.  The increasing quest for profit from banks from the same population they are supposed to be benefiting will most likely end up driving customers away to other alternatives.

A no less expensive but better customer experience and clearer purpose is that of a casino.  In contrast to banks and investment firms,  casinos are explicit in how they are making their money in exchange for entertainment.   Their service is entertainment via dining, drinking, gambling, and unique experiences, in exchange for a percentage of their customer’s cash. The casinos usually request the money either up-front in the case of gambling or provide a price list so that the customer can make the informed decision of what they can or cannot do.  In this model, the customer is aware of the direct costs and benefits to themselves. From a customer service and experience viewpoint, the casinos, although often lambasted for taking money from customers, is a more honest profit model and is in line with their purpose, entertainment.

Creating a product or service that fulfills a community need is why businesses should exist and working with a business that matches your goals benefits both you and your colleagues. A team with a shared purpose is why we continue working in groups despite the hassles of scheduling, personalities and annoyances that come along the way. If the company can be profitable in its purpose it should be able to sustain itself and provide continued value to the community. As an employee and investor,  you should select the companies you want to support explicitly.  Whether that company is a bank or a casino it is usually best if they stick to their purpose and continue to create value for their community.