How to Know When Your Startup is About to Implode

A common question I get from entrepreneurs is, “How do I know when my startup is about to implode?” It’s an important question and one that needs to be asked often. The answer is not a simple one as it depends on several factors.

You may have read about the 40% Rule. The rule states your growth rate plus your operating margin should equal 40%. Let’s look at this rule a bit closer using a five-year analysis, with year 1 not necessarily indicating first year in business. COR + Operating Expense includes cost of revenue and operating expense.

Growth At All Cost: 100% Growth and -60% Operating Margin

The Growth At All Cost scenario is a common scenario in venture-backed companies. The idea is your high revenue growth would offset the losses. However, this scenario does require a substantial amount of capital to sustain.

This scenario is acceptable on a long term basis for ad-based models, which require the company to build up a user base to sell ads against or monthly subscription models, which require substantial sales and marketing dollars to acquire a customer who will pay small amounts over monthly payments, eventually allowing you to recoup sales and marketing expenses. In general, we commonly see this scenario in growth companies — across various industries — looking to land grab where they can. The initial goal is growth, not profitability.

If your company is at this stage and can justify this performance you are safe, given that you can raise enough capital to stay afloat.

growth at all cost

Break-Even: 40% Growth and 0% Operating Margin

The Break-even scenario is typically seen when a company is moving out of growth at all cost stage and is normalizing. On average, a company reaches break-even point near year three. However, it is highly dependent on your industry and growth strategy. For example, if you’re building a marketplace (low risk), you may reach profitability sooner than a company with an ad-based (high risk) model. A marketplace allows you to set up a platform and receive compensation once transactions occur, hence decreasing risk.

One caveat: a low risk revenue model (i.e. marketplace) can still incur significant year-over-year losses if it focuses on a growth at all cost strategy. Uber is an example of a company that should breakeven, yet continues to expand in various regions.


Ramen Profitable: 20% Growth and 20% Operating Margin

The Ramen Profitable scenario is typically seen when a company is moving out of break-even stage and gaining profitability. This is typically experienced beyond year three. However, as previously noted, it could take longer depending on industry and growth strategy. On the flip side, it could be achieved on day one if you are building something that is inexpensive to run and produces significant revenue.

Ideally you would continue on this path until you’ve reached the point of market saturation, defined as the point in which you can no longer gain market share. Unfortunately, some companies fall into two dreaded scenarios: Plateau or Decline.


Plateau: 0% Growth and 40% Operating Margin

The Plateau scenario is typically seen when a company has stalled. Immediate action is needed to determine whether the customer profile has changed or whether the cause is economic forces outside of your control. For instance, has the customer pain point changed no longer requiring the product or service? We saw this when the demand for taxis was offset by the demand for black cars. Or perhaps the economy has changed and consumers are no longer spending in this segment. We saw this in the past few recessions. Consumers began to prioritize their spend and there was very little companies could do to change this behavior. In either case, if you are able to cut costs allowing for a 40% operating margin you have a chance at survival. The real question is: How long can you sustain this?


Decline: -10% Growth and 50% Operating Margin

The Decline scenario follows the Plateau scenario and is further indication that the company is in trouble. At this point, the company may want to determine whether a sale or divestiture is in order. If revenue is declining, the ability to sustain a 50% operating margin will become increasingly difficult.


Early Stage Model: 300% to 50% Growth and -100% to 20% Operating Margin

 On average, a company can expect to have high losses in the early years, break-even around year three and settle into 20% operating margins in year five. Naturally, this varies by industry but is a fair range.

early stage

The graph below illustrates how each of the six scenarios fits into the company lifecycle.


Modeling Early Stage Growth

The 40% Rule provides high level scenarios for mature companies but if we want to see granular data for early-stage companies, we need to look at our weekly growth rate. A good benchmark for weekly growth rate is between 5% to 10%. If we extrapolate this growth rate out, we see that it aligns with the Early Stage Model. I rounded the numbers, but the weekly rates of 5% to 10% will get you close to 100% to 300% annual growth.

growth rate

How to Track Your Numbers

I am a strong believer that you should track your metrics daily. Whether it’s revenue or users, the ability to spot issues is easier if you’re observing your metrics on a daily basis.

If you see your daily metrics slipping, you are in a position to make adjustments. If you track your metrics monthly you may miss a critical inflection point.

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15 Women Who Led IPOs and Bagged $400 Million

Over the past five years, the number of women who have founded companies has increased substantially. Naturally, the number of female-led IPOs has grown as well.

The largest win took place in 2016 when Therese Tucker, who owned 15.60% of BlackLine – a company she founded in 2001, went public. The average IPO takes 7 years. BlackLine took 15 years to IPO, but it looks like patience paid off handsomely. Therese’s shares are worth approximately $171 million today.

The sector breakdown provides insight into where women are succeeding. 60% of the companies were in the life science sector. Of these companies, 80% were in drug development – mainly drugs developed to fight cancer. 13% of the IPOs were in software – specifically marketplaces focused on recommendations. Another 13% were in the environmental sector – solar power and natural pesticides. 7% were in financial technology, and 7% were in wireless technology. It’s no surprise that 86% of these companies share the common thread of aiming to make the world a better place. Not only are women making strides in leadership and wealth creation, they are saving the planet and its occupants.

What Does it All Mean?

The data shows that women are taking risks. 11 of the 15 women were founding CEOs. The remaining 4 joined within 1 year of the company’s inception. Women are generally stereotyped as risk averse. I believe it’s hard to see yourself as a CEO if you’ve never encountered a female CEO. But I believe as more women become visible in leadership roles they will inspire the generation behind them to follow. More importantly, risk can be mitigated by thoroughly researching the market and making sure any company you join is a winner.

70 Cents On the Dollar 

We often hear that women making 70 cents on the dollar is holding women back in the area of wealth creation. As an entrepreneur, however, your focus should not be on your base salary, but instead on your entire compensation package. Entrepreneurs, regardless of gender, should be open to a smaller salary while building their company and amassing equity (read: potential wealth).

An area women lag behind men is retention of equity. In the average male-led IPO, the male CEO held approximately 15% of the company’s equity at the liquidation event, whereas the average female-led CEO only held approximately 6%. Willingness to negotiate compensation is key. Again, in the world of entrepreneurial finance, the amount of equity you negotiate is often more important than your base salary. If you don’t ask, you’ll never receive.

Here’s to the Next Five Years

Do your homework and make sure you’re on a rocket ship not a dinghy. Whether you come on as the CEO or the CTO, you want to make sure your company has what it takes to beat the competition. Women have only been solidly in the workforce for a few decades, but we can glean valuable insight by looking at those women who have built companies, successfully executed an exit, and amassed substantial wealth. The key to wealth is holding on to equity, which can be achieved by raising internal capital and negotiating your valuation and financing terms when you decide to raise external capital.


How Entrepreneurs Can Avoid Million Dollar Legal Mistakes

When joining or building a company, it is imperative that you understand the laws around equity. As an employee, not understanding how stock options work may leave you with expensive tax bills for worthless stock. As a founder, doling out equity too liberally will leave you with a sliver of the company by the time you exit through an IPO or acquisition.

Stock Options 101

Typically, when you get hired at a large firm you are given access to an HR department that explains your 401k package options. You may even receive a workshop to help you learn about the various investment strategies and mutual fund options. This is not always the case when working for a startup.

Perhaps you’ve heard stories about employees who did not understand their options and ended up with a sizable tax bill for stock that was worth a fraction of the intended price. When it comes to stock options, timing and taxation are everything.

When you receive stock options, your shares will vest over a set time schedule. This is called your vesting schedule. The shares that are vested are available to you and those that are not vested are considered restricted shares. The company has the right to buy restricted shares back from you since you didn’t earn them.

At any time you can exercise your options to convert them into shares, yielding a mix of both common shares and restricted shares. Entrepreneurs exercise early to benefit from the small variance between the strike price and the current market price. This is why timing is important. You will be taxed at conversion, so convert when with the lowest possible tax event.

Exercise if you believe the stock will appreciate in value. Be certain to research your company’s industry to understand positioning. Is this company Uber or Sidecar? Facebook or MySpace? Exercising shares of worthless stock will leave you with a net loss. Do your homework to understand the company’s outlook.

Taxation and the IRS

Of course, there is always paperwork. You must understand the proper documents – Section 83 (b) election — that are filed in each event to remain in compliance.

Section 83(b) election is a letter you send to the IRS letting them know you’d like to be taxed on your equity, even shares of restricted stock, on the date the equity was granted to you rather than on the date the equity vests. Failing to file this one document will cause taxation at the vesting date, not the grant date.

Tip: Always consult an attorney when you receive equity or stock options. Your specific taxation will vary based on your country of origin.

Equity as an Infinite Currency

Another common mistake that founders make is giving away too much equity and to the wrong people. It’s a common misperception that equity is free and limitless. Actually, all shares have value and limits.

When deciding whom to give equity and stock options, ask yourself this question: Is there value creation and duration? In other words, is this person creating value and for a long period of time?


A branding team creates a logo and graphics during a two-week period. This type of service should be paid in cash.


A developer signs on to build your prototype and your future platform. This type of service should be paid in equity.

Whether you’re a founder or early employee, your equity and stock options should be handled with care. Treat them like gold. In some scenarios, they are worth more than gold.


Entrepreneurs: Don’t Get Too Confident, You Might Get Burned

As I discussed here, there are many lessons to be learned while watching TV. This week on Million Dollar Listing San Francisco we see a case of an overly optimistic seller. This is a common occurrence, as it’s easy to get attached to the sale price you have in your head.

The worst thing you could do in a booming economic period is get overly confident and believe the bubble will never pop. A strong job market fuels real estate prices. In fact, some argue that the booming tech industry is to blame for the insane real estate valuations we are witnessing today. Regardless of who is to blame, as a seller you must know your place.

When deciding to sell real estate or a company, you need to understand your position in the current economic cycle. As I’ve written before, there is a natural 8-year economic cycle – 1992, 2000, and 2008 were down years. 2016 will be no different.

Unfortunately, greed is a natural emotion. It’s intoxicating to believe the party will never end. It’s normal to want the best for yourself, your property, and your company. With this in mind, you must take calculated, not reckless, risks.

The key is to balance all data available and make a decision based on facts.

We can learn a lot from those who came before us. Let’s take a look at some high profile tech companies who had to answer the age-old question: To sell or not to sell?

In 2006, Viacom offered Facebook $750 million. Investors rejected the low offer, which prompted Yahoo! to approach the company with a $1 billion offer. Still, the offer was too low for the board. What would the world look like today if Yahoo! acquired Facebook? I don’t want to know.

A few years later, it was Facebook’s turn to pull out the checkbook when it set its sights on Twitter. Both parties agreed the valuation estimate was $500 million. Facebook presented an all-stock offer but Twitter wanted cash. Facebook’s share price at the May 18, 2012 IPO was $42.05. Today the share price is $96.44. Stock doesn’t seem like such a bad currency after all.

In 2008, Yahoo! rejected a $44.6 billion acquisition offer from Microsoft. The reigning CEO, Jerry Yang, felt the offer was too low for a company that had a market cap of $27 billion. By 2009, Yahoo!’s market cap dropped to $17 billion. Today, Yahoo! is on the mend thanks to Marissa Mayer. The company is now valued at $34 billion, which makes $44 billion 7 years ago a healthy offer.

Fast forward two years and we saw Google offering to purchase highflying Groupon for $6 billion. Then CEO, Andrew Mason, balked at the offer. At the time, Mason thought the party would never end. Groupon’s growth was astronomical. Yet, if your growth is not sustainable, it means nothing. Today, Groupon is valued at $3.2 billion.

In 2012, Rovio, developer of Angry Birds, rejected a $2 billion offer from Zynga. Instead, the company prepared for an IPO, which some Analysts predicted would value the company at $9 billion. The IPO was aborted and today Rovio is laying off staff. A happy bird in hand is better than two angry birds in a bush.

Last, but not least, Snapchat recently rejected a reported $3 billion offer from Facebook. Today, the company is valued at $19 billion. Only time will tell if Snapchat made the right choice.

It’s easy to get caught up in the emotion of a sale. If you are emotionally attached to your company, it will be harder for you to let go. This is why it’s critical to look at the data and make a decision based on economics, not emotions.

Are you considering a sale? Check out our free guide to valuing your company here and contact Atelier Advisors.



How to Value Your Company

Whether you’re looking to raise a round of capital or sell your company, it’s important to understand how to value your company. The best way to value a company is to research comparable transactions in the market. We’ll take a look at Fortune Brands’ acquisition of Skinnygirl for an easy-to-follow example.

Revenue Estimates

We first develop revenue estimates to determine whether or not this transaction is in fact comparable to the company we are valuing. Revenue estimates are also helpful in creating financial forecasts. In other words, you can use comparable company data to project your own company’s growth.

We estimate revenues for Skinnygirl by gleaning press releases and researching prices.

We know a case of Skinnygirl costs $125. This is likely not the dollar amount received by Skinnygirl, but we will use this for our example. The sales volume for 2010 and 2011 can be found here. A Skinnygirl executive stated that Skinnygirl was 2% of Fortune Brands’ total sales in 2013. A press release noted that sales were down 26% from 2012. From this data, we arrive at the estimates below:

2010 = $18,881,250
2011 = $73,250,000
2012 = $68,000,000
2013 = $50,000,000

Valuation Estimates

When companies are acquired, there are two main components – up front payment (in cash or stock) and contingent consideration (commonly referred to as an earn-out). An earn-out is a payment that is contingent on future performance, such as sales volume. If the acquired company hits all sales goals it will get 100% of the earn-out.

I took a look at publicly available documents to determine the acquisition price of Skinnygirl. It was announced in 2011 that Fortune Brands (now Beam Suntory) would pay a maximum of $28 million in an earn-out to Skinnygirl. According to SEC filings, they made the following payments:

Q1:12: $2 million paid out for 2011
Q1:13: $8 million paid out for 2012
Q1:14: $6 million paid out for 2013 (estimate)

At the beginning of 2013, there was an $18 million balance on the earn-out. At the end of the year, it was stated that there would be a $12 million benefit due to revised sales volumes. SEC filings noted, “The substantial decline in Skinnygirl is largely due to the substantial decrease of the U.S. ready-to-serve spirits category in 2013.” In plain speak, Skinnygirl did not meet the earn-out requirement, so $12 million was reversed in the books. We estimate the earn-out payment for 2013 at $6 million.

The 3 year earn-out yielded $16 million, instead of $28 million.

In the 10Q for the first quarter of 2011, it was reported that Net cash used in investing activities for the three months ended March 31, 2011 increased to $72.7 million primarily due the acquisition of the Skinnygirl cocktail business. This tells us the price was at most $44.7 million ($72.7 million – $28 million). With a revision to the earn-out, the final price was at most somewhere near $60 million ($44.7 million + 16 million). We can cross reference this number by looking at other comparable transactions.

In March of 2012, Fortune Brands paid $605 million for Pinnacle vodka and Calico jack rum, which reportedly sold 3.1 million cases of liquor in 2011, which would equate to $297 million in sales. That gives us a revenue multiple of 2x. Skinnygirl reportedly sold 151,050 cases in 2010 with revenue of $18.8 million.

Based on 2010 sales, Skinnygirl would be valued at approximately $37.6 million.

Optimizing Your Acquisition

In this example, $12 million was left on the table when sales in 2013 dropped drastically. I believe sales were driven in large part by Bethenny Frankel’s ability to stay in front of, and connect with, her audience. Unfortunately, 2013 was the year she left Bravo for Fox and went through a nasty divorce. 2013 was also the year that her fan base turned on her. I don’t think this is a coincidence.

When your personal brand is your corporate brand, it is critical that you are presenting yourself in a consistent manner. It pays to keep your dirty laundry behind the scenes and by all means ignore the trolls. I’m not claiming it’s fair, but it’s reality. No pun intended.

Want to learn more? Get our Guide to Valuing Your Company here.


What Every Startup Founder Needs to Know to About Acquisitions

I wrote about the long and arduous IPO path a while back. Here we discuss the equally daunting mergers and acquisitions (M&A) path.

The growing trend in early-stage M&A is to ditch the suits. According to Dealogic, 73% of acquirers utilized a formal investment banking firm in 2003. By 2013, only 31% of acquirers used a formal investment banking firm. Ironically, M&A volume has increased, not decreased.

Acquirers, typically large technology firms with cash to burn, are recruiting classically trained investment bankers and training them to identify early stage opportunities. We call this function corporate development, as the role finds holes in the corporation’s current technology and uses acquisitions to develop these areas. The focus is not so much on revenue, but product and staffing needs. Hence, the newly coined term acquihire, which occurs when you can’t hire engineers so you acquire them.

On the other side of the transaction, the acquisition targets don’t have the resources to recruit a corporate development team. However, early stage companies need to be armed with the same expertise. They need acquirer research, a valuation estimate, and a negotiation plan.

Here’s what you need to do it yourself:

Acquirer Research – Begin reviewing your competitive landscape for companies that may work well with your team. Look for companies that share your culture, value, and vision. It’s good to get to know these companies before you need them. Strategic partnerships are a great way to test the waters.

Valuation Estimate – Be armed with a valuation estimate based on related transactions in your industry. You can pay for a service that tracks these numbers or you can research them on your own. This guide to valuing your company explains the methodology.

Negotiation Plan – If you do your homework (know what you’re worth) and have discussed all the possible outcomes (asset sale, equity sale, or acquihire) you should be able to set parameters for negotiating the transaction.

Closing the Deal

Most acquisitions will require you to stay around. If it’s an acqui-hire, the assumption is that you are now an employee of the acquirer. If it’s a traditional equity sale, you will more than likely receive an earn-out in your offer. For example, you will be required to stay on for a set period of time to earn additional compensation based on the company’s performance. If it’s an asset sale, you are simply selling certain assets and in most cases won’t be required to tag along.

It is critical that you understand what the “NewCo” will look like. Will you be replacing an existing team? Perhaps you are tasked with creating a new division. Make sure you are on board with the integration schedule. If not, it could hamper your ability to receive compensation outlined in the earn-out.

Need help putting together your valuation? Check out The Guide to Valuing Your Company here.