But even if you are a founder, don’t do it for the money. Do it because you love small teams. Do it because you love your product. Do it because you love playing the startup game (even if you don’t win it). But for the love of God, don’t do it because you think you’ll get rich and retire on a beach somewhere when you’re 30. Because, as crazy as it sounds, when you sell your first company it almost certainly isn’t going to happen.

Let’s run through a common exit scenario. You and 2 co-founders spin up a company (say you’re creating one of Mike Arrington’s “Dipshit Companies that wants to sell to Google for $20m“). You take a smallish seed round and a small-ish Series A round (yeah yeah, you can bootstrap– but the vast majority of 7 to 9-figure exits are funded companies). So after investors and options for employees, let’s say you each own 20% of your company (it can be a lot less or more, depending on what kind of leverage you have while fundraising, how big your options pool is, and how many of those options are exercised/accelerated upon exit). Now let’s say you exit for $20m 3 years into it. Congrats! Light up the cigars and start hunting for beach houses– you’ve now joined the new rich! Except you really haven’t. You see, you (like a lot of folks) aren’t really thinking what it means to retire at 30. You’re not alone. The fellas at AdGrok have the same mental math going on in their head in their “Fuck You, Money” post:

“Before anything else, let’s do the numbers: money market funds yield around 4%. That’s $400K interest on $10MM, which is certainly a living wage, leaving aside inflation. Of course, it doesn’t have to last forever: human life is sadly finite. Crunching more realistic numbers, ‘fuck-you money’ is about $4.2MM for a 30 year old guy who plans on dying at 70 and wants to make $200K/year. Well within the payout picture of a fortunate startup founder whose company is acquired.”

Of course, many of these numbers are strange. 4% for a money market? I’d love a link to that– the best I’ve been able to find is around 1.5% right now for a jumbo money market. Dying at 70? Chances are you’ll live to 90, at least. “Leaving aside inflation”? That’s disastrous (why would you leave aside a number that cuts your 4% by more than half?!). Let’s run through some REAL numbers, using my “Early Retirement Spreadsheet” (AKA “Fuck You Money Spreadsheet of DOOM” – feel free to save a copy and noodle with it).

In our above scenario, our happy founders are walking away with 20% of $20m, or $4m (might be a touch more due to unclaimed options, or a lot less if your investors are the double-dippin’). $4m– we could live on that forever, right? Let’s plug in some variables. 3% for average inflation (a touch higher than the average over the last decade to be conservative). Let’s assume you can get a 5% return (even though the last decade gave us -0.99% for the S&P and the outlook isn’t too rosy). And let’s assume you want to live in a major metro area in a nice house, a couple of kids in private school, and solid travel budget. You’re a millionaire, right? So let’s assume your annual family budget will be $200k. Upper middle class– certainly not in “butler country”, but real comfy, flying first class and living large. Here are our variables:

That’s not too crazy-conservative, is it? Heck, if you’re earning 5% on $4m, that’s $200k right there. No problem, right? You can coast forever with your fat nest egg largely untouched. You’re probably doing what I (and the AdGrok guys above) were doing: “Leaving aside inflation”. Let’s look at what you’ll have to spend to keep your $200k per year lifestyle with compounding annual inflation.

Wait a minute! I’m going to be spending nearly half a million dollars per year when I’m 60 to compensate for a 3% annual inflation? Don’t worry– you’ll be broke LONG before you 60th birthday. Let’s look at how your F@#$ You Money evolves over time with these variables.

You don’t even make it to 50. If you want to be optimistic about inflation and investment income (after all fees) and nudge them to 2.5% and 7% respectively, you don’t make it to 60.

There are a few morals to this story:

• make sure you freakin’ LOVE what you do. Love the game, love your product, love your co-workers, love your market.
• If you are going to be a mercenary, make sure to optimize not just for “f@#$ you money” but “f@#$ you influence”— make sure that as you sell your $20m company that you are well positioned to build another company, have a fat executive job, some great advisory roles, paid speaking engagements, and the like. Because you’re still going to want income.
• DON’T love the idea of living rich AND being retired. You can live rich on $5m OR you can retire early with $5m– but you sure as hell aren’t going to do both… for long.

Note: If you’d like to see the spreadsheet, it’s here. You can make a copy of it if you’d like to noodle with the variable to find your personal “never have to work again” number.

Since I’ve announced that I’m moving on in the coming weeks/months, I’ve been bombarded with cool offers at existing startups, larger companies, and, of course, I’ve been pondering some of my own startup ideas. So his question which I didn’t really consider very carefully at the time is now one that I’m thinking a LOT about.

So without further ado, here is my “checklist for good startup ideas”. No startup will do great on every aspect of the checklist, but this allows me to put startups/products to a sniff test that I think is pretty darn useful. Note, this list is in rough order of importance.

1. How deeply do you think the startup will effect people’s lives? Can you imagine them using it every day? Can you imagine them being royally pissed if they couldn’t use it? This can range from utility (gmail) to emotion (twitter), but if a product isn’t in the “I’d rather chew off my own arm than lose it” category for a meaningful percentage of it’s users, it should be a non-starter.
2. Are the hypotheses that form the basis of the startup tractable? In other words, can test the idea(s) in a short period of time? I’ve talked about the importance of tractability before (hat tip, Ev Williams). Bottom line is that most initial hypotheses are wrong to varying degrees. Twitter was very tractable. Tesla is not. I’ll re-use the money quote from Fred Wilson: “…Of the 26 companies that I consider realized or effectively realized in my personal track record, 17 of them made complete transformations or partial transformations of their businesses between the time we invested and the time we sold. That means there a 2/3 chance you’ll have to significantly reinvent your business between the time you take a venture capital investment and when you exit your business.”
3. How does the cost-of-acquisition, cost-of-goods-sold (COGS) and revenue-per-customer stack up? Most software startup have a pretty low COGS, so this question generally comes down to, “How much does it cost to buy a customer and how much revenue does that customer represent over their life?” This obviously requires a lot of guesswork early on, but experience is a helluva teacher here. If you haven’t been on the wrong side of this ratio a few times, find a mentor who has. Any way you slice it, you need to fine a “scalable, cost-effective way to get your customer’s attention”. I can’t count the number of startups that aimed squarely at small businesses or “prosumers” with sub-$100 price point and have no idea on how they’re going to buy a customer (other than word of mouth, SEM/SEO, and PR).
   
   I love extremes here. Zynga, Twitter, and Facebook has nailed one extreme– their cost of acquisition is free and nearly infinitely scalable. If you can build a service that grows virally (free and growing customer acquisition), you can focus most of your attention on value creation and revenue-per-user. With a little success there and a little time to let the virus spread, and you can almost not help but succeed. I think it’s hard to overestimate the power of free marketing/customer acquisition.

   There are certainly extremes on the other side. What do you think Oracle’s revenue per customer is? How much can they afford to “buy” a customer for? What about Groupon?

   Pro Tip: If you’re raising angel or Series-A money and you say you’ll be using the proceeds for things like magazine ads and wrappers on busses, you’ve probably already lost.

4. How MANY lives could you imagine touching in 5 years? This is different than asking about total addressable market (TAM). Craigslist started as a classified ads mailing list for San Francisco. Amazon started selling books. Have some imagination and consider what your company could morph into. Is it interesting enough to justify the opportunity cost and the fact that you’re looking at a drastically reduced salary for 2-5 years?
5. Is it an invention or re-invention? Hats off to you inventors out there, but I strongly prefer an existing market to creating one from scratch. The companies whose equity I covet didn’t build anything NEW, they just built something BETTER (Google, Facebook, Apple, Amazon, Craigslist, eBay, Zynga etc). In short, the first mover advantage is a crock of shit (most of the time).
6. Is it worth talking about? Can you tell a story about the product that would make a blogger say, “Holy crap– I could write a story around that that would get tons of links, tweets, and comments?” One of my favorite products is Visual Website Optimizer (it’s a brilliant A/B testing tool). The founder (a great product designer who I’ve had a few conversations with) sent out a barrage of emails to major tech bloggers and heard nothing but crickets (he appealed to Hacker News readers for advice— I think the discussion is interesting). His fundamental problem is that he doesn’t have a story that will drive links/tweets/comments/pageviews– all of the metrics that pro-bloggers care about. Oftentimes, clever PR people can create a story out of something that has nothing to do with the product (see: 37Signals & Zappos), but it certainly helps a lot if your product is funny, controversial, unusually useful, or inherently exhibitionist.
7. Are you passionate about the end-game? This one is hard to rank. All of the points above assume you are a “mercenary” founder (maximizing for opportunity) rather than a “missionary” founder (passionate about a vision that keeps you awake at night). Great video on that point here. Regardless of whether your end game is a vision realized or a big pile of cash (or some combination thereof), you need to be passionate about it… You need to have something that powers you through the bumps in the road where a rational person would cut and run. Both motivations are dangerous, by the way. If you’re motivated by cash, you might have a hard time sticking through tough times when you realize what you’ve built might only be a single or a double. If you’re motivated by vision, you might not like the pivots your startup needs to take to survive/succeed.
8. Is the market moving in the right direction? Can you imagine there being a LOT of growth and consolidation in the next 5-10 years? I just saw my first RedBox the other day (it’s a cool box outside of supermarkets that allow you to rent DVDs). They are currently on the wrong side of a market shift away from physical media– can you imagine people renting DVDs in 10 years? I think this one is particularly hard to get right (which is why it’s low on the list).

That’s my list. Am I missing something that’s on yours?

With Nivi and Naval preaching the gospel of social proof (can I get an “amen”?!) and with fundraising posts and articles espousing the importance of introductions, it’s no surprise that about once a week someone asks me to introduce them to someone else. It’s especially common around Y Combinator Demo Day, where YC groups shift from pure product mania to fundraising mode. I’m pretty sure that YC tells new crops of startups to ask for introductions from the funded companies from previous sessions.

What does surprise me is how people ask for these introductions. Here’s pretty much how they usually read:

“Hey Tony. I’m [insert name] from [company name]. We’re starting our fundraising effort and I was wondering if you’d introduce me to [insert RescueTime investor/advisor].”

I usually will make the introduction, but the person asking for it is certainly not making the most of the opportunity (and asking me to spend my social capital by doing so). So after making a mess of these introductions in varied ways, here is my suggested checklist for making an introduction (it’s pretty much my reply when I get a request like the one above):

• Write the introduction for me. Seriously. You know more about your story than I do. You know the things to say that will make someone light up. I don’t. I might flub it. I can personalize it (“Hey [insert investor name]- hope your trip to [offensively exotic location] was fun. Welcome back! Listen, I wanted to introduce you to…”), but you should make the pitch. Bonus: this saves me a few minutes of writing, which is kind and thoughtful of you!
• Don’t bury the lede. What’s the thing that will get an investor excited? Be concise, but talk about social proof, traction, growth, size of the market, how badass your team is, mainstream press coverage, other investors who are on board, and user passion/joy. Choose whatever distinguishes your startup from the sea of startups that investors read about every single day. Unless your product is revolutionary, spend more time talking about your market (“we’re helping companies in the billion dollar widget maker market sell doodads”) and your team than your product (“we’ve got an ajaxy shopping cart!”). If they investor blogs or has EVER talked about their investment strategy, hopefully you’ve read how they think and tune your pitch to match that.
• Heap on the social proof, man! Getting an email intro from a near-stranger (me) is about the weakest social proof you can get (but it’s better than nothing). Tell us how many other investors you have soft-circled. Give us a link to a list of all of the blog posts praising you. Or all of the users tweeting about you. We’re herd animals. If the investor feels like the herd is leaving him behind, that’s a good thing.
• Think about why it’s an opportunity for investors. If I’m writing to an investor about a company that looks like a credible opportunity, that’s me doing them a favor. If you don’t have any bullet points that many you look like a great opportunity, that’s me doing you a favor and adding noise to their already overflowing inbox.
• Keep it short. All of the above stuff could mean a lot of content. You’ve got to pick and choose what to send and hope it’s enough bait for the investor to dig in and learn more.
• Bonus points: track it. When we were talking to investors, we created custom (private) pages for each investor we were courting giving them a ton more to dig through and get excited about if they wanted. The emails were short and sweet with a “want to learn more” link at the end. We used Google analytics to track which people clicked through and which individual pages they clicked on so we could know what to focus our discussions on when we met them.

All that said, if you’ve got a great investment opportunity (with a launched product and some happy users), don’t be shy about dropping me a line if I can help (with introductions or advice).

(post scriptum: If you are in the market for introductions, you should check out VentureHacks’ StartupList!)

(post post scriptum: If you’d like to learn more about making good introductions, Chris Fralic just wrote an outstanding post for the “connector” – The Art of the Introduction)

So when selling our company and getting presented with a cash/stock options package, I was damn excited about the options. I dutifully did a bit of research to try to understand how they worked, asked some smart questions, and was a proud new owner of startup equity. 365 days later, I left Jobster– on good terms, but I chose not to exercise my options.

Now, as RescueTime is expanding its team, I’m on the other side of the equation– putting together stock option plans for new hires. So I figured it might be useful for folks we’re talking to for me to put together so thoughts and resources about startup compensation, particularly in the area of stock options. A big part of my motivation here is that I think most startups are QUITE content to let employees think that options are this magical ticket to wealth and prosperity… It feels dishonest.

3 Harsh Realities of Startup Options

1. Employees with decent salaries and options will almost NEVER get rich in a liquidity event. The people who might get rich with startup equity are the founders and the investors (not coincidentally, the people who took significant risks). There are obviously exceptions here– I read that Google minted 900 new millionaires when they IPO’d. Good for them. But when you do the math on probably exits for most startups, it’s good– but it’s not quite so rosy. VentureHacks has a breakdown of what startup employees might expect in terms of equity. Assuming you don’t get diluted with further investment down the road, a lead dev or director might expect 1% ownership (vesting over 4 years). So in the event of a $50,000,000 exit, they’d walk away with a cool $500k, IF they’d been there for 4 years or longer.

2. Options vest over 4 years. Everyone loves the idea of the overnight success with a quick-flip to Google. It’s vanishingly rare, but it does happen. When it does, the founders generally do okay, but what happens to the late-comers with unvested options is a question mark. Those unvested shares COULD accelerate (meaning they could all vest when the buy happens). Or they could convert to options in the purchasing companies stock (par value). That’s all part of the negotiation and it all depends on the leverage you have with the buyer.

3. How the options are set up very much effect how attractive the company is to a buyer. We’d LOVE to offer 100% acceleration upon change of control to our hires– that’d mean that all options would immedietely vest and our whole team would be rich and happy– but not particularly incentivized to stay and work for the buyer.

So are Options a Crappy Deal?

The best way to look at options are as a high-risk investment– it’s important to look at the cost of the investment, the chance that the investment will “hit”, the likely magnitude of the return on investment, and the percentage you’ll likely have in your pocket at the time of a liquidity event. Here’s the best way to look at the math.

• The COST of the investment is the difference between what you could be making (your market value) minus the salary that you are offered. So if you’re worth $85k/yr and the offer is $75k/yr, you’re investing $10k per year in this high-risk opportunity. If you’re getting paid market value, then… Well, there’s no risk– and you shouldn’t be expecting much reward.
• The CHANCE the investment will hit is a huge question mark. Think hard about the market for such a company. Who would buy it? Can you imagine Google and Microsoft fighting over the company?
• The MAGNITUDE of the return is another question mark. If it’s a web startup, there’s lots of data out there about sale prices. The question is: how big is the opportunity? What are companies in your space getting bought for? It’s easy to test a few scenarios.
• The PERCENTAGE of ownership is a bit of a moving target, but you can at least know where you start. Again, take a look at VentureHacks for a reality check.

So to boil it down in an example, let’s say we have an engineer who is getting .5% of the company vested over 4 years. He’s making $80k, but probably could make $90k at a company with limited equity opportunity. Let’s assume a target exit price of $50,000,000 (oh, happy day!).

Our engineer is spending $10k per year to have a shot at a $62,500 per year. If he spends the full four years there, he’s “invested” $40k for a shot at $250k (a 6x+ return– not bad). When you run the same scenario with a billion dollar exit, it’s starting to look a lot prettier. When you run it at a Flickr-sized exit ($20m), it’s not looking like that great of a bet. If you want to get into the finer points, you should probably consider the benefits as well as the cost of the options.

The only way to buy more reward is with more risk. Some founders will be willing to give up lots more equity if you’ll work for less, but it’s honestly fairly rare if they’ve reached the point where they have enough cash to hire people for them to be terribly eager to part with lots of equity. There’s obviously a small army of “idea guys” out there who would happily give you huge piles of equity if you’ll work for free. And, of course, the best way to get rich with equity is to start your own company.

If you don’t fancy rolling the financial dice by “investing” in a startup, most startups are probably happy to pay you market rate and dial down your options… But either way, there are lots of career perks that you’re buying by working in a startup. Which brings me to…

You’re Buying More than Just a High Risk Investment

Needless to say, most options aren’t a very good investment. A chance at a 5x return is great, but most startups are facing longer odds than 5 to 1– so you should be damn sure that you believe in the company, the team, and (most importantly) your ability to influence the outcome.

I think it’s important to note that our engineer in the above example is buying a heckuva lot more with his $10k… Though they are things with a very subjective value.

• He’s buying startup experience. If you plan on spinning up your own thing someday, there is no substitute for working in a startup to learn what works and what doesn’t. You don’t have to sign on with a experienced startup founder… It’s good enough to get paid to watch them make mistakes that you can avoid when it’s your turn.
• He’s buying a “clean slate”. If you get to a startup early enough, there is lots of blue sky. The early days of product development (for many people) are the most rewarding.
• He’s buying startup cred. When it comes time to spinning up his own thing or getting his next gig, it’s a big plus to have that background. It’s obviously a HUGE plus to be part of a winning team (if an exit happens).
• He’s buying relationships. One of our investors says that 99% of his deal flow comes from people he’s previously invested in or people on their teams. Working at an early stage startup is an opportunity to meet investors and other important startup folks– good leads for future endeavors.
• He’s buying a work environment that is comparatively bullshit-free. Little bureaucracy, few meetings, flexible work schedule/environment, etc. If you’ve ever had an environment like this, you know how addictive it is and how elusive it is in larger companies.
• He’s (hopefully) buying a chance to work on a product he likes/wants to use.

Obviously, all of these perks are really only perks for people who see themselves working on/in startups in the future… For people like this, the $10k price tag (when you roll in the high-risk investment op) is a great investment. For folks who are just chasing the idea that they are going to get rich taking decent-paying jobs with post-funding startups, they are in for a long series of disappointments.

(note: if other folks have insights on startup compensation/options, please chime in. Despite writing a Newbie’s guide, I am, admittedly, a bit of a newbie! )