Session 3, Part 2: Financial Projections

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Mit.

Edu.

JOSEPH HADZIMA: OK, youmet the financing sources.

You got a little bitof an insight there.

Part of what you're going toneed when you talk to them is some idea of whatthe financials look like for your business.

And joining us tonightto show you how to do that is Charlie Tillet.

Now, Charlie's been doingthis for– he was in the $10K.

I think he'll talkabout that a bit.

CHARLIE TILLETT: Yep.

JOSEPH HADZIMA: And I wasin– I've been doing things around the world– Iwas in Istanbul two years ago, in asetting with 25 teams from around the Muslim world.

And I was mentoringa team from Pakistan.

And I'm looking attheir slide deck, and I get to the financials,and I say, where did you get this template? And they didn't quiteunderstand what I was saying.

And I'm looking at it,it was Charlie's template that he uses in the course.

So his speeches here havetransformed financial plans all over the world, inPakistan, and he's graciously come back to talk to us.

Charlie was theperson I mentioned who I met outside of the MITEnterprise Forum meeting, and asked him what he was doing,and that led to a whole career with a bunch ofentrepreneurs up north.

CHARLIE TILLETT: Yep.

JOSEPH HADZIMA: AndI'll sort of let you pick it up there, Charlie.

CHARLIE TILLETT: OK, great.

Thanks, Joe.

What was the firststory he told? AUDIENCE: Jumping inyour pickup truck.

CHARLIE TILLETT: OK, yeah.

So we will get to that.

So it's great tobe here tonight.

I've got probablytwice as many slides as I should cover in my littleover an hour that I've got.

So I'm going to go quick.

But feel free to ask anyquestions as we go along.

And what I'll try and do is,I wrote down a few notes, listening to thepanel, the great panel that we had here,maybe some terms that they brought upthat they didn't really give enough explanationor background on.

So I'm going to try to touchon those as we go as well.

So tonight we're going totalk about your business plan financials.

Putting together thatcritical spreadsheet that you've got to have when youwalk into that meeting, right? Or when you sendsomeone your deck, and how to put that together.

But we're going tostep back a little bit.

And as people say, I was aCFO of a couple of companies.

But part of my job wasbeing a salesperson.

And what I woulddo is I would walk into these meetings witha deck and with a team.

But my job was to sellthat team to the investors.

And in return, theywould give us money, and we would give them stock.

But what we're reallyselling is the team, and the concept of the businessthat we're trying to build.

Then, will talk about whatis your business model, and building yourfinancial projections.

And so this template thatI'm going to show you tonight is up on the website.

There's a newtemplate this year.

It's got a little more detailin terms of cost of goods sold, in case you're doing somethingthat's got more of a hardware component.

This gives a littlemore detail on that.

But that was what Iwas trying to think of.

So this template isgoing to be out there, so that you can download it.

It's an Excel spreadsheet.

You can start pluggingin your own stuff in it.

And I'll tell youthe things that you need to take out when youactually show it to someone.

And then, the lastpart is we're going to talk about sharing the pie.

So I've added a couplethings to this talk about putting together yourbusiness plan spreadsheet.

And one of them is talkingabout the venture capital perspective, and helpingyou sit it in their shoes and evaluate your opportunity.

But also thinking about theother uses or takers of equity in your company.

And by equity, I mean stock.

So I've got coupleslides on here on thinking about yourcompany, and all of the people, and all of the entities thatcould potentially get stock in your company,and what that does to your ownershipin the company.

So my background is I was agraduate from Sloan in '91.

That was the inauguralyear– oh, well, in 1990 was the inaugural yearof the $10K Contest.

Well, it's now the $100K.

And we were thethird place team.

So rather than get,you know, I think it's now $20,000 or $30,000worth of free legal service and accountingservice, we got $300 to split betweenthe three of us.

So since that wasn't enoughto start our business, we all went our separate ways.

But what I did,Joe introduced me to some guys who hadan interesting idea for some networkmonitoring equipment.

And they didn't reallyknow how to build a business around that.

And that experiencein the $10K Contest was critical, because I'dworked with these two guys.

And we'd sat at the– we didn'thave Wi-Fi at that time– so we're sitting inthe computer lab, plugging it into aspreadsheet late at night, going, well, if we increasethe sales price by this much, what does it do to our business? If we are able to reducecost by this much, what does it do to our business? How many salespeopleare we going to need? And I went throughthat whole exercise of building that template forthe business plan contest.

And because of that, Ihad tremendous credibility when I started.

I knew what I was talkingabout when I went in to talk to these guys whohad this data communications product.

And I was able toconvince them that I could help them build their model.

And sure enough, Iwas able to do that.

But it was the enteringinto the contest, and working with theteam, and working through all of that, thathelped give me that experience.

The company wasNetScout Systems.

We completed severalrounds of venture financing there, and went public in 1999.

I then got involvedwith a dot.

Com company, which fortunatelydidn't last too long.

And then was at aHomeland Security company that made bomb detectionequipment for airports.

So completely differentindustry, but the same metrics.

The same tools apply.

The same spreadsheet thatI'd built to get NetScout off the ground wasthe same spreadsheet that I used to getReveal off the ground.

And it's the same spreadsheetthat you guys can all use to get yourbusiness off the ground.

I raised $125 million inmore than 10 transactions over that period.

So you're probablysaying to yourself, I'm too busy todo my financials.

Right? I've got moreimportant things to do.

One, they're not goingto be right anyway.

I mean, who cansit here and say, we're going to be able to bespot on on our financials? Right? The second is, the VCs aren'tgoing to believe it anyway.

They're going tolook at your numbers, and they're goingto say, they've got their own ideas of this.

And the third is, you've gotmore important things to do.

Building the team, figuringout what the product is, and looking at whoyour customers are.

But the realityis the financials are the scoreboard, thescorecard for your company.

So if you don't knowwhat you're shooting for, then how do you knowwhether you're making progress against those goals? But the more importantthing is kind of what I wastalking about with me and my team in the $10K Contest.

It helps you understand whatyour key assumptions are, because you've got to put thoseassumptions into either numbers or formulas.

You've got to understandwhat the drivers are.

So if you're able toincrease prices by 10%, what does that do? Is that an importantlever or not? Or is it more importantto get your costs down? Or is it more important tooutsource your development and get your R&D spending down? Is it more important to dosoftware as a service model, or sell it is a product? And how do those thingsimpact how much cash you're going to need? So it's a great exercise thathelps you understand what's going on in your business.

Because as the CEOof your company, the number onejob is to maintain the cash in the company.

It's the oxygen supply.

And without that, you could bedoing everything else right, but it doesn't takelong for people to start walkingout the door when they're not getting a paycheck.

Now, your managementteam– we've had those days where Ihave to go to the guys and say, hey, guys, there'snot going to be anything in the envelope this week.

But for your rankand file employees, you can't be missing payroll.

And your vendors will onlylet you stretch out payables for so long.

So you've got to know whereyou stand with your cash, and what cash you need.

So you don't needto be an accountant, but you've got tounderstand these key terms.

And you've got to beable to discuss them.

Because the investorsup here, they also don't expect you tobe an accountant.

But they do expect youto understand the drivers in your business, and what thekey metrics in your business are.

In Reveal Imaging–Reveal Imaging was a company that madebomb detection equipment.

And there we had anall-star management team.

We had five guys– thiswas founded in 2003, 18 months after 9/11–we had five guys who'd been in Homeland Securityfor more than a decade each.

So there were alot of people who wanted to get into HomelandSecurity on September 12, OK? But there were nota lot of people who were in Homeland Security,the Homeland Security business, on September 10.

And we had five ofthose guys here.

So we had a market opportunity.

The Congress had said,all passenger bags that go on a passengerairliner in the United States have to be screenedfor explosives.

And we want a machine thatcan automatically do that.

We don't want peoplelooking at X-ray images.

And there weremachines on the market.

These guys had actually–of the eight machines that had been certified–these guys had been involved in getting fourof those machines certified.

So we really hadan all-star team.

They had come up with anidea for a product that was half the size ofthe existing equipment.

Also half of the throughput,but half of the cost.

And so those metrics were verycompelling for the smaller airports like Burlington,Vermont, or Nantucket, Mass, rather than the Logan's.

But there's 500 airports inthe country, and one by one they were getting tickedoff by our competitors.

So we had an opportunityto get to market that we had to get to fast,because once those airports were staffed with ourcompetitors' equipment, they were no longeran opportunity.

So we went out, and wehit the ground running.

And we started raising moneythe first day we got together as a management team.

We raised an angel round within90 days of $1 million dollars.

And then, within six months, weraised our first venture round.

And it was a $5 million,but it was in two tranches.

The tranches were a$5 million tranche, and a second $5 million tranche,based upon hitting milestones.

Because we wanted to raiseas much money as possible, but our investors were reluctantto give us everything up front.

So we reached thiscompromise, where we said, OK, we're goingto hit some milestones, and because we hadthe financial plan, and we knew how far $5million would take us, we knew what we could get donebefore we ran out of money.

And so we were ableto pre-negotiate an increase in value uponhitting that milestone.

So it was kind of awin-win, because we did not have to spend– once weraised the $5 million, we didn't have to immediatelystart thinking about raising the next $5 million,because we had that kind of in our hip pocket.

All I can say is that,as soon as we raised a round of financing,I started thinking about the next financingthat we were going to do.

It could have beenbank financing, like an equipmentline, which is simply as you buy equipment foryour manufacturing facility, or as you buy computers foryour software engineers, you send a copy of theinvoice over to the bank, and they will provide–they will give you 90% of that money back– andyou now have a loan to the bank.

So it didn't look like alot of money, $500,000.

But as we were getting closeto running out of money, and we hadn't metthat milestone there we had committed to toget the second $5 million, that $500,000 wasvery important to us.

Because that gave us anextra three months of runway to get closer to the goal.

So I'm going to kind oftake you behind the scenes to think about what doesa venture capitalist want.

When they put intheir money, they're interested in getting 3xto 5x absolute returns.

So if they put $1 millioninto your company, they want to get $3million back to $5 million back, on top of the $1 million.

So they've got to get $4million to $6 million back.

And if it's $5million, do the math.

Their investment horizonis five to seven years.

And what I will say is that,when you take venture money, that clock starts tickingthe day that that money gets wired into your account.

And while five yearsseems like forever, the investors realize that fiveyears goes by in a heartbeat.

And they will startpounding you to run faster than you think you canpossibly run from day one.

And it's motivating,and it's a great thing.

And if you havethe right partners, they're helping youdo the right things.

But you got torecognize that it's going to be– I think theyadmitted up here– it's going to be a veryintense environment when you take that money.

So you better be prepared forit when you take the money.

They also want to get–I mean, you heard up here that they want to get asignificant amount of money invested.

It depends on the firm.

Some firms might wantto put in $1 million, some firms might wantto put in $5 million.

It depends on the firm.

But they want to havea significant amount of money invested.

And they want to have asignificant ownership.

So if $5 millionis their target, they don't want toput in $5 million and get 10% of the company.

They want to have– at anearly stage investment– they want to have asignificant amount.

So the formula to thinkabout how much equity you have to give up isthe percentage of equity that the venturecapitalists are going to get is the money that theyinvest– and we'll have some examples onthe next page– divided by the pre-money value plusthe money that they invested.

Now, that's the formula.

It doesn't really give youthe answer, because what's the pre-money valuation? But as you heard up here, kindof where is the market today, he was saying he seesa lot of companies in the $3 million to $6million pre-money range, right? So there is kind of a senseof where the market is today, and what othercompanies are getting.

But where that pre-moneyvaluation comes in, that's the key tothe negotiation that you have to do.

The other part is how muchmoney they're investing.

So if we look at acouple of examples here.

Say a Series A round, $5million invested on a $5 million pre-money.

So we take the $5 millioninvested, we add that to the pre-money of $5 million.

It's 5 over 10, itcomes out to 50%.

If there's a Series B,let's say it's $10 million invested on a $15million pre-money.

That'd be $10 million over 10plus 15, would be 10 over 25, or 40%.

But recognize that when theSeries B money comes in, the Series A investors getdiluted by the same 40% that everyone elsegets diluted by.

And I have an examplewalking through that.

Typically, the Aand the B investors are going to be the same people.

So the B investors are kindof diluting themselves.

But recognize thatthat dilution happens.

So don't think that you'regiving up 50% of your company, and then 40% of yourcompany, and you're left with 10% of your company.

You're really left with30% of your company, right? So if an investor is lookingfor three to five times on their money, andthey've put $15 million in, and they own 70% ofthe company, then three times the $15 millioninvested is $45 million, plus the original$15 million back, so they've got toget $60 million.

They own 70% of the company.

So that company has to be valuedat $85 million to $130 million for them to getthat type of return.

And so in order toget so that valuation, you've got to grow yourrevenues to $40 to $60 million.

So there's a lot ofbusinesses that you guys could start that can grow to–you know, another comment you heard here was makesure that your investors and your opportunity andyour investment dollars are aligned, right? One of the bigproblems was people going after what turned out tobe a small opportunity with too much capital.

So the problem is, is thatonce someone has $15 million invested in your company, you'vegot to go after the big return.

So you could havea business that could be a greatbusiness for you and a couple of your MITpals that goes to $5 million in revenue, or $10million in revenue, and there's three of you,and you each own 33%, and you have no outside income,and no outside investors, and it's very profitable.

It could be agreat business that could be just agold mine for you, but it would not be anappropriate investment for some of our panelists here.

And if they had comein as an investor, then there's going to be amismatch, and a lot of tension.

Because you can't get to ahappy place for both of you.

So I know that this screen's alittle bit hard to read here, but let me just walk youreal quickly through.

If you've got afounding group here that has four million sharesbetween all of the founders, they've got 100% of the equity,and there's 100% right there.

You then bring in some earlyemployees and give them– and there'd be alist, I have a list in the back of showing kindof who would get what– but you have someearly employees, and maybe some advisors,that get a number of shares.

And so already the foundersget diluted a little bit.

They then bringin an angel round of $500,000 at a $4.

5million pre-money.

So we know for our formula,$500,000 divided by $5 million, the angel investorsare going to get 10%.

In this case, and in all thesecases, new shares are issued.

The founders continue to owntheir four million shares, but now there's five millionshares in the company, and the founders havebeen diluted to 80%, OK? We now have kind of theclassic A round venture capitalists come in, andthey put in $5 million at the $5 million thatI talked about earlier.

They get 50%.

But one of thethings that is going to happen when theA round comes in is the investorsare going to want to see that youhave an option pool so that you can issue stockoptions to your employees.

Because all employeeslike stock options, and it provides extraincentive to your employees.

But the investorsare saying, we don't want to be diluted for thefirst 100 people that you hire.

So you've got toset aside options to take care of those peoplewithout them being diluted.

So they still get their 50%, butyou've got to create this pool.

And in my example, it's 12%.

But it's somewhere in the10% to 20% range, right? And that's a topic fordiscussion and negotiation with your venture capitalists.

Anything I'm saying wronghere, feel free to hop in.

So then we have our finalround is that $10 million at $15 million, andthese investors get 40%.

Notice the A investorsare now down to 30%, and our founding teamis down to 18.

2%.

So this kind of walks youthrough the progression of how stock gets distributedto both employees, angel investors, andventure capital investors.

Yep? AUDIENCE: So the question Ihave is other than the stock distribution, dothey get more control because they ask formore seats on the board? Is that something which happensa lot when the second round and third round happens? CHARLIE TILLETT: So the questionis, do they– so first off is the investors are going toget preferred shares that have many more rights thanthe common shares, OK? And there will beanti-dilution provisions, there will beratchet provisions, in case there's a down round.

But probably the most importantthing that will always happen is that they will getboard representation.

And that is a littlebit of a negotiated– it's not negotiated that theyhave board representation, but what I've seen is, so let'ssay that you're the founder, you say we have twoseats, the founders have two seats on the board,your venture capitalists come in, they get twoseats on the board, and then you agree thatthe fifth board member will be mutually agreed upon.

And you've got tofigure out– again, if you have problemsdeciding on a mutually agreeable fifth board member atthis stage in the relationship, then these are not theright venture guys for you to be working with, OK? So it should be prettyeasy to find someone that everyone agreeshas domain knowledge, has expertise in the field, isentrepreneurial, and is going to be kind of neutral, right? So does that answeryour question? Yep? AUDIENCE: Yeah, on a previousslide, you were talking about, say you've taken $10million in VC money, but it turns out theopportunity was smaller.

It's only $5 millionin revenue per year.

What are theoptions, then, there? CHARLIE TILLETT:So her question is, let's say you've taken moremoney than the opportunity.

There's really nohappy ending there, because the investorsare going to want to get their money back.

And a company thatgrows to $5 million, it's kind of thewalking dead, right? So you're nowmaking enough money to where you're notgoing out of business, but there's another problemthere, is that companies that only get to $5 million and $10million– now, I don't know, how much revenue doesPinterest– you know, there's a lot of companiesout there that have no revenue and have tremendous valuations.

But let's not plan that we'regoing to catch lightning in a bottle, OK? So a company that has $5million to $10 million in revenue, the reality is thatthere's a very small market.

Who's going to buya company like that? When we were at RevealImaging, we grew the company to $100 million, and we grewthe company to $50 million in revenue, but our buyers wereaerospace defense companies that are huge.

And they were willingto pay us $125 million for $50 million revenue,but nothing more than that.

They were only willing to payus kind of 1.

5 times revenue.

They were hoping that we wouldhave $500 million in revenue, because they were willingto pay $1.

25 billion.

But the problem is that a$5 million to $10 million company doesn't getany big company who's your– it's too small to gopublic, and the big companies, it's not big enoughto move the needle.

Especially if you'vealready proven that it's not going to go like that, right? You've already decided thatit's going to go $5 million, $6 million, $7 million.

It doesn't get anyone excited.

So the business model,and in my mind– I mean, you heard the term used acouple of times on the panel tonight– how I thinkof it is it's an income statement in percentage terms.

And we'll show you someof the business models from a number of companies in anumber of different industries.

But when you think aboutyour business model, think about your businessreaching critical mass.

Do you have to have some kindof geographic dispersion? Or do you need acritical mass of sales in order to get yourvolume pricing down? Or maybe it's thenumber of customers that gives you some kind of synergy.

So when you think about yourbusiness model, think about it, it's in the happy times, right? It's reached criticalmass, and it is kind of hitting on all cylinders.

So how many are Course 15? OK, maybe about athird, or maybe 40%.

So this is going to bea little bit boring.

This section is going to be alittle bit boring for you guys, but I want to make sureeveryone's on the same page here.

So when we talk about the incomestatement, we start at the top.

And it's your sales number,also called your revenue number, and that's the products thatyou're shipping out the door, or the service thatyou're providing, and the dollar number thatyou're putting on that invoice.

So it's after anydiscounts that you give.

It's after anykickbacks or anything.

It's the number– whenyou send out an invoice to that customer, what'sthe dollar on that invoice, and what's the checkthat you're going to get from that customer.

Your cost of goods soldis the material costs, the labor it costs tobuild your product, it's the facilities inwhich that product is built, but it's also your support cost.

So if you ship a product, andyou have a one year warranty, or you have a tech supportline that people are calling, that's part of your cost, too.

So you've got to staffthat tech support line.

You've got to manit, maybe it's 24/7.

If you've got ahardware product, and it breaks withinthe warranty period, you've got to fix that.

You've got shipping costs.

You might have to sendsomeone out into the field, if you've got a big machinelike we had at Reveal that weighed two tons.

So those are allthe things that go into your cost of goods sold.

It's not your R&D.

So it'snot your programming cost.

Your product developmentcosts go down in R&D.

Then, you have yourthree main departments.

Sales and marketingis self-explanatory.

R&D would be all of yourprogramming, product development, anymaterial that gets bought as part of yourproduct development process.

Then, your generaland administrative is kind of everything else.

Your CFO is in there,your CEO is in there.

HR, IT, your facilities,your facility staff for the non-manufacturingfacility.

And at the bottom isyour operating profit, or EBITDA, earnings beforeinterest, taxes, depreciation, and amortization.

And I like to use that as theyardstick, because it gets really complicated addingin capital expenses and depreciating stuff, and thatkind of obscures what's really going on in your business.

So I would urgeyou in your plans don't depreciateanything, and also don't start allocating yourgeneral and administrative expenses acrossother departments.

Just let them sit in your G&A.

So I get a lot ofbusiness plans.

I'm happy to look atanyone's business plans.

My email is at the endof this presentation.

Any time, whether it's partof this class, or any time in the next 10 years, you wantto send me a business plan, say, I'm getting readyto make a presentation.

I want someone tolook at this and just make sure it'snot totally crazy.

So I get a lot ofbusiness plans.

And the first thing that I dowhen I look at a business plan is I look at thetop line, and say, how big is thisbusiness going to get? What is the marketopportunity here? So here's anopportunity, they think it can grow to $75 million.

The next thing that Ilook at is, in year four, kind of the happy times, oncethey've reached critical mass, what does thisbusiness look like? What are the gross margins? I've worked incompanies that have 80% gross margins and companiesthat have 50% gross margins, and I can tell you it'sdramatically easier to make money andrun a business when you have 80% gross marginsversus 50% gross margins.

It's dramatically different.

And then, where are thebig expenses down here? What are they spending on R&D? Particularly, whatare they spending on sales and marketing? Because most firms end upat about the same place in R&D spending oncethey reach critical mass.

They end up about thesame place G&A spending.

But the sales and marketingwildly varies, depending on is it a consumer product, is ita business to business product, is it a luxuryproduct that you have to do a lot of advertising,is there a lot of trade shows.

So it depends on your wholesales strategy and distribution strategy, and that shows upin your sales and marketing.

The last thing that I look atis kind of the operating profit over the this four year period.

Because that gives youa pretty good yardstick for how much cashthis company is going to take to getto profitability.

It's not perfect, but it'sprobably within 20% or 30%, which is a good– youknow, it at least says to me this company, $3.

5million plus $2.

5 million is $6 million, maybe it lost alittle bit here in year three, so it's $7 million.

It's not a company that'sgoing to need $20 million.

But it's also nota company that's going to need $1million or $2 million.

So it gives you just a senseof what this company needs.

Now, let's say you're lookingat your business plan.

I would urge you tolook at the same thing.

Start at the top line,and say, do I really think this business cando this kind of revenue? I would also urge you to lookat year four or year five, whatever it's goingto take you get to that place, thecritical mass, and say, does this business modellook like other companies in my space, or is it different? And if it's different, thatdoesn't mean it's wrong.

It just means that you betterunderstand why it's different.

Maybe you're doing somethingdramatically different.

Maybe you've gotsome tremendous cost of goods sold value thatother companies don't have.

But you've got tounderstand that.

Then, I would urge you tothink about a year one, because thinking aboutexpenses in year four is a very difficult exercise.

Because you can't even–I mean, here you are, you're getting yourbusiness off the ground.

It's hard to think about ifI had $75 million in revenue, where would that money be spent.

But it's very easy to thinkabout the next 12 months.

And who are my key hires? And how much are thosepeople going to cost? And what are thestuff that they're going to need to buy tohelp them do their job? And you're probably notgoing to have a lot of sales, so you don't reallyneed to think too much about cost of goods sold yet.

OK? But you need tostart thinking about what are my staffingpriorities, and what are the things that we need,and where are we going to locate our business, and what we don'thave to spend on facilities, and that kind of thing.

And then, while year oneshould be fairly easy to do, year two is not that muchmore of a stretch, because you are ready have kind of thoughtabout where I am in month 12.

And so you just kindof extrapolate that into what are we going to doonce we start having revenue? OK, so what is my supportteam going to look like? What is my sales teamgoing to look like? And put some numbers on that.

And then, once you'vedone that, look at where your percentagesare out here in year two.

And you already looked atwhere they are in year four.

And kind of make year three askind of a blending process, OK? Now, you're not going todo this on an annual basis.

I'm going to urge you todo it on a quarterly basis.

And we'll get into thosespecific spreadsheets and talk you talk youthrough that in a bit.

So the business model in termsof this percentage of income, or percentage ofrevenue, exercise helps you think about what yourbusiness is going to look like, and how you'regoing to get there.

It's going to showhow your business is going to make money.

So let's look at a numberof different companies, OK? This is a number inthe retail sector.

You guys all know them.

Walmart, the low costleader, Target's kind of a middle market, andNordstrom is more high end.

What has categorizedthese businesses.

They all have crappygross margins, right? 24% for Walmart, 34%percent for Target.

They spend nothingon R&D.

Target should probably spend alittle something on their IT department, though, right? Now, all of this information isavailable from the Securities and Exchange Commission, or youcan get rid of Yahoo Finance now.

So just going toYahoo Finance, you can pull up the annual reports.

You can get all thisinformation off of there.

Most companies dothe lump sales, general and administrativeexpenses together.

So I don't have abreakout on what they're spending on salesand marketing versus G&A.

But you can seethe sales, and SG&A comes in kind ofacross the board here.

But not tremendously profitable.

But very high annual revenue.

I mean, look at Walmartat $344 billion.

So 6% of a big numberis still a big number.

One of the things that'suseful to look at, not comparing yourselfto these companies, but comparing yourselfto your peers, is going to be lookingat revenue per employee.

So I just threw thison here so you could– it does tell a lot how companieswithin similar industries have very similarrevenue per employee.

And in retail, it's in the$150,000 to $200,000 range.

Let's look at therestaurant business.

It's probably even worse, right? Again, terrible gross margins,but actually the profitability is a little bit betterthan the retail stores.

But look at the revenue peremployee, $45,000 per employee.

So think of this.

The cost of goods are 68%.

And a lot of that'sgot to actually be meat and potatoes, right? So how much money isactually left over to pay– if your averageemployee is $45,000 per person, you can't pay thatperson $45,000 a year.

So this idea thatthey're going start being able to pay fastfood workers $15 an hour, which is this bigargument, there's just not enough money there.

It's a crazybusiness here, and I suspect that there are alot of part-time workers.

But it is aninteresting fact here that all these businesses havesuch low revenue per employee.

Let's look at someinteresting companies now.

Cisco, very goodgross margin, 64%.

We see R&D is at 13% andoperating profit at 25%.

These might be acouple years old, but they're in line with this.

And revenue per employeeis $573,000 per employee.

Think of that versus$45,000 per employee, OK? So you can affordto pay your Cisco employees $100,000 to $125,000.

You can't afford to dothat at McDonald's, right? So again, theseare characterized by R&D spending of kindof the 10% to 15% range.

Except for Dell.

And Dell is reallyjust a box manufacture.

They're just an assembler.

They're just asupply chain story.

They're not an R&D story.

And it comes outin their numbers.

Medtronic is amedical device maker, but it really has all thecharacteristics of a technology hardware company.

Let's look at somesoftware companies.

Again, even bettergross margins.

Say R&D is in thatsame 10% to 15%.

And the revenue peremployee at Microsoft is about the same as Cisco.

Oracle and SAP,which are more peers, have very similarrevenue per employee in that $250,000to $300,000 range.

The internet companiesare all across the board.

I mean, Apple's not reallyan internet company, but they are kindof interesting here in that they have $2 millionof revenue per employee.

Mind-boggling.

I mean, Google is at $1 million.

I started putting Google onthis after they went public.

And I said, well, theycan't sustain that.

They were about $1million when I first did it I think three years ago.

And they've actually increasedtheir revenue per employee as they've grown.

So they've becomemore productive, which is kind of– fewcompanies are able to do that.

Usually, companieshave a decrease in revenue per employeeas they get bigger.

Google's been ableto increase it.

Again, here, R&D spending.

I mean, Apple is so big thatthat 2% is still a huge number, right? But if we look atthe rest of these, it is a little bitacross the board, and it's part of where a companyis in this stage of their life cycle.

But this gives you kind of asense of where companies are.

Another thing that'sinteresting here is the two companies withthe lowest gross margin are Apple, which isselling hardware, and Pandora, whichis selling music.

So just because you're in aintellectual property business, or in a– I don't know what youwould call music, if you're not calling it hardware.

But it's kind of interestingthat their cost of goods are actually as high as Apple's,because of the royalties that they have to pay.

And that creates someproblems for them.

I think they're nowstarting to show a profit, but it's still avery tough business.

Looking at business modelsover a period of time, they evolve slowly.

I've been doing thistalk since at least '98.

And just looking at Cisco,it looks like the same.

I mean, yeah, it goes upand down a little bit.

But companies donot dramatically change over a period oftime once they kind of hit that critical mass.

So as you'rebuilding your model– I know the talk yesterday wason your product and pricing your product– what's the valuethat you bring to the customer? And how is that valuegoing to be split between you and the customer? I hear a lot ofpeople say, well, we have a product that willsave our customers $10,000.

So we think we shouldcharge them $10,000.

Well, at $10,000,they're indifferent whether they do it manuallyor whether they do it with your newpiece of equipment.

So you've got toprice that product to where it's compelling forthe customer to take that risk and make that change.

And if it's a $10,000value to them, you've probably got to pricethat at $2,000 or $3,000, and let them capture themajority of that savings, because they're taking the risk.

And so you've gotto figure out how, at a $2,000 or$3,000 price, you're going to be able to sellthat and capture enough value yourself, OK? Your distribution strategy.

So think about the price, andthen your cost of goods sold should be prettystraightforward.

I mean, you know thematerial that goes in there.

Again, it's not howlong is it going to take to develop this product.

That's part of your R&D, andthat's a whole other exercise.

But it's, if I sell a unit, howmuch material goes into it, how much labor goes intoit, how much overhead in the manufacturingfacility goes into it, how much support am Igoing to have to provide? These are all questions that,if you sit there and noodle away at it, you can come up witha pretty reasonable range, and come up with yourcost of goods sold.

When you think about yourdistribution strategy, how am I going tosell my product, that could have– I have anexample of that in here– that could have a huge impacton everything involving your business, in both yourrevenue all the way down to your sales and marketingand your operating profit.

So that's a huge decisionyou're going to have to make.

R&D, I would argue, shouldend up at the 10% to 20% range generally.

As we've looked ata lot of companies, that's where they end up.

That doesn't mean you shouldn'tbe at 30%, like Zynga was, depending on where youare in your life cycle.

But if you're atechnology company, and you're not spending10% of your revenue on R&D, you're yourself short fortomorrow's products, right? Because you've alwaysgot to be evolving.

G&A is going to endup at 5% to 15%.

The lower you canget that, the better.

That's where the CFO is,so just squeeze that down.

And make sure you buildin an operating profit.

Now, you're operating profitshouldn't be 40% to 50%.

There's a few companiesthat can get away with that.

But to think that yourcompany is one of those is probably unrealistic.

So if you're puttingtogether your model, and you keep coming up with a40% to 50% operating profit, you should really questionsome of your assumptions.

Do I really, am Imissing anything here? I'm not saying it's wrong.

It might be doable.

But you're going to getsome pushback on that from people who've lookedat a lot of business plans.

So I talked about howyour distribution strategy is going to impactyour operating profit.

So let's look at anexample here where you're selling it throughyour own direct sales force.

You have $100 million inrevenue, your cost of goods is $40 million, leavingyou with $60 million, or 60% gross margin.

You have $23 million in salesand marketing, $12 million in R&D, and some G&A,bringing your total expenses to $40 million, and an operatingprofit of $20 million, or 20%.

So let's say, insteadof that, you say, I'm going to bringin a distributor, and give him a 20% discount offof our list price or selling price.

And in return for that 20%,he's going to go out and sell it to the customer.

He gets to keep the20%, but he frees me up of all the sales andmarketing activity.

Well, not entirely.

Because even thedistribution channel needs some care and feeding.

So you can't completely getrid of your sales force.

You can't completely get ridof your marketing efforts.

But you can cut those back.

And in my example, I said,well, you could cut it back from $23 million to $8 million.

Now, your R&D isstill going to be the same, becauseyou've got to keep feeding the machine withnew products, right? And your cost of goods isgoing to be exactly the same, because you're shippingthe same number of units.

But because you havefewer employees, you probably don't needquite as many people in HR, you don't need asmany bean counters.

Your G&A is going tobe a little bit less, and so that's goingto be $4 million.

So in this example, your revenueis reduced from $100 million to $80 million, andyour operating profit is reduced from $20million to $16 million, but you're stillgetting a 20% profit.

Now, I don't know whetherone is right or wrong.

I would say that thedistributor model is going to be great if itcan get you to market faster, or if it can take you from$80 million to $160 million faster than you could groworganically from $100 million to $160 million.

You're still gettingthe same 20%.

And whether that 20%came out at 15% or 25%, the more important numberhere is the $16 million in operating profitversus the $20 million in operating profit.

So as you'rebuilding your model, there is some businessplaning software out there, kind of like a TurboTax.

It asks you abunch of questions.

It asks you the questions,you answer the assumptions, and it spits out a plan.

Do not use that software,because the beauty of this exercise, thebenefit of this exercise, is understanding exactlywhat's going into your model, and building it yourself.

And when something doesn't addup, figuring out what's broken.

When you start getting50% operating profits, start saying, let's lookat my revenue per employee.

Oh, my revenue per employeeis $1 million per employee.

Well, Google does that,and Apple does that, but there are not verymany other companies that have $1 million inrevenue per employee.

So maybe I need to add moreemployees to my staffing plan.

And where am I going todeploy those people in order to build up my organization? So it's doing it, it'sworking the exercise that is the real benefit.

Build your sales projectionsfrom the bottom up.

Anyone watch Shark Tank? OK.

I gave this talkabout two months ago, and everyone said, no, it'son Friday night, I go out.

You know, I'm not waitingat home Friday night.

So someone was onShark Tank last week, and they said they'reselling a product that went into school lockers.

And they said, why areyou valuing your company at $5 million? And he said, well, there's50 million school lockers in the country, and we onlyneed to get 5% of them.

I mean, it's a crazy– that'swrong on so many counts.

Because it doesn'ttalk about how you're going to get into eachschool, how many are going to sell into each school, whatis your distribution strategy to get there.

So instead of saying,the market is huge and we're going toget a slice of it, what you said needto say is, we're going to have five sales guys.

And each salesguy is going to be responsible for aterritory in the country.

And each territory has–I'm kind of making this up about the schoollockers as I go here– but each territoryhas 25,000 schools.

And I expect each salesguy to higher 10 reps.

And each rep is going togo to two schools a day.

And we expect a closure rate of10% when they go to a school, and each school that buys theseis going to buy 50 lockers.

And you put thatall in, and it'll come up with a model for howmany you're going to sell.

And that may not be–it will not be accurate.

Because as you put thistogether, it's a crystal ball.

And when you getout there, you're going to find out a sales guycan't go to two schools a day, and he can't close 10%,and they don't buy 50.

But when you get a guyout there selling stuff, he's going to beproviding data, and you're going to start gettingfeedback to say, we can visit threeschools a day, but there's onlya 5% closure rate, but each school that doesbuy is going to buy 75.

And then, you canadjust your model.

But since you'vebuilt your model, now you can adjustit, and figure out where you're going to go next.

The last thing is thatthere's spreadsheet overload.

So never do a bestcase, worst case, and present threedifferent models, and say, if everything goes right,here's what we need.

I'm not saying don'tlook at contingencies.

But just put yourbest foot forward.

Put your bestestimate on the paper.

Say, here's what wethink we're going to do, and leave the best case,worst case for someone else.

I might give you some rules ofthumb on the next spreadsheet.

These are focused on makingyour investment interest attractive to investors.

Just like your $5million business might be a greatbusiness, it's not going to be attractiveto investors.

So I may say, don't puttogether a business plan that only gets you to $5 million.

That could be a great business.

OK, so don't let mediscourage you from that.

It's most relevant fortechnology companies.

So if you're going tostart a fast food chain, these metrics are notgoing to apply to you.

And like I said, it mightnot apply to your industry.

Staffing is what's goingto drive your expenses, OK? Most technology companies,staffing is 50% to 66% of your expense.

And your averagecost per employee is going to be about $90,000.

I know it sounds crazy,sounds crazy high.

But the reality is,in Boston, first off is, who has administrativeassistants anymore? Unless you have like alarge manufacturing staff that's doing kind ofassembly and stuff like that.

But in most of the companiesthat you guys are going to be starting, it's going tobe a lot of technology workers, it's going to be alot of programmers, it's going to be a lot ofsales and marketing staff, it's going to be afew finance people.

I mean, the financeand HR are probably going to be the cheapestpeople in your company.

I mean, really.

A programmer thesedays, especially if you want to get aalgorithm engineer, algorithm engineer isprobably going to cost you $125,000, $150,000 a year.

OK? Just a programmer'sgoing to cost you $80,000, $90,000, $100,000.

And these folks are goingto want raises every year.

So salaries are going tocome in at about $90,000.

Employee benefits are goingto add about 15% to that.

So I know you've all heardhorror stories about General Motors pays theirguys $25 an hour, but they're truecost is $50 an hour.

Ignore all thataccounting mumbo-jumbo.

You can add in 15%, and that'llbe a pretty good yardstick to cover their FICAexpenses, which is Social Security tax,and their health insurance.

OK? As I said, salaries are going tobe about 2/3 of your expenses.

And sales staff is reallyindustry dependent.

So I've got someyardsticks on here, but it reallydepends on– if you got a guy who's sellinglockers to a school system, OK, you can probably get thatguy for, I don't know, probably $50,000 a year, and maybegive him a 10% commission or something.

Or maybe $40,000 a year.

So you know, thisis not a guy that's selling complicatedsoftware sale, OK? But someone who is sellingsomething like that is going to need $150,000to $250,000 a year.

So I don't have time to gothrough a case study here, but a couple years ago,I went in when OpenTable went public, and just lookedat some of their publicly available information.

And this first page is allof the publicly available information.

But I was able to reallyuncover a lot of things about how they rantheir business, and how they weregenerating revenue.

And I would just urge you tolook at these next few pages.

This presentation willbe on the website.

In terms of cash flow, it'scritical to understand it.

But producing acash flow statement is really complicated, andit's really prone to error.

And the reason isthat you have to put in all of theseformulas, and then the plug number that makesall the formulas work is cash.

So any error in any formula, oranything that you fat-fingered wrong shows up as cash.

And sometimes it'sto the negative, sometimes it's to the positive.

Every time I dothis, I say I'm going to put together a cash flowjust so people can look at one.

And maybe I'll chastise myself,and I'll go home and do this.

And if I do, I'llsend it to Joe.

But a good proxy forcash flow is just looking at yourcumulative operating losses over the period oftime, and adding in any capital expenses that you had.

And while that'snot perfect, it's a pretty good numberfor how much money this business is going to need.

So a lot of people ask me, well,how much should I pay myself? And venture catalysts, theydon't want their entrepreneurs to starve, but theywant them to be hungry.

So what I would urge youto do is think about maybe what you made beforeyou came back to school.

I mean, I assume a lot ofyou are graduate students.

Or think aboutwhat your peers are going to make as they'regoing out into industry.

Now, if you're in a veryspecific discipline, and your peers are going outto work in that discipline, and because– let's saythey're geological engineers, and they're going togo up to North Dakota and make $250,000 a year becausethey're helping drill for oil.

Well, you can'tsay, well, look, I could be drilling for oilin North Dakota for $250,000 a year.

Therefore, that's whatI need to pay myself.

So that's kind ofan extreme case.

But think about whatyour peers are making, and generally youcan argue that that's what you ought to be paid.

Or what you were gettingpaid in your prior life, unless you were an investmentbanker in your prior life, right? Your investors want youto earn a living wage.

They don't want you to beworried about paying the bills, or getting your car fixed.

They don't want youto work 23 hours a day with as few distractionsas possible.

But they want to make surethat you're still hungry, and increasing shareholdervalue every day.

So here's what we want toget to is our profit and loss statement for four years, OK? And so I've got thiscolor coded spreadsheet, and here's the code here.

Anything that's in blue comesfrom another spreadsheet.

And I've got alittle column here that you would take out whenyou actually presented this to anyone that says, here,this is coming from the P&L by quarter spreadsheet.

And so this spreadsheet's gotabout 12 pages on it, right? So here's your summary pagehere, and as you can see, everything comesfrom another page.

So nothing showsup on this page.

But as you're puttingtogether your spreadsheet, you're going to keepcoming back to this and say, how does this look? Does this make sense? Do my sales go like this? Or do my expenses go like this? Or is everything kind of ina nice, smooth trend line? Or if it's not,can I explain it? So for example, I might have nomarketing expenses in year one.

I might have a tremendous amountof marketing expenses in year two as we launch our product.

And then those expenses,maybe not in absolute terms, but in percentage terms,come down in year three, because now we've alreadyreached the market.

So the next spreadsheet, andthis spreadsheet is actually– I would urge you to,at least to start with, do for your projectionson quarterly terms.

Because there's alot of times you're going to be fat-fingeringstuff in here, and when you have48 cells that you have to fat-fingersomething in, you're going to make moreerrors than if you only have 16 to put them in.

And so this spreadsheet goesout to about here, which is year 4, Q4, right? But as we can see, everythingfrom our quarterly statement also comes fromanother spreadsheet.

So let's look at thedetailed spreadsheets.

And the first one isour sales spreadsheet.

So here, in the red,is input numbers.

So I've got my unitsales in units, and I've just pluggedin some numbers here.

Now, you're going tohave to justify these in the rest of your projectionsby what's my sales staff, and how much units am Iexpecting a salesperson to sell.

Here's my unit price, and I'vegot a couple different models.

And as you can see,when I launch model two, I decrease theprice on model one, because now it's old technology.

And so our product revenueis simply a multi– you know, the black is acalculated figure– it's just a multiplicationof those two.

And then the magentanumber, that's what goes to ourother spreadsheet.

So our support revenue,here's our installed base, and there's some retentionon our installed base, and then we charge 15% ofwhat the value of that product is to show what oursupport revenue would be.

But you're just goingto have to play around with thesepercentages, depending on your productand your company.

But I just wanted to show thatthere was actually some support revenue in it as well,and this support revenue goes to the other spreadsheet.

So then we have ourcost of goods sold.

So we have our units thatare coming from our others spreadsheet, and we've pluggedin our unit cost down here.

And so this gives us ourvariable cost per unit.

We've got the 20 units at$1,500 per unit, comes down to $30,000 in material cost.

But I've also got some staffing.

I've got a VP of manufacturing,I've got a supervisor, I've got a technician.

He can build one unit a day.

And so I've got to thinkabout how many technicians I need as I ramp upthat product volume.

OK? So we'll talk about thestaffing plan on another page, but those staffingcosts get added up into salary and benefits.

We have our variable cost here.

We have a facilities cost thatis really a step function, because you can't rampup facilities in line with– you can't addanother 100 square feet, you've got to rent 10,000 squarefeet, and then another 10,000 square feet if you need more.

So we just pluggedin some numbers on our facilities expense, andthat gives us our total product cost of goods sold here.

When we look atthe staffing plan, this is a spreadsheetyou're going to keep coming back to over and overagain, because, as I said, this is where 66% of yourexpenses are going to be.

So first is, you'vegot a spreadsheet that goes down to about here withall of your departments.

And I would urge you, don'tcreate too many lines in here.

Don't create a juniorprogrammer, senior programmer, programmer level three.

You know, kind ofglom things together, because you're going to befat-fingering a lot of stuff in.

And do the same thingwith their salaries.

If a junior programmermakes $80,000, and a programmer makes $100,000,and a senior programmer makes $120,000, justput in programmer, put them all in at $100,000.

You know, again, this is goingto be your guideline, right? So you've got this for all ofyour departments down here, and again, this spreadsheetgoes all the way out to here.

So the companion partto this spreadsheet is actually over on theright side of this thing.

And now you plug in salariesfor each of these staffing positions.

And all this spreadsheet does istake your number of employees, and remember, thisis a quarterly, so we're taking the annualsalary, dividing it by 4, multiplying it by the numberof people in that position, and then we're addingin our benefits at 15%.

So FICA is 7%.

And I've done the math, I'vedone the math dozens of times, 8% of your totalpayroll is usually enough to cover healthinsurance for everyone, at kind of a 75% to 25% ratio.

Because some peoplearen't going to take it.

Some people are going tobe on their spouse's plan.

If you're a techcompany, you're going to have a lot of single people,so they cost about a third as much as the married people.

And so 8% works outto be pretty good.

But your employeesare still going to want to getraises in year two.

Just because you're astart up, they still want a little something extra.

And as I mentioned,a lot of companies have problems gettingthose expenses up in years three and four becausethey don't add people enough.

One of the thingsthat people don't do is they don't rampup their salaries.

So add in 2% a quarter,that gives you 8% a year.

It's not an unreasonable number.

And again, while most payrollsare going up kind of 3% these days, if you're trying tohold on to technology talent, you're going to have to givethem a little something extra.

So again, this goes out–just add 2% a year out until year four.

And so the math getsdone, and these go to the departmental expenses.

Non-salary expenses.

Well, we've got oursalary expenses, and then you've got techsupplies and miscellaneous.

I would urge you to put inas many formulas as you can.

So for like your programmers,put in $2,000 per person, per month.

It sounds like a lot, but I'veworked in a couple technology companies, and it couldbe an oscilloscope, it could be some cabling, itcould be some CAD software.

Whatever it is, these guys canfigure out a way to spin it.

If that sounds like too muchto you, put in $1,000 a month.

But the beauty of that is that,as you change your staffing plan, this number just rampsup and down in line with that.

So you can make dramaticchanges to your staffing plan, you don't have to come backhere and fat-finger anything in.

But some of these things,you are going to have to, especially in themarketing area.

You're going to have to decide,what trade shows do I go to, and what am I going todo for sales expenses? And then you couldeven put in commissions in here, commissions asa percentage of sales, if that seems to work.

And so therefore, asyour cells ramp up, your commissions rampup in line with that.

And here's your travel perperson per month for your sales people is $3,000.

That seems to be prettygood number there.

I put in telephone andinternet per person, and that just ramps upas your company ramps up.

So use as many formulasin this as you can.

And so that brings usback to our quarterly P&L, and where it all comes together.

I've got a quick examplehere on your CAPEX.

And so what I did was Itook your total revenues, but I offset revenuesby a quarter, figuring thatcustomers are going to take 60 to 90 days to pay.

So if you bill themnow, assume that you're going to get money 90days from now, right? And hopefully,you'll get it sooner.

But your other expenseis your employees, which are 2/3 of your expenses.

They want to get paidon payday, right? They don't want to getpaid 30 days from now.

So I just assumed–you know, this is a little bit of aconservative look at it– but I assume your other expensescome due in the current period.

And so based on that, you plugin a starting balance here, and you say, where doesthis money get us to? This money gets usto the end of Q3.

In that case, I'm going toneed to raise additional money, and how much money am I goingto have to raise there to get us to the next milestone? So in this case, Isaid, well, maybe we've hit a milestone hereat the end of Q3, and that's going toallow us to raise our next round of funding.

OK? I've talked about most of these.

Showing steady andconsistent growth.

And here's somesuggestions in here, in terms of an executive summaryversus a full blown business plan.

In reality, theexecutive summary is all most people aregoing to want to look at, at the beginning, andthen when they really get into due diligence,they're going to want to look at the rest.

So I think I can get through therest of this in five minutes, because I've goneover a lot of it.

What I would say, as you thinkabout equity in your company– you're sitting around aconference table here at MIT, and you're thinkingabout the company, or maybe you've been workingon the company for the last two years and you're reallyready to launch it– all I would urge you is thatthe work that is yet to be done is far more than the workthat has been done already.

Even though it feels likeyou've done a tremendous amount, the work that it takes growingto a $1 million dollars is hard.

But growing from $1million to $10 million is equally hard, if not harder.

And going from $10 million to$100 million is really hard.

So the fact that a lothas been accomplished, there's still a lot left to do.

So you don't want toreward people for what's been done in the past.

You want to incentivize themto do things in the future.

So I'm a big believerthat everyone should vest.

I used to beadamantly against this when I was a memberof a founding team.

But I've heard horror storieswhere three or four people get together, and oneguy, or one person, gets an opportunitythat they can't pass up and they leave withtheir 25% of the company.

And then the threepeople that are left are now working forthemselves, and not taking a paycheck, for someonewho's actually got a great job.

So I think everyone should vestover some kind of three or four your period.

Typically, this is theranges that you would see.

A CEO in the 5% range,5% to maybe 10%.

VPs in the 1% to 2 and 1/2%.

This would be after dilution.

Senior managers about 0.

25%, anda senior individual contributor about 0.

10%.

If you're on thefounding management team, you might get two to threetimes this amount, in part because you're goingto get diluted.

And if you're founding employee,you might get even more.

So if you have a seniorindividual contributor, who's really importantto the company, and he's going to get 0.

10%,that's the kind of person you might give 0.

25%or 0.

50% up front.

So let's look atsome examples here.

You get a sense I alwayslike to look at the endpoint, and then go backto the beginning and figure out how I'm goingto get to the endpoint.

So my endpoint here is lookingat this whole dilution, and here this isthe same spreadsheet that we had earlier,I've just add a little more detailwith some names here, and some specificsabout the people.

So looking at this point, thisis where we're going to get to.

But at the beginning,we have four founders that have split the equity$2 million, $1 million, and $1 million.

OK, that all soundswell and good.

They have 100% here.

As we bring in ourkey employees– here we have a VP ofR&D.

He's critical.

Normally, you'd say a VPof R&D would get about 1%.

Well, in reality, by thetime we get out to this, after all of our dilutionout here, this VP of R&D is going to be at 1%.

And some other keyemployees here.

And maybe a board ofadvisors or board members, who would get some equity.

We then bring in our angelinvestors, who get 10%, and everyone uphere gets diluted.

And we then bring inour VC round at 50%, and, again, everyoneup above gets diluted, including the angels.

One of the things thatgot brought up– you know, Axel was talkingabout $50 for 10%.

And my initial reaction wasthat seems really onerous.

It doesn't seemlike a great deal.

But when you realize thathe's coming in at this stage, he's coming in reallyas the angel investor, and by the time this all getsdone– well, what's my example? My example actually works out.

Just take a zero off of this.

His 10% is going to getdiluted down to 2.

3%.

So if you're getting all thatother value, then that 2.

3% doesn't seem to betoo much to give up.

I will say that angel investorsare pretty keen on looking at this spreadsheet, too.

And while a lot of people thinkthat angel investors will not be as tough negotiatorsas the VC investors, I would argue they're investingtheir own money rather than the firm's money, and they haveseen this spreadsheet as well, and the angel investors willbe every bit as tough as the VC negotiations.

Now, friends and familyis a different story.

And I've had very good successwith friends and family coming in, but I mean they'reyour friends and family.

You're not going to tryand screw them over.

So hopefully you're goingto give them a fair deal to begin with.

So it's 9 o'clock on the dot.

I can take one or twoquestions, but then I know that Joe'sgoing to shut me off.

Any– OK, one here.

AUDIENCE: What are theusual terms on the vests with the original founders? CHARLIE TILLETT: Ithink over four years, what you might say– so fouryears with quarterly vesting.

I mean, you could domonthly, but I mean it really doesn't matter at that point.

So four year vestingwith 1/16 every quarter.

Or you what you couldsay is, let's say you've been workingtogether for a year, you say, everyonestarts with 20% vested, and then the remaining80% vests over four years, or three years.

Something like that,just so that someone doesn't get coldfeet when they going starts to get tough andbail on the rest the team.

AUDIENCE: So if they leave aftertwo years, would they still get the part they hadbefore, or would they– CHARLIE TILLETT: Yeah.

So let's say youwere going to get 160,000 shares over four years.

That would be $40,000 ayear, or $10,000 a quarter.

Every quarter, you vest $10,000.

So if you leave after two years,you have your 80,000 shares, and you go, and they're yours.

And the $80,000 thatyou didn't invest– look, if you thought itwas going to be successful, you shouldn't be leaving.

So you've left that,and those are gone.

AUDIENCE: I waswondering if you could talk a little bitabout the difference between the CEOs and the CFOs? First, the difference, B,whether a start-up needs a CFO at a very earlystage, and the last part is, you know, whomakes the decision? CHARLIE TILLETT: Well, look theCEO makes all the decisions.

I serve at thepleasure of the CEO.

But the CFO– Ithink by the time you take your firstventure money, first off you have themoney to pay a CFO, and it will be money well spent.

Because as I showed you, allthose rounds of financing at Reveal, I can't tellyou how much dilution I saved my foundersby thinking ahead about what we needed to do.

So I saved my salary andequity for him, you know, 10 times over.

But we did have a deal.

For the very firstyear, I worked half time for half salary.

And then, we agreed that as thecompany– I was in a position where I could work half time.

And so I think it'sgood to have– maybe you have a mentor advisor for thatfirst year and a controller.

But the problem is, is thatyou really want someone, especially when youstart raising money, you want someone who's beenthrough the process before.

And they will saveyou– you know, an experienced person willsave you a couple percent of dilution right off the bat.

So what's that worth? It all depends.

So you sell your company for$200 million, it's worth a lot.

OK, maybe one more.

Oh, looks like I'vegotten everything.

So thank you very much.

[APPLAUSE].

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