Sramana Mitra: The subtext of all these things that you’re saying is that there aren’t that many billion-dollar exits. Ultimately, the only valuation that matters is your exit valuation. If you’ve got a billion-dollar valuation in a private round and then you exit for $200 million, what is that going to do for you?
Heidi Roizen: This is the thing that is a little troubling to me. We have really redefined success. Now, it’s coming back. It’s rationalizing again. If your goal is, “I’m going to sell my company for a billion dollars or I’m a worthless human being”, you’ve really set yourself up in a very difficult circumstance if you just look at the math. This speaks to the entrepreneurs’ fundamental motivation.
Do you want to change the world with what you’re doing or do you want to ultimately make some money? Most entrepreneurs will argue that they want to do both. Most companies sell for sub-$100 million. Some successful companies sell for sub-$300 million. Even when you get above $300 million, you’re talking about a fairly rare happening. I really encourage entrepreneurs to run, every step of the way when you’re raising money, what I call, a waterfall chart.
A waterfall chart is a spreadsheet that shows various outcomes. What do each of the stakeholders make? What do I make? What do my employees make? What do my angel investors make? You cannot discern that just looking at a capitalization table because these terms are very complicated.
I would really encourage every entrepreneur to run a spreadsheet before raising money. Run your edge cases and understand what you’re getting into. At least, you are knowingly going into that next fundraising understanding that you’ve just raised the bar for your exit in terms of the return to yourself and your earliest investors.
Sramana Mitra: There are a couple of points that come to my mind as I’m listening to you. We work with these highly sophisticated technology gurus. Everybody is a technology guru in some domain or the other. These supposedly genius people don’t understand probability.
Heidi Roizen: They don’t understand simple math. I teach at Stanford. I joke with the engineers, “I teach here in the engineering school and yet I’m a creative writing major. I don’t have a technical degree.” There are a few things about math that I know that is amazing to me. For example, there is only ever a hundred percent. You can make 100% worth more, but in every company I know, the cap table adds up to 100%.
Therefore, the idea that you’re going to pay somebody a percent and you’re going to pay someone else a percent and every time you raise money, those people need to be made whole, that is ultimately impossible math. The next thing is this idea that all companies are ultimately valued. People argue with me about this. Ultimately, companies are valued at the NPV of their future cash flows.
At the end of the day, a company that never makes money is ultimately not going to be of value. Why do people buy companies that don’t make money? Because they presume they can bring them into their parent company and ultimately make money either on that technology or using that technology to enable other revenue streams.
Another simple thing I see all the time is where this genius engineer who will say, “I have two job offers. One of them is at this company and one of them is at that company, but these guys only offered me 10,000 shares and these guys offered me 100,000 shares.” That’s meaningless. Do you know what the shares are worth? Do you know how much debt and venture is sitting on top of the common?
Even as an employee going to an entrepreneurial company, you need to understand because the face value of these shares is, in itself, a meaningless piece of data. It’s like having an equation that is unsolvable because you just don’t have sufficient data to actually understand.