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Ask HN: How to get out of a startup cleanly to start a startup?
7 points by edb on Oct 29, 2008 | hide | past | favorite | 25 comments
Wow, this will be hard to sum up, but bear with me: I currently have 45% ownership of an unincorporated canadian startup. The business is as follows:

We started a web hosting company that resells shared hosting. Our costs are simply server rental fees, advertising and support agents who reply to emails. We've been profitable since day 1 and make a respectable living (roughly 100k per year profits to split between the two of us)

Last summer, we bought out another hosting company that doubled our income and our profit at a really good price. (paid roughly 60k)

On the side, we have a third website where we get client contracts sporadically to provide us extra income.

I want to get out of this and start my own startup, hopefully with the help of YC. I haven't been working there anymore for the past 2 months except to tie up my current projects.

How do you go about valuating such a venture? My partner tells me that the best way to estimate a hosting company's value is to look at the income without expenses over one year.

For the dev company, my partner says that since none of it is recurring income, it has no value above and beyond the accounts receivable for current projects.

I've been working on this for 2.5 years and I feel like I'm getting the short end of the stick if I get nothing but 70k for my half, given that we bought that second company who was the same size as ours initially at 60k and it was way undervalued. If I accept this offer, I'll definitely have money to sustain me at least for a year while I work on my startup. Should I strive for more or just take what I can get? Am I being greedy?



There's no ironclad rule of valuation, but a normal way to go about this would be to set the whole company valuation at N x forward revenue, where N is a function of how much value is locked up in the company due to its youth and lack of sales, marketing, and distribution.

Two benchmarks:

A solid services company sells for 1.5-2x forward revenue; a services company making $5MM a year might be valued at around $10MM.

A solid product company with a really bright future might sell for 5x revenue; a product company making $5MM might be valued at $25MM.

You're definitely more towards the "services" side of this spectrum: you're an IT services company (with a productized IT service) in a totally commoditized market segment.

You don't have a "right to liquidity". Your partner is within her rights to give you no money, allow you to maintain an equity stake in the company should it ever be sold, hire someone to take your place, and pay them out of the operating budget for the company.

You also don't usually value a stake in (what is now) a 2 person company at 50%; a more typical structure would reserve a large chunk of the company ownership for employees, rather than diluting and restructuring with every hire.

So, if you have 40% margins --- ie, you're more efficient than Rackspace --- you're aiming to gross ~400k in the next 12 months. Do the math, then discount heavily because nobody is actually buying you, and your partner is taking all the risk.

For the business you're talking about, less the value you brought to the table (presumably 50% of all the work), 70k sounds like a great deal.


Talk to the experts in the field -- that is, experts in the field of web hosting, not experts in the field of startups. I'm sure people over at webhostingtalk.com will have a much better idea of what your company is worth than anyone here.


Maybe try to see what a a comparable hosting company costs.


why don't you use your ownership income to hire someone to replace you? that way, you won't have to sell your stake at a price you don't like, someone can still be doing the necessary work you won't be doing, and you'll still have a passive income stream.

just my uninformed $0.02.


I just need this off my plate. Even when the workload is light my partner doesn't like the idea that my concentration isn't fully directed at our business. We've had many open conversations on the matter and we both agreed it would be a good idea if he bought me out.

If he was interested in doing something else, then we could set this up as a passive income generator, but he's not interested in that


He'd still have to be active on the board, and make sure his partner doesn't run the business into the ground.. e.g. by hiring someone to do his job, and go live of his passive income stream :)


while true it wouldn't be a clean break, he'll still have a lot less responsibilities with free time to work on the new project


When you start a new startup it's better to have cash in the bank, so you can estimate how much run way you have left.

You don't want to worry about two startups. It's too much.


When you have another partner who has no other ventures to worry about, there shouldn't be anything to worry about.


Except what the other partner thinks about you leaving, while still holding significant stake in the company. This is perfectly acceptable if you're Paul Allen escaping Microsoft after it goes public. But expecting a partner to work full-time, while you outsource (or just stop taking part) and maintain ownership, is a way to lose friends and get into legal trouble down the line.

Vesting schedules are designed to help prevent situations like that, among other things.


Could you elaborate?

I assume that even without actually hiring someone to replace you directly, you could differentiate between salary & dividends. Then you continue to pay the salary to the remaining founder & any replacing employee & split the dividends. I guess the remaining founder would receive gradual increase to his equity share as part of his package.

BTW, wouldn't most vesting schedules have already left this founder with quote a bit of equity (2.5 years)?


I assume that even without actually hiring someone to replace you directly, you could differentiate between salary & dividends. Then you continue to pay the salary to the remaining founder & any replacing employee & split the dividends. I guess the remaining founder would receive gradual increase to his equity share as part of his package.

Yep. That would probably cover it. Though, my thinking in this case is that in a partnership of two people, if one leaves it's probably going to hurt the company in the short term. There's just a lot of loose ends to tie up...and as others have mentioned, being free of the whole thing may be more valuable (because let's face it, a 100k annual revenue company isn't going to make him rich--unless it grows dramatically, which would generally mean the other found did some kick ass work without the other holding him back). If he's feeling the urge to do something completely different, there's a lot of good arguments for doing just that.

BTW, wouldn't most vesting schedules have already left this founder with quote a bit of equity (2.5 years)?

Yes. And a board seat and the responsibilities that go along with that.

But, every case is different. Nobody here can tell someone else what will make them happy.


I read somewhere that a reasonable measure it to consider the invenstment. If you were to buy your share, you'd have to put $X down to get a return of 45%*profit(not salaries)/year. Calculate backwards to get the interest rate on various down payments, and see what makes sense.

Considering that the 100k is profit and not your salaries, the share's profit is $45.000:

$100.000 = 45% interest rate .. a little too nice!

$1.000.000 = 4.5% interest, keep your money in the bank

$300.000 = 15% interest - pretty sweet spot.

Back-of-the-envelope, I'm niether an accountant or an auditor.


I've been modded a bit around on this, does anyone care to elaborate on whether this is a sensible method?


I want your bank. Where do I sign up for a 4.5+% account?


It's 6.25%, actually.

http://www.danskebank.dk/Dansketoprente


I would try to sell 60-70% of my share and use the remaining bit to outsource the work in maintaining the work I was doing, then sit on the $1-2k coming in every month as a safety net to pay the bills and give me the full purchasing price to invest in my start up (though I'd advise investing much less to keep your start up honest)


Hello Edb,

I agree with noodle's comment(s) below. Your best bet is to hire someone to replace you and retain your stake in the company. The cost of an employee will definitely reduce your annual income, but then you won't have to worry about being cheated out of your share of the company's value.


1) Agree on ownership (you own 45%?)

2) Your partner needs to start taking a salary - negotiate the amount.

3) Pay partner's salary directly from the profit, and then split the remaninder according to equity.

What's complicating matters is that you are splitting the company profit and avoiding salaries.


You should consider having your business audited and valued - a valuation could be as high as 4-5 x EBIT. In terms one partner acquiring the interests of another, a (significant) discount would normally be applied.


If he's offering $70K for 45% ($1555 per 1%), would he accept $86K from you for his 55% (a smidge more per share)?

That's one way partnerships can deal with a situation where one or the other partner wants out or to go solo: have a put-up-or-shut-up binding bidding process, where whoever offers more per share gets to -- and indeed has to -- buy the other out. (The payment could be in installments out of future revenues.) Sometimes this is written into operating/partnership agreements from the get-go.

Even granting that you would prefer to be in another business, if you owned it 100% for another $86K, could you then sell the whole thing free and clear for more than $156K? (If not, it's hard to argue your 45% share is already worth more than $70K.)

Or, could you hire staff and become a four-hour-workweek owner collecting an acceptable return on your >$156K investment?

That's the analysis that counts in tiny, closely-held businesses. There's no liquid market in their ownership and their value is often tightly bound with the owner/managers.


Trying to get as much money as you possibly can fits the definition of greed, but that really doesn't matter. You want to get as much money as you can without feeling guilty.

There are different ways to determine the worth of a hosting company. One way is to look at revenues + growth in revenues + number of customers - risks. Another way is to look at the amount of money you'll get if you were to sell, minus the effort needed to sell.

Hosting companies are worth very little when you sell them. You experienced this yourself when you bought a competitor for 60k. So by comparing the revenues + health of that company with the merged company, and you'll get a reasonable valuation. I've seen hosting companies get sold for less than $30 per customer, so the number you'll get at is going to disappoint.

If your hosting company is still growing quickly you have to make an estimate of the value of the company in a couple of years, and your total contribution to that. Since hosting companies that grow too quickly always destroy themselves growth is bad indicator of value.

The bottom line - hosting companies don't create much value and the little value they have is decimated when sold. You don't have any IP to speak of, and it's a high-maintenance environment (unless you outsource everything, but the hosting companies I know still had to deal with all difficult issues themselves). Your partner also has to find somebody else to take your place (I assume), which can cost up to a year's salary easily. All in all, your partner isn't getting a great deal here either.

As the saying goes - if both parties are unhappy the deal is fair. And that's what it looks like from here.

Postscript:

- once you leave, your partner cannot leave anymore. He can't just walk away with 70k. He might not want to leave, but knowing that leaving isn't really an option can be depressing.

- most hosting companies go kaput within the first 5 or so years. I haven't looked at the data since I left the scene, but chances are your company will be gone in 3 years. You didn't mention any problems in the OP, so I take it's all sunshine now. However, if you're leaving (partially) because of burn-out (boredom) then burn-out is probably not far behind for your partner. In that case, you'll get 45% of 150k, and he'll end up with 100% of nothing + a total burn out.

- if the person your partner hires to replace you doesn't work out - see above. Big risk for him there too.

- in his position, how would you feel about your partner leaving and having to pay him 70k? Would you gladly give him 110k (or whatever amount you had in mind)?


Don't leave. What if your startup does not work-out, what's your backup plan?


I'm still young and cost of living here can be 15k/year. I can afford to take the risk right now.


Well, take the risk if you wish, but why don't you just invest money in hiring people to make the product for you? Divide your time in half between both jobs, with a clear agreement with your partner that you will only spend half the time.

I just don't think that if you are a single person trying to work alone on an app that is aimed at the YC demographic that you will produce anything spectacular. When you work with other people, you'll tend to have more diverse opinions. And you will learn to juggle your responsibilites in a way that will train you for running a real business.

If you are just sitting at home alone working on your idea for one year, it's an entire year out of the 60 you got gone.




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