

Is Your Startup A Cash or Equity Business? - eladgil
http://blog.eladgil.com/2010/08/is-your-startup-cash-or-equity-business.html

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JangoSteve
_Figuring out what sort of business you want to start, (or, in hindsight, have
started) impacts everything from whether you should raise money to how to
compensate your employees._

Interestingly enough, the corollary is also true. Figuring out what sort of
headaches you want to deal with helps you decide what sort of business you
should start.

I prefer release early/often, grassroots B2B customer development, and
bootstrapping over large development cycles, long-handed B2C marketing, and
funding. That is precisely why I focus my efforts on creating cash businesses
that are finely targeted and strive for profitability as soon as possible.

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eladgil
Absolutely agree - founders should think through what they want from their
business up front, and what sorts of headaches they do or do not want to have
to deal with over time.

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asanwal
Interesting viewpoint Elad. A few points/considerations:

Building equity valuable companies is way tougher and much riskier. Your
examples of Google, Facebook, Twitter are all rare. And for every Goog,
Twitter, FB, there are many carcasses of others who've not made it. For
entrepreneurs balancing risk-reward, trying to build a company that is solely
equity valuable is tough.

Also, I don't think the equation is quite so binary. Cash businesses, by
virtue of the cash they generate, can expand and enter adjacent markets and
these growth initiatives can increase the equity value of the company. Amazon
comes to mind.

Lastly, although these cash businesses are not as sexy, there is still equity
value there. There is a whole ecosystem of mid-market private equity firms
interested in these types of companies and buying their equity.

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lsc
for many cash businesses, the equity is much smaller than you would think. I
run what is essentially a hosting company, right? I've gotten a few offers,
and do you know how hosting companies are valued?

approximately one year revenue plus the value of your hardware.

And this is a growing company in a rapidly growing market (I double every 6-8
months)

I mean, it's something, but not compared to what you expect from equity
businesses, and not nearly enough to cause a rational agent to sell at the
margins we see, I mean, unless you were just sick of doing it.

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JacobAldridge
This is a very useful distinction, especially for partnerships. I've seen many
partnerships in my role (as a business coach) where this distinction has been
the root of all their disputes - one is choosing to invest for the future in
an equity business, while the other is choosing to maximise the immediate cash
income.

FWIWI, most businesses I've encountered are cash businesses - some consciously
("I bought myself a job") and many through lack of realisation that there is
an alternative they can choose.

I agree wholeheartedly with the point that companies change over time -
founders need a cash reward for their effort at some point, and companies
(Microsoft is a great example) will often reach the peak of their equity
build, in which case switching to cash may be in the better interests of
stockholders, employees etc.

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aresant
One thing that's not mentioned, is the tax implications of each.

In a cash-flow business you're going to wind up paying out ~45 - 50% in taxes
on the income (especially if you live in CA!!!)

In an equity business you wind up paying on capital gains, which if you hold
your stock for more than 1 year can be as low as 15% (in the US, anyways).

Once you do the math accross 3 - 5 years it often makes more sense to build an
equity valuable company for sale.

For cash-flow heavy businesses, a strategy to reduce tax and increase equity
value can be to pay modest salaries and pump the bulk of the cash back into
business expansion.

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eladgil
Really good point. I was thinking of putting this in the post but decided to
not get into it. Thanks for pointing it out.

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sushrutbidwai
It will be great to build a business which is cash + equity similar to
37signals. It had early cash-flow and value of equity is definitely similar to
equity based businesses.

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yurylifshits
Event business (conferences, tradeshows, music events) is another example of
cash business. You can be profitable within weeks from the start.

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avichal
Great post. Keep it up Elad!

