Participating Preferred Stock Can Skew Valuations

David Cummings on Startups

Imagine for a second that you make $50,000/year salary as an employee at a startup. Feeling the entrepreneurial itch, you make the plunge and start a company thinking that one of your first financial goals is to grow the company to the point that you can make $50,000/year in profit. Only, once you achieve $50,000/year in profit, you quickly realize that $50,000 in profit doesn’t equal your previous compensation. As a business owner, to pay a $50,000 salary, you also have to pay employer taxes (roughly 10% or $5,000 in the case of this salary) as well as employee benefits (easily $5,000 per year). Thus, to pay yourself the previous $50,000 salary, it’s really closer to $60,000 in expenses. All the taxes and extras are distortionary in that many people don’t think through the costs involved.

Yesterday’s post titled Example Founder Dilution Over Multiple Financing Rounds didn’t touch on an…

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