If a venture capitalist offers you a certain sum of money in exchange for a shareholding in your startup, what are the rules governing these deals and how much of your business should you part with?

Paul Graham has done a pretty good analysis of this perennial teaser for new business owners. The answer apparently is :

1/(1 - n)

Whenever you’re trading stock in your company for anything … the test for whether to do it is the same. You should give up n percent of your company if what you trade it for improves your average outcome enough that the (100 - n) percent you have left is worth more than the whole company was before. For example, if an investor wants to buy half your company, how much does that investment have to improve your average outcome for you to break even? Obviously it has to double: if you trade half your company for something that more than doubles the company’s average outcome, you’re net ahead. You have half as big a share of something worth more than twice as much. In the general case, if n is the fraction of the company you’re giving up, the deal is a good one if it makes the company worth more than 1/(1 - n).

If you were in this scenario, you would already have gone through a lot of hoops to get there. You should bear in mind from the outset that a VC company like Sequoia gets about 6000 business plans a year and funds around 20 of them.

Face it, you’re going to have to be good to get the cash, so you are entitled to drive a hard bargain. According to Graham, Sequoia will allow you to do so.

Read Paul Graham’s account of VC funding options in full.

Location, location, location is said to be the mantra of real estate salesmen. Does the same apply to starting a business? Of course, but there are exceptions to every rule and sometimes the flipside becomes the upside.

How, for example, could you start a business in the middle of nowhere, miles from what we now call civilization?

It’s not easy, but something with computers and the Internet springs to mind, doesn’t it? But what if you’re a technophobe and hopeless with computers?

Well, all is not lost. Take the amazing story of John Fanuzzi who moved from Philadelphia to Montana in 1980 with everything he owned in the back of a pickup, including his two children of five and two years of age. He was a single father and had a lot on his plate.

He’d done a bit of project managing in the past and was a skilled carpenter. His business idea was to build a company in the unlikely field of massage tables.

Fanuzzi was in this situation because he had injured his back and a doctor said it couldn’t be treated. He was cured, however, by a single visit to a massage therapist. Who says alternative treatments don’t work?

The therapist had told him that it was impossible for him to source a portable massage table for the patients who couldn’t come to him. John was so grateful for his cure, he replied without thinking, “No problem, I’ll make you one.”

He began building it in his driveway, having spent $100 on materials and costs. It was so successful, the news got out and soon orders came flooding in. The problem was, John didn’t have enough to fork out $100 for each table while it was being made. He bridged the gap by asking for a deposit of $100 for each table, then charged $185 for the completed item. Classic bootstrapping methodology. Fanuzzi was in an ideal situation. He had no overheads and lots of customers.

After the move to Montana, he persuaded local teenagers to assemble his products for piece-rate wages and even shipped them on Greyhound buses.

Later, in the 1990s, Golden Ratio Woodworks, based in Emigrant, Montana, became an established and going concern. He was doing $200,000 of business a year. His debts were almost zero and customers paid in cash.

Then it took off in more sophisticated areas of the U.S, like California and the East coast, where buyers thought it “kinda folksy” to order from Montana.

In just a few years, John Fanuzzi had built a national business employing dozens of workers. He had done it with no capital and used basic cash-flow techniques to accomplish his personal American Dream.

Small Business Booster will soon become part of Syntagma Digital’s new network magazine, Moneyizor.

This will require a change of livery and a regular slot in the magazine’s dynamic content producer.

Moneyizor will cover all aspects of finance and business, including the stock markets, innovation, entrepreneurial matters and small business.

Watch this space for more news.

A New Series on Business Startups — Part 4

As buying a franchise is really a special case in setting up a business — all the donkey work is done for you; you just buy a package — I’m slotting a few words about them here, so you won’t have to read on in this series if you don’t want to.

A franchise is a ready-made package, usually comprising the product or service, the equipment (often tailor-made for the job), the consumables, all literature, including leaflets, flyers, letterheads, customer-facing materials, training, plus image, exclusive area of operation, advertising and sometimes, leads to potential customers.

All that doesn’t come cheap. Expect to pay a 5-figure sum for anything worthwhile.

When signing up to a franchise deal, there are a few details you should get clear first:

1. Make sure your contract mentions the period of the agreement. This is often five years, but it can vary. It should also specify a renewal option. Check any small print in the renewal terms in case they involve much greater expense or other prohibitions.

2. Nail down the exact location you’re getting and your rights to exclusivity within it.

3. All fees and costs, plus calculation formulas, should be presented to you. You also need to know if you can sell the business on for a profit.

4. A clause specifying that you can leave the business to next of kin in the event of your decease is also important, if a little gruesome to the squeamish.

5. Costs of training of you and your staff should be met from the fees you pay to the franchisor. Hidden costs for training can be large and sometimes disabling.

6. If you think you know enough to set up on your own after a few years, talk to the franchisor. Enlightened businesses will provide opportunities for you to expand with greater input to the business as a whole.

Above all, make sure you are aware of all the subtleties of the business before signing away your cash.

Go to Part 5.