It’s your EQUITY – manage it wisely…

As a founder equity tends to be one of the most cherished assets at your startup.  For many of us, it is ONE of the drivers of entrepreneurship – to own our businesses and have a shot at real wealth creation (wealth is different than rich – you can get rich in corporate America).  I’ve now been involved in a healthy volume of equity related startup equations (~10), I’ve participated in some and passed on others (I’m passing more these days).  My perspective is not from a VC funding perspective – but from the very early stage (pre-funded and angel funded) – the phase that matters most to founders because it can cause so many problems at times when you don’t need to be slowed down (IMHO).  So here are a few things I’ve seen:

  • One startup not start up because the founder was foolish about distribution (he thought his idea was worth literally 99% – LMAO).
  • One startup shutter the doors because the primary founder did not want to get diluted (he had Hollywood ego syndrome).
  • One founder miss talent opportunities due to unwillingness to distribute real equity (he complained how hard he has worked to get to this point).
  • A few situations where messy cap tables make further investment or acquisition non-issues (it costs to much to deal with all the BS).
  • A few situations where original founders ‘moved on’ but owned way too much equity to making the startups tough to fund and tough to attract more top talent (VCs would recap anyway, so do it now and save a headache)
  • A few entrepreneurs understand that the earlier the deal the riskier the deal for investors and talent alike so they are generous with equity.
  • A few situations where the equity was managed very well.

And now I’m on the founders side of a few deals and am applying everything I’ve learned to ensure we all do it right.  I’ve been lucky to have great legal counsel [SIDE NOTE: Get good legal now and get a firm that specializes in the venture space – read: don’t mess with local guys].  So what follows is a summary of what I’ve learned and is an excerpt of an email I just sent a friend that is starting up as we speak (this is NOT legal counsel – get a lawyer who knows how to set all this up).

  • Make sure all the founders are on a vesting schedule from day one.  DO NOT do the ‘we each own 33% from day one” – everyone has to earn in.  You might be able to give credit for time contributed thus far, but set the schedule so it is clear how much is earned at what clip rate.  This protects each founder as a going concern and anticipates the chance that a founder may want to move on at any point and should not have all the equity tied up.  And lastly, it is not unheard of for startups to have to restructure the cap table to get further funding.  If you are set up right from the start you just look like smarter entrepreneurs.
  • Be smart how much equity you dole out to founders and early participants (advisors, service firms, etc).  To turn it into a scalable business there is a likelihood you will want to bring in some other top talent – that will require decent equity.  Leave pools for senior management and employees.  You will get diluted with investments, so make sure you factor that in.  Bottom line manage it wisely.  Also, watch out for gate keepers that want to charge you for introductions – don’t do it if you don’t have to (this comes in the form of ‘pay to pitch’ and ‘pay for access’).  Everyone that earns equity needs to create value and there are enough people in the world that won’t charge you to introduce you to people – remember ‘success begets success’ and ‘slime begets slime’.
  • Understand that if in the early days you don’t have much more than working code and a great idea, you may have to give up more than what  you read in the blogoshpere (most of what you read is for Tier A VC funded companies with experienced founders – so if that isn’t you, all terms are open to negotiation).  With every level of traction and prior success, you are in a stronger negotiating position.  This doesn’t mean give away the farm.  It just means have realistic expectations of how you can utilize your equity to build your company.

So the bottom line on managing your cap table:

  • Everyone has to earn in – make ’em work for it.
  • Equity is likely all you’ve got – distribute it.
  • Protect the founders as a going concern – things change.
  • Show you know how equity works – show you understand the game.

In addition to driving the upside opportunities of your company, you are always de-risking the deal for those who have, or will, invested in your dream (both in financial capital and personal capital).  It’s your damn equity – so manage it wisely because it may be all you’ve got ; )

GO START SOMETHING>>>

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Comments
6 Responses to “It’s your EQUITY – manage it wisely…”
  1. scott says:

    “One startup shutter the doors because the primary founder did not want to get diluted (he had Hollywood ego syndrome).”

    Hilarious. I’ve heard that quite a bit.

    • gammill says:

      Scott, Always sad to see good products/opportunities wither away because of out-sized ego. ‘Live and learn’ is all I can say to those folks.

  2. Ken says:

    Thank you for this level headed and well thought out entry.

  3. JR says:

    Thanks for the thoughtful post.

    Do you have any ballpark figures for a pure equity comp sales director position at a pre-angel stage startup that is just about to launch V1 of its product? Salary/benefits are expected to kick in once revenues get off the ground in 6 months or so. About 4 people working on the project right now.

    From the employee perspective, I’m looking at what I can make today in the market, say 160k/yr. Thats about $15k/mo fully loaded cost to the company. I’m investing time instead of cash in the company, and consider 4months no salary a 60K investment. I like the market prospects of the company and think a 1million valuation is fair given that nothing is proven. $60k/$1mil should give me a 6% stake in the company, that’ll only get diluted after the Angel, series A and possible B rounds.

    What do you think of my logic arriving at 6%?

    What kind of ballpark dilution generally occurs at Angel and series A?

  4. Paul Mobley says:

    Thanks for taking the time to write this excellent article about equity strategies at the startup phase. I agree with the recommendation that everyone, including founders, have to earn-in. Assigning a value to a company that has not been able to fully execute their strategy is very difficult and it’s a high risk investment. Often the founders have a harder time seeing this risk because they are too close to the action. Thank you for sharing your wisdom from past experiences.

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