Be Generous with Equity

January 27th, 2015 / No Comments »

When talking about startups, so often the talk turns to money. What’s the current valuation? What will the company sell for? Or, how will the IPO do? And, how high will the stock go?

What we talk about far less is the money trail that happens along the way. Sometimes that means entrepreneurs don’t know some key points pertaining to paying themselves. Here are three points to consider:

Founders must be aligned with investors and shareholders so that if the company wins, everyone wins. That means as much cash as possible is put into the business to fuel its growth. That also means that founders must forgo the big salaries they might have earned at larger companies, which would be too big a drain for a growing business. When I see a startup with a lot of former senior executives who want big salaries, I run for the hills. Think about how fast that money goes! A seed round is usually between $1 million to $3 million, and that money must be used to hire a bunch of people, build a product, take it to market, pay for a (hopefully) cheap space and continue with research and development. Combine that with big salaries and all that money is gone in a year. That’s why I advocate paying founders what they need to live and granting generous equity — when the company wins, they also win. This equity is what carries the opportunity to dramatically change people’s lives. It’s the opportunity to create more than a good living and retirement, and to establish generational wealth. Most startup founders are aiming to create outsized returns, not incremental ones, and are willing to swing for the fences to change the world, their own lives and their family’s future.

That said, founders must pay themselves a decent salary. They have to be able to pay their bills and not accumulate debt. They cannot take so little that there is conflict at home. (After all, there already may be conflict at home since they work such long hours!) People need enough to be clothed and fed and should even be able to buy a house. There’s another thing too: as companies evolve and mature, it is okay for early-stage employees to have their cash compensation begin to creep up to market, although I still favor long-term equity over cash.

Founders must be granted some flexibility. Specifically, they should be able to sell secondary shares. This is controversial — it was not that long ago that secondary share sales were very hard to do, and a founder had to wait for the IPO and the payday that came with it. I know it’s not popular with some investors who want everyone to be “long” forever, but there isn’t anything wrong with applying a rationed approach and allowing founders to get some of the benefit from their hard work. We all know timing is a really hard thing. Even if you believe 100% in the company and the stock’s upward trajectory, no one has any control over what the market will do.

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