One of the biggest problems with entrepreneurs I see as a lawyer is that they are not willing to share equity.
As I've discussed elsewhere, equity is ownership of the company. Founders (i.e. initial owners) of the company, are hesitant to dish out equity to other individuals, investors, and the like.
When an investors invests in a company, the investors will purchase and receive equity (shares) of the company from the company. Along with the shares, the investor will receive various levels of control of the company, voting rights, etc. The company will use the funds from the purchase to help grow and operate the company.
Founders can be hesitant to give out this equity to investors and others for various reasons which I will discuss in this article.
The main point of all of this is this: in order to achieve success in growing your company into something quite large and expansive you have to give equity. I've talked to investors in the oil and gas industry extensively about this. There are large numbers of these energy tech investors in the Houston and Dallas areas--all of Texas, really. They are wary to work with entrepreneurs that don't want to share equity. Entrepreneurs need to be realistic and understand that in order to grow their company and receive investments they must be willing to part with equity.
So let's talk about this and examine what this is all about because this is definitely a major area of concern when it comes to startups.
1. Why don't founders want to share equity?
I want to briefly touch on why these individuals don't want to share equity and address these concerns.
a. Founders believe that if they dish out equity then there will be less payout for them in the future
This is WRONG. Giving out equity to investors will, in the long run, lead to a greater payout in the future--maybe not as a percentage, but as a raw number.
b. They are control freaks
I understand why many founders are control freaks. They want to everything to be done in a certain way. I get it. The thing that these founders aren't understanding is that you have to tip toe the middle line. There is a way to be in control and act on your vision AND also share equity.
c. They are not ready
Some times companies are not ready to get investors and give out equity. That's normal and fine. They need to operate a little bit longer and have some more data behind their methods. As an attorney though, I often see another problem where people don't FEEL that they are ready. That's a different issue entirely. You will never be 100% ready. This is a problem of perfectionism. Some times you just have to go for it.
If you feel like you're having a readiness problem, make sure that its a real readiness problem of the first type, and not the second type where it's just a feeling.
d. They believe they can do it alone
See the number 1 problem I listed here: https://www.startuplegalstuff.com/startup-best-practices-faq/
e. They are fearful
It can be scary to bring someone on board to your company. You're opening up all of your financials and what you've done so far in the company. It can be a little nerve-wracking, but it is also ultimately beneficial for you. It can create more accountability which can be a good thing.
2. What does it mean that energy tech founders don't want to share equity?
So I've discussed why founders don't want to share equity, now I will go into HOW they are not sharing equity.
Sometimes it doesn't literally mean that founders don't want to give out equity. It can mean that founders, through behavior, don't want to give out equity. It's how saying "this pen is only for sale for $1 million" is essentially the same thing as saying "this pen is not for sale."
So this is how, through behavior, founders don't want to share equity.
a. The founders want an outrageous valuation
In Startup Math I discussed how the amount that an investor invests and how much they purchase of the company largely depends on the valuation of the company. An investor can use the valuation of the company to determine all sorts of other variables and how much equity he/she will be purchasing.
A lot of entrepreneurs like to have an outrageously high valuation that makes no rational sense. Some times they, under some kind of delusion, believe it should actually be that amount. Some times they use it as some kind of stupid anchoring negotiation technique that doesn't really work.
You have to get the right valuation for your company. Do your homework on this. My experience has shown that it's better to be fair with your investors than to try to out-weasel them. What's good for you should also be what's good for them.
b. They don't want any kind of employee equity compensation plan (options).
You can get by without an employee equity compensation plan. But you will have a hard time attracting top tier talent if you're not willing to pay the dollars to employees. Either you have to pay market rate to top employees via cash OR a combination of cash and equity.
Yes, giving out equity to employees will dilute founders, but again--you have to share equity (or give out a lot of cash) if you want your company to go places.
c. They actually don't want to share equity.
Different from the scenarios above, sometimes founders explicitly state that they do not want to give out equity to anyone. That's all well and fine and good if you know what that means. That means that you'll not have investors and that growth will be a lot harder. Again, if you're fine with that then OK. However, keep in mind--if you have some a competitor that is offering a similar product or service to you and they have investors, they will have an advantage over you when it comes to marketing, operations, and the like.
3. Why share equity?
I want to take a step back and remind you why companies need to share equity and what purposes it serves.
a. Selling equity helps the company grow
It's better to have a small piece of a far larger, tastier pie than a huge piece of a pie that sucks. Sharing equity with the proper investors can help get you that larger/tastier piece.
Remember that a good investor can often do things for your company beyond just giving you straight up cash (which is a big deal in itself). Some investors can open up certain markets to you. They can connect you with other influencers that can help grow the company.
Growth it what it's all about. Now of course, you can grow in a proper way that is fitting to your vision and that is sustainable, but you have to grow your company. Recall the fundamentals of any business--formation, growing (financing), operating, and exiting. Selling equity through channeling investments is one of the key ways in helping your company grow.
b. Giving out equity to employees helps get the best talent
If you're a startup, that means that you're using most of funds you have to grow. Money can be hard to come by for some companies and if you want to hire the best people, that means you're going to have to pay a lot to hire them. Use stock options to supplement their pay. Employees that go to work for a small startup go there not just for the funds, but often go there for the potential financial realization of the operation.
Takeaway and items to keep in mind
Again--it bears repeating--SHARE EQUITY. You will not get the investors, the investments, the employees, hell--even the customers you want if you do not do this.
In order to best prep for sharing equity do the following:
a. Do your homework
Read and check out the sidebar for more information. In particular, you need to brush up on startup math, understand dilution, and understand stock options. Get a lawyer to help you act on all of this.
b. Be reasonable
See the blog post about being unreasonable. You want to be fair to your investors. You need to. Its actually ultimately good for you.
c. Control the flow of equity
When I say share equity, I don't mean for you to give out equity willy-nilly. You also have to be fair to yourself. Control the flow of equity distribution. It needs to be done with a steady hand and it needs to make sense. Again, a lawyer can help with this.
d. Read the article on keeping control of your company
A lot of not giving out equity is based on fear and that fear is often based on not having control. Read the article on the sidebar about keeping control of your company https://www.startuplegalstuff.com/keep-control-of-your-startup/
If you do all of these things in a systematic, reasonable way, you can share equity, get the investments you want, get the employees and customers you want, as well as keep control of your company.
