At a recent lunch, one of our portfolio company CEOs shared an alarming example of what happens to entrepreneurs who don’t appropriately protect their founders’ equity. A friend of his had sold an ad tech company for more than $100M. Big success, right? Depending on whom you ask, three quarters of venture-backed companies fail to return investor capital, much less make their founders rich. One would expect then, that a $100M+ sale is a success for the entrepreneur as well as for the investors. But in this case the selling founder walked away with less than $1M in personal proceeds. Is that outcome a success for the founder considering the risk he took, the hard work he put into his company, and his critical role in building a $100M company?
Even without knowing all the details of that story, there’s a lesson to be learned: if you succeed on every other front but fail to preserve meaningful equity, it could feel like a failure.
It’s not just about the dollars. Entrepreneurs start businesses for a number of reasons, including a desire for independence, the pursuit of a passion, and control of their financial future. But independence, control and potential life-changing wealth ultimately stem from an entrepreneur’s equity.
How you manage sales of equity has a lot to do with what you are trying to accomplish. For example, an entrepreneur might develop a small but very profitable business where equity’s importance lies in determining who receives distributions or dividends. The entrepreneur did not have to sell equity across multiple rounds to be successful. He or she retained its value as well as the control that went with it. Alternatively, building a high-growth company might require carefully crafted equity capital raises to fuel rapid growth and capture market share. Particularly when eventual exit multiples are high, the “smaller piece of the bigger pie” strategy might be the best path forward. In either scenario, your founder’s equity is an incredibly valuable currency; guard and manage it judiciously.
One other point on this topic: most investors are skeptical of an entrepreneur too willing to quickly surrender a large chunk of their business ownership. It begs a number of questions, some troubling: Is the entrepreneur committed? Does the owner ultimately believe in the success of their business? Is the entrepreneur financially savvy enough to be a good steward of our capital? Is this a founder who is more focused on the cache of fundraising than building a viable business?
Selling equity for the right reasons and at the right time is critically important. The thoughtful entrepreneur will value his or her equity and have a coherent strategy for capitalizing the business over the long term.