Protecting Founder Equity
One important maxim in startup companies is that future investors are betting on the management team and not betting on each other. When founders get diluted below a reasonable level, say anywhere below 50% prior to significant institutional rounds, whose company is it? All of your investors are best served by your founding team staying at the helm and staying highly motivated to realize the dream. It works against investor interests to own an outsized percentage of a venture where no one absolutely has to make it work.
It can be very difficult to raise the early dollars for a new venture. If you don’t have some seedling money from people who already know you and who will back you on sheer faith, shaking dollars from new acquaintances, no matter how warm the introductions, is a daunting task. The longer the personal relationship and the more you have demonstrated your abilities to someone, the higher is the likelihood that you’ll get some financial support. The institutional VC’s refer to this process as “connecting the dots” — which takes months or years and keeps them from writing checks on impulse. Early angels may not be as reticent, but the same thought process is at work.
If you try to solve this dilemma by valuing your business at a bargain price or by throwing in investor-indulgent features that are outside the norms, you may break the ice with a few unsophisticated investors. But, all you will accomplish is making it much harder to raise the amount of money you really need. In particular, when you are working on any idea of consequence and shooting for an eventual $100M+ exit, every step of the way needs to leave room to preserve your founders equity, take care of your key hires, and allow for multiple investment rounds at higher and higher valuations, each of which rounds is mathematically backed by a plausible calculation that a 10X return is in the realm of reality. If that is all done right, everyone in the stack gets a fair return.
If, on the other hand, your thirst for cash causes you to give away too much too soon, you might determine you are personally better off financially just getting a job. Worse yet, if you let the company run out of money, the next investor, if there is one, will have the power to rewrite all the rules no matter what valuations or incentives were offered earlier. All the power shifts to that newest money, and every earlier investor has two choices: (1) write it off or (2) accept the dilution.
So, here’s some positive advice on how to do what you enjoy and get it funded correctly:
- Prepare yourself for the journey. Be realistic about the time and dollars it will take to reap the rewards of your skills. Start only when you and your family are ready, you have a clear plan in mind, and you have some flexibility to roll with the punches that will inevitably come your way. Do not assume your idea is worthy right now and that it can be funded, even if you are surrounded by startups that seem to be sailing smoothly. Inoculate yourself against early onset startup fever.
- Apply yourself to activities in school, work, civic life, social pursuits, and all your endeavors in ways that create a personal following for you. Demonstrate your leadership or technical skills through your actions. You will never assemble a quality following by mere “networking.” You must do. Then you are ready to do more and to garner the support you need.
- Take advantage of all the startup resources available to you. Frankly, there are so many resources that it’s overwhelming. It becomes easy to get engaged in “startup theater” with a bunch of peers who keep starting things and then letting them wither when the tasks get more difficult. Choose your resources wisely and spend your irreplaceable time on the ones that work best for you personally. Seek formal programs and individual advisors and mentors, and pay attention to them. Read blogs like this one. Read stories of leadership, like military histories. Hang out with peers who are accomplishing good things. Participate when asked in your technology community. Make yourself capable of being not only a founder but an operator, a salesperson, a deliverer, and a finisher.
- Do your research, and do some more. Find that idea that people “can’t not want,” and don’t settle for less. It’s easy to fool yourself into pursuing a bad idea if you assume others have the same interests and use cases you do. Go out into the world and do the hard work of customer discovery. Break down some doors to talk to actual users, decision makers, and potential purchasers of what your product or service is intended to provide.
- When the timing is right, which is to say you have paid heed to all the foregoing advice and are personally ready, latch on to an investor who has come to know you and get that person or that fund to lead your financing rounds. Professional investors of all stripes have developed followings that help confirm their own assumptions about deals and who will pile on the dollars to get the job done at a reasonable valuation. They’ll be happy to be invited to the party. They know they are protecting each other by making sure there is enough money to get the mission accomplished and that the founders are being treated fairly. Other than “you’re too early,” the most often turndown you’ll hear on the funding trail is “I’ll invest once you have a leader.” Take the lead in making that happen.
You must have the long view in any startup. Always be thinking years down the road, even though your forecasts of today are out of date tomorrow. You will work tirelessly every day toward the priorities of the moment, but you’ll always be working backward from your ultimate objective. Every major decision you make should be in the context of that long view, and, if you are able to adhere to that method of thinking, you’ll end up with the equity you deserve and with happy investors.
Then, it’s time to start all over again…
This post is guest written by Ben Dyer and was first published on his blog here. Ben is an Entrepreneur in Residence atMorris, Manning & Martin, LLP in Atlanta, GA and a Mentor at Atlanta Tech Village. The founder and president of Peachtree Software, Ben Dyer is a serial entrepreneur and leading technology advisor. He continues to partner and consult with innovative companies to deliver a better future.