Two of my biggest passions are writing and helping entrepreneurs. Since I'm usually out helping entrepreneurs solve real world problems, it leaves me short on time to do the first. So I decided to combine these 2 passions into one by writing a blog that captures "under the waterline" issues that vex Entrepreneurs & Founders. Their solutions are usually lurking "in my inbox" and these are snapshots of real conversations I've had - with names changed to protect the innocent - and not so innocent. :)
I’m calling it:
Inside my Inbox: Actionable Tips for Entrepreneurs & Founders from an SV VC
I hope in reading these, you will find some valuable guidance. I welcome any feedback and follow up questions.
A Bigger Piece of the Pie - How “Justly Served” Desserts can Sweeten the Deal for Co-Founders
When starting a company, one of the pressing things that founders struggle with is how much equity to give their Impactful-Second-In-Command (ISIC). An ISIC is the CEO’s "go to” person in the company, the leader when the CEO is not around, the CEO’s shoulder to cry on, rock to get support from when things are tough, champion to celebrate successes with - you get the picture. We all need one of these and if you’re lucky enough to find one - you REALLY want to hold on to them. So to me, it’s a no brainer - you have to give them enough to make them feel valued, to motivate them when times are tough, to give them a reason to believe when the spiral is downward. Apparently, this is not as clear cut to all.
The Context - I received an email from a Founder/CEO, post-Seed, a few customers, and starting to see some traction. Let’s call him Kenny. His CTO, we’ll call him Alex, joined prior to the Seed Round. Alex was not just any CTO- he was Kenny’s ISIC. He was a key player in everything that had unfolded until now and had a huge stake in their milestones going forward. Kenny rightfully wants to increase Alex’s stake and he is thinking of giving him another grant - bringing him up to 5%. He called to ask for my blessing on his strategy.
I have a philosophically different approach to this issue. As an Investor who has too often seen things go south due to bad blood between founders and ISIC’s, I can tell you that this matters. A LOT. And it’s best solved early on, before you run into the inevitable rough patches. Here’s my approach:
- Who's your REAL partner - This is the person who will give their blood, sweat and tears for you. The person you’ll depend on for psychological support, the person who will work by your side, through ups and downs, highs and lows, till death (or M&A) do you part. This is the person that you must invest in first and foremost. Look for the partner/ key employee who is not afraid of risks, willing to take a salary cut, showing commitment that they are willing to ride through the ups and downs of a startup, not concerned about title, bring intangible values to the company and add value in more than one way. This is who you want to keep motivated.
- Do Unto Others - You’ve run the numbers, you know what kind of a financial outcome you’d be happy with in the case of an Exit - you have to run the scenario for your ISIC’s stake through the same logic you’d use for yourself. Give them a meaningful stake - not just the numbers - rather, whatever you think a meaningful financial outcome is. When they run the math on their ownership, it should be an "OK, I've done well for myself" moment.
Let’s look at the numbers - as CEO, you own 50% of the company - you think you’d probably sell for $200M - meaning, you’ll make $100M pretax. Now think “hey - what should I give my ISIC?” Well, if he has 5%, it means he’s making $8-$10M and you’re making $100M?! Is that the right number for someone carrying such a tremendous load? And that’s the upside number. Let’s face it, there is a high likelihood that the company will not get to that positive of an outcome. The ownership for the ISIC needs to work in a down scenario as well. The ultimate point - the absolute number someone makes can make a huge difference in their motivation. Make realistic calculations and use the same math that you use for yourself.
- (Don’t) Ask and You Shall Receive - Still rivers run deep. Just because someone is quietly working away, don’t think they aren’t having deep thoughts about this. Don't "disadvantage" the “non-metoo” generation - just because someone doesn’t stand up and demand doesn’t mean they don’t deserve to receive. Don’t let the squeaky wheel always get the grease, oil the smoothly running wheels so they keep running smoothly! It’s your job to look out for the quiet ones and make sure they’re not being under-served.
- Give Before They Ask - If you make a preemptive move, you will ALWAYS have the moral advantage. They will remember this moment, they feel taken care of by you. This becomes exceedingly important when the going gets tough - you can dip into the “piggy bank” of tit for tat - you did something for them, when you need them to do something for you, you can draw upon that “remember the time that I…” and then ask for something. They’re much more likely to return the favor.
- 1/10th is Too Big a Gap. You having 50% and your next in command having 5% is an unnatural gap. It should be more like a 1/5th gap. If Alex is THE guy, I'd DOUBLE his ownership at minimum - i.e. take it from 3% to 7% ...and then give him ANOTHER 3%. If you decide to give him 10%, which you should, a ⅓ of it can be performance/milestone based: 10 production customers, a successful Series A, 50% increase in MRR, etc. There is a tremendous alignment of interest when there is a performance element attached to the grant. Ultimately, if he stays 4 years and hits the milestones, he ends up with 10%. Alex is happy and you as founder should be ecstatic, as your equity becomes a lot more valuable.
Just to play devil’s advocate for a moment, there are cases where equity is not necessarily a motivator for the ISIC. Some folks are risk averse and prefer higher salary over high equity, especially where stock options require them to put in their own money to acquire the stocks and deal with any potential tax implications. IMHO, if you find this in your ISIC, you might have other problems… As a founder (especially in early stages) the only currency you have to play with is the equity, it is important to keep the long-term goals in mind when doling out the shares to the key stakeholders of the company, so take my advice with the proverbial grain of salt and use your own good judgement.
To summarize, remember: 50% is worth nothing if your startup implodes. Incent your next in command to achieve greatness, so that they get to work fired up and feel like an owner not employee.