Inside my Inbox: Actionable Tips for Entrepreneurs & Founders from an SV VC
The Inside my Inbox blog series captures solutions to “under the waterline” issues that vex Founders. Snapshots are real conversations I’ve had with Entrepreneurs. I hope they prove helpful. (Note: names have been changed.)
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 rock to get support from when things are tough, the 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 need to give them enough to make them feel valued, to motivate them when times are tough.
My Inbox - 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. He called to ask for my views on his strategy.
As an Investor who has seen things go south due to bad blood between founders and ISICs, I know that this matters. A LOT. And it’s best solved early on.
Here’s my approach:
- Determine who your REAL ISIC partner is - 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 M&A or IPO do you part. If you have one, you want to keep them motivated, and this is the person that you must invest in first and foremost.
- Do Unto Others - Give them a meaningful stake – don’t just default to what “the chart” says. When they run the math on their ownership, it should be an "OK, I've done well for myself" moment. Run the scenario for your ISIC’s stake through the same logic you’d use for yourself.
- Example: As CEO, you own 50% of the company. Let’s say you think you’d probably sell for $200M, and after several rounds of financing, you’ll make $50M pretax. When thinking about what to give your ISIC, run the numbers. If your ISIC has 5%, it means they’re making $4-$5M. Is that the right number for someone carrying such a tremendous load? And that’s the upside number. The ownership for the ISIC needs to work in a down scenario as well. Make realistic calculations and use the same math that you use for yourself.
- Be Proactive - As a Founder, you need to “grease the wheels” so they keep running smoothly. Not everyone will speak up about their equity stake. If you make a preemptive move, you will ALWAYS have the moral advantage. They will remember the moment and they will feel taken care of by you. This becomes exceedingly important when the going gets tough. When the time comes, they’re much more likely to return the favor.
- 1/10th is Too Big a Gap – If you have 50% ownership, initially, and your ISIC has 5%, this is an unnatural gap. It should be more like a 1/5th gap. If Alex is THE guy, I'd DOUBLE his ownership at a minimum - i.e. take it from 3% to 7% ...and then give him ANOTHER 3%.
- Incentivize Performance - Use performance incentives and milestones in the structure of the equity stake. For example, add equity upon meeting key company milestones – e.g. 10 production customers, raising a successful Series A, 50% increase in MRR, etc. – this ensures that there is an alignment of interest in staying with and growing the company. Ultimately, if your ISIC stays 4 years and hits the milestones, they end up with 10%. Alex is happy and you as a Founder should be ecstatic, as the company and your equity become a lot more valuable too.
Does it always work?
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 when stock options require them to put in their own money. IMHO, if you find this in your ISIC, you might have other challenges.
It is also important to keep the long-term goals in mind, including future dilution, when doling out shares to key stakeholders as equity is often the only currency you can offer as an early stage Founder and other considerations include how you motivate other key management executives.
To summarize: 50% ownership is worth nothing if your startup implodes. Incent your Impactful-Second-In-Command to achieve greatness, so that they get to work fired up and feel like an owner, not an employee.
- Tim Guleri