This morning I saw a post by Paul O’Brien titled “A VC is asking 6% for acting as an advisor…” – My first thought, that is some b******t – O’Brien agreed. His post is well worth reading, and it lead me down another thought pathway.
When you give out
a lot of equity, you are handing away control!
You can give someone so much equity, that they should be a partner and should behave like a partner. But sometimes they just end up as an employee who is very hard to fire. I’ve had this problem a few times in my businesses, and have seen it happen even in true startups.
Let me explain, by “true startup”, I mean, a company that has funding from VC’s, has a board, is expected to trade at a multiple of revenue – not EBITDA – and is creating a product. Those bootstrapping, and starting service companies are entrepreneurs too, But I’m using this, limited definition to make a point.
I’ve never been the founder of a true startup. I have been part of successful (and unsuccessful) investor pitches. I’ve done product design for failed startups, held marketing jobs at successful ones, been on teams who made VC’s “good”, and in running a digital ad agency I’ve worked with all sorts of startup companies.
But, I’ve never been the founder of something that had a board of five, where two members are investors, two members are founders and all parties agreed on the swing person, in the fifth seat. That is the typical structure of an early startup board. An important setup, because it gives the founders autonomy, but lets investors have enough control to protect their early investment. It also means, a founder can be fired, as can a non founder with substantial (vested or scheduled) equity.
In the past, my “founder title” has been limited to services companies. Some grew to be larger than myself, some were just a way to bill for consulting – a term I now try to avoid. But sometimes when I’ve added a “partner” without a board, I’ve created a nightmare scenario.
If you have an employee who is not doing their job, you talk with them about it, and if need be you fire them. The perhaps overly ’80’s action movie saying is “Lead, follow, or stay out of the way”. With a partner, often it takes more steps to fire them, without a board those steps are often unclear, or costly.
Scenario: You and a partner run a small services business, with revenue from clients. Your partner has taken to working less, and their work product is of poorer quality. You cannot just fire your partner, and since you don’t even have a board to go to, you are in a marriage that no longer works. Some options exist, but many have a possibility of lawsuits. The most likely case is you have to buy out your partner for a multiple of EBITDA. This is a rock and a hard place.
I recently had an reasonable amicable parting of the ways with a former partner in Push ROI. Part of the reason is that the company is working on pivoting away from service and towards SaaS. But even with a non hostile breakup, getting all accounts turned over, and names off of everything takes time, under even the best case scenario. If you have to deal with animosity, and even litigation it may just be faster to start a new firm.
Giving a VC 6% is crazy, and as O’Brien said,
“A VC would warn you of how bad an idea it is to allocate so much [to] anyone who isn’t full time.”
While I do think you can have a non full timer who can justify 6%, on a vesting schedule. My statement assumes that person is highly motivated, and is actually committed to doing things to increase the multiple of everyone’s equity.
A truly terrible scenario is when you have a party who is “full time” but isn’t really working. Someone who doesn’t share in the vision for the firm and who’s commitments are lip service at best. When someone says they are “all in” on a project right before signing a funding round that will give them a solid salary, that means almost nothing. It’s the people who are still “all in” when they find out the investor’s terms are unacceptable and you’re passing on this money, that earn being a partner.
Their is always a time to leave a sinking ship, don’t commit to the Titanic or WeWork. I mean it when I say, setting metrics that allow for failure is as important as defining success. But you don’t want a fair-weather partner either.
A partner in any business, is the person who will be sweating it out with you, when you’re trying to make payroll. If you don’t make the payroll, you’ll lose employees, but if you lose a partner when they don’t get the check they expected, they were just a hard to fire employee.