Stock is your most important asset – and you should treat it as such

StocksDuring my days as a struggling entrepreneur, I needed help. I was willing to do almost anything to get it, but the thing I needed most was to simply pay for help, but the thing I needed the most is the thing I didn’t have – capital. Many entrepreneurs are similarly situated, and it is the plight of many dreamers that aren’t lucky enough to be born with a silver spoon in their mouths, or have a rich uncle that’s willing to fund a seedling enterprise.

Fundraising is the single hardest obstacle for most entrepreneurs to overcome to get their business off the ground. Fundraising takes patience and persistence and every dollar raised is precious – if you take it from your savings – it took you eons to earn possibly, if you get it from friends and family – they may not be your friends or even your family in a few months, and an outside investor expects that dollar to magically triple or quadruple in value in a short period of time, otherwise they can become your worst enemy. My point is that every single dollar is exceptionally precious.

Why then wouldn’t you give away your most numerous commodity – stock – to preserve your least available and currently most valuable commodity – cash? The answer is simple, and terms like – future value, control, liquidity, and of course dumping come to mind.
Right now, with all of the other struggles with building and managing a business, your company’s stock is valueless (at least in your eyes – and probably anyone who is looking at your business as well). The truth is that your stock won’t be worth anything until you have an exit – and at that time – the value of your stock explodes from basically an intangible asset that merely represents your blood sweat and tears in paper form, into something that is a (hopefully massive) store of value and is liquid. This is the exit that everyone dreams of – and what keeps you going as you build your baby. Now that it has value though, everyone wants some – and wants to be your friend.

Now that you are exiting, you have to come to terms with the manner you are exiting. Are you going public? Did you sell your business? Are you taking on a Series A round (and positioning for a B, C and even D)? Now you ask yourself where is the stock coming from? The answer is – your pocket. The victory of your first exit now becomes bittersweet. Why?

Well, your stock – the one thing you had too much of in the beginning is now scarce – the thing you wish you had more of. Your stock is worth money, and more importantly it represents your ability to control your enterprise. If you are simply selling your business, those profits – the blood, sweat, tears, sleepless nights, missed dinners and bedtimes with families – your sacrifices – because no one has sacrificed more than you for your business – are gone. Other people you gave stock to, people you thought were co-founders that disappeared, vendors that helped for an hour or two that didn’t really do much are now basking in the glory of your hard work and profiting from it – profiting unfairly – but of course, they took a risk too that your stock would become worthless.

So, how does this break down…
Lets say your business is sold for a million dollars. You gave 5% for advice – that really didn’t help you that much. 5% for a connection to an investor that never panned out. 10% to two co-founders that walked away on you, and 15% for a co-founder that has been with you through the thick and thin, but you couldn’t give him more because you already had dished out 30% of your business. Now, you’ve got 55% of your company left, meaning you get $550,000 from the sale – great, but does that compensate you for the time, sacrifice and other pain? Lets say you spent your savings – which was worth $100,000 5 years ago, but you could have put it to work and it could now be worth $110,000 or $200,000. You’ve got to pay taxes on your windfall, and of course, you worked twice as many hours as a normal job – which would have paid you $60,000 a year – for 5 years, that’s $300,000 in wages. You trashed your credit (like most founders) in the process too, and you’ve got $25,000 in credit card debt. Now, does that $550,000 payday even allow you to financially break even? What about the emotional toll on you, your family and your children? Where does your AND their pain and suffering fit into this picture???

Lets take this scenario one step further, you get a Series A, and the investor want’s 20% of your company. You (and everyone else gets diluted – because you NEVER EVER allow someone to come in with a non-dilution clause), and now, you are left with 44% of your company – just marginally higher than your new investor. Of course, if your new co-founder always votes with you, you have a majority against the new investor, but – and here’s the but – the guy that gave you advice, and your two flake co-founders can always come back out of the woodwork and put their – 8% now – with the new investor to easily create majorities.

Now, you go through a B, then a C and then a D – at each level taking a nominal 10% of your remaining equity… You go from 44% to 39.6% to 35.4% to 32% – 32%. Now you’ve got 32% of something that should be worth a lot of money – which is good, but you also have lost control – and who knows maybe lost the job you created for yourself in the process.

The moral here is that your stock is precious and should always be treated as your most valuable commodity – because it is. Your business is a success and will be a success – you always have to remember that. Here are a few simple rules to live by:

  1. Never give people stock in your business without a tangible, quantifiable and VALUABLE contribution. It’s fine to give “co-founders” a stake in the company, but tie it to specific, quantifiable and valuable performance objectives. If they can’t deliver – they don’t need the stock and haven’t earned it – this might sound harsh, but a startup is a gamble, and everyone involved is risking their money, their time.
  2. Bring in people you trust – with your life – at the beginning, but make sure you structure stock ownership agreements and operating agreements to make sure that you have addressed the issues of severing the relationship. You never – ever – want someone to have a say or stake in your company without delivering. Decide in the beginning what happens if things go badly – best friends, spouses and family have ended their relationships because of business – it happens, and make sure you’ve properly dealt with it.
  3. Make sure people buy their stock – have people give the company notes when they get stock – even founders – notes that can be cancelled with payment – or performance. Don’t simply give away the house to get someone that you think could be an asset to your business in the door.
  4. When you give away a single share remember two things – once you’ve given that share away, the incentive to earn that share is removed. Second, if and when your stock does become valuable what is that person – that paid nothing – going to prize that stock’s value at? Are they going to hold onto it to protect their investment – or are they going to sell it for any price – and I do mean ANY price? This is important – very important – to protect your company in the long run as well.
  5. Finally – always keep in mind that giving up stock severely limits your ability to control your company in the future and lessens – and eliminate – your future financial gains. You are an entrepreneur because you don’t want the 9 to 5 and you want to make money – make sure your risks pay off!
Posted by: mprictor on September 17, 2014
Posted in: Law, Starting a Business