Other Key Considerations for Equity Allocation
Part 3 of the Equity series. The Equity series concludes with five additional key considerations for startups, as you lay the foundation for the future growth and development of your new business.
- Equal split of equity and decision-making with a Partner(s). For this arrangement to work, quick decisions have to be made and put in writing so progress is not deterred and there is no confusion over what was agreed to. Teams need leadership and someone has to act as a leader to build value effectively.
- Allocating fully vested equity to a partner who has not been properly vetted. Don’t do it – here’s why: fully vesting a major C-level executive with substantial equity, only to find out they don’t work out, means you have just given away all of that equity. You have also limited your options for giving equity to the new C-level executive who does work out, because buying back the equity you gave away may prove difficult.
- Giving equity to an advisor who later proves to be unethical could affect your brand and ability to do business. Conduct proper due diligence and background checks up front to avoid such situations.
- Back up your actions – maintain accurate records. When you are spending money to get a company up and running, there is a tendency to deposit funds in the bank account and worry about documentation later. As the Founder, you need to “paper up” transactions and issue yourself either a promissory note, stock certificate or some other form of documentation to back up the deposit of funds – and here’s why: I have seen many Seed and Series A rounds delayed because accountants and attorneys are working to determine what the actual capitalization of the company looks like. Don’t be that shortsighted founder.
- Refusal to part with any equity. Some entrepreneurs refuse to give away any equity and this is not good either. This example explains why. I once met with an entrepreneur who told me he had a solid offer for a large investment in exchange for 50% equity in his company, which he turned down. Further information revealed the entrepreneur was having difficulty making payroll, paying rent and keeping the company moving forward due to limited financial resources. I walked away from the conversation concerned he would, at the end of the day, own 100% of nothing when he ran out of money.
In conclusion, here are some final words of advice on investors and equity. Once you have proven your unique value proposition by building your customer base and generating revenue, you may start to seek an Angel or Seed round of investing. Do your due diligence prior to entering into a partnership with an investment partner, including speaking with other entrepreneurs with whom they have invested. The right investment partner will offer invaluable wisdom and advice.
Beware investors who may attempt to incorporate unreasonable terms or harass you to a point where you put your business’s survival at risk. Avoid these types of arrangements: a convertible note that converts into 100% of the equity to the investor if the company defaults on the payment; terms that allow the investor to fire the CEO/Founder without cause; or surrendering voting rights to make major corporate decisions at the expense of engaging with that investor.
The common theme here is to be a well-informed entrepreneur by doing your due diligence as you journey through your startup adventure.
Mindy Barker & Associates ([email protected]) works with entrepreneurial growth companies to help maneuver the many questions of funding, employee compensation and other decisions and is available to discuss your questions on equity.
Part 1: https://mindybarkerassociates.com/virginity-and-equity-think-before-you-give-away-either/
Part 2: https://mindybarkerassociates.com/primary-considerations-for-equity-allocation-agreements/