This post is a word of warning to those founders who are starting businesses and intend to raise money from investors for It: protect your equity.
Equity is your stake in your business. I know you probably know that, but there’s a reason I’m saying it.
Investors trade equity for money. This is supposed to be a mutually beneficial trade. The business grows faster because of the investment, and while you give up a piece of the pie, the pie grows so much that you ultimately still benefit from giving up a few slices.
But there’s a big pitfall first-time founders face.
How Founders End up With Single-Digit Equity
Single-digit. AKA you founded the company with 100% ownership (or 50% with a partner) and ended up with 7%.
The following is based on a true story.
I knew a guy who went through a startup accelerator. He had an interesting idea, but more importantly, this guy was charming and knew how to sell (the most important skill for entrepreneurs). So he managed to get funding.
For some founders, funding is like the holy grail. You struggle for years just to get funding (what’s profit?). It’s kind of like dating—those who can’t get it are desperate for it, and those who can get it see it’s not all it’s cracked up to be. But I digress.
Turns out, he was a little too good at sales. After just two or three rounds, he diluted his own shares enough to the point where he was now a 7% shareholder.
This isn’t just a problem because you earn less whenever you have an exit.
The problem is if you end up needing to raise more money, you won’t do it if it cuts your stake from 7% to 3.5% of your own company (pre-exit). You’ve set a cap for your company’s growth because you raised too much too early.
Not to mention it kills your motivation to f*cking hustle for a lucrative, ambitious future for your company.
Remember: equity is your stake in your business. If you have little stake, why would you give above-and-beyond effort? It’s no longer your baby. You’re just the babysitter.
What Kind of Future Do You See For Your Company?
If you’re running a business and you start to plateau, maybe you’re okay with a big dilution if it means you actually get paid decently in the short term. Maybe your company isn’t meant to scale to unicorn status, and you want to get married next year so a little more money would help.
However, if you have your eyes set on unicorn or decacorn status, do not give up equity so easily.
Not only will it make decision-making difficult when you don’t own as much of your own company, but it gives you less and less leverage for future funding.
Every percent matters.
Your stake = Your Effort. If your ambitions are high, guard your stake to stoke your effort.