This CEO-Turned-Investor, Who Sold His Company For $500 Million, Thinks Founders Should Stop Giving Up So Much Equity. Here's Why. Giving the good stuff away will only hurt you in the long run.
By Carey Smith
Opinions expressed by Entrepreneur contributors are their own.
There's an equity issue with young founders, and it has nothing to do with society at large. It has to do with the fact that too many of them give too much of the good stuff away. And by choosing the short-term gratification of big money, they're doing serious damage to their long-term prospects.
A few years ago, I sold the company I bootstrapped and grew for nearly 20 years, Big Ass Fans. Using some of the proceeds, several colleagues and I moved to Austin and set up an investment firm to help young founders grow their companies. Because we're contrarian to the core, the advice we give them is different from what they are likely to hear from other investors. For one thing, we tell them they don't need as much money as they think they do. If anyone had handed me a million dollars back in the day, I wouldn't have had a clue what to do with it, but I'm sure I would have spent it.
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Our goal is to actually help founders — not just shower them with money and cross our fingers. The high failure rate of VC investments clearly shows the error of those ways.
Unfortunately, many founders arrive on our doorstep carrying heavy baggage. They have been steered wrong or made rookie mistakes. A few have been shafted by so-called partners. Some have scarcely any equity left to their name. Last year alone, we met with more than three dozen startups whose first-time founders no longer controlled their companies. Nearly 20 of them owned 20% or less. Most memorable of all was the young man who retained only 1.6% equity. He was desperate for someone to buy him out.
To quote Hank Hill, the famous TV Texan and propane mogul, "Now that's just sad."
The fact is, once founders have doled out most of their equity and blown through their investors' "infusion," it's hard to attract new backers; often, founders are left with few options other than working for existing investors or selling. And by that point, their baby of a company is no longer precious to anyone.
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Something for "nothing"
Generally, founders end up in this predicament for several reasons. First is the existential problem with equity itself: I call it existential because, in the minds of young founders, equity doesn't seem real; it hardly exists, especially early on, when the company is making next to nothing. What's 25% or 30% of that? As we all learned in grade school, it's nothing. Yet suddenly, people are willing to accept those chunks of "nothing" in exchange for more money than most of these founders have ever seen in their lives. And at that point, if they don't have a strong business plan in place, while they may be in for a wild ride, they're headed for trouble.
Also to blame is an overabundance of confidence. It seems to be an occupational hazard of entrepreneurship — first-time founders think that because they're smart and developed a cool product, they can conquer the business world. They imagine people like them do it every day. But the fact is, the overwhelming majority of founders don't catch lightning in a bottle, only a few fireflies at best. In the business world, successes are precious and few.
I learned that the hard way. Before Big Ass Fans, I worked for years trying to build my first company before augering in. That's why I'm so determined to help other people avoid that experience, and why I'm so focused on the need for a good business plan, one that details exactly how the money will be spent: How many people to hire and when, what kind of facility to rent, etc., and has as its goal to break even as quickly as possible.
Lacking good business plans, founders see their newfound riches quickly disappear. For example, there was the candy maker who spent his nearly $70 million fitting up a grand manufacturing facility, but because he lacked manufacturing experience, both his equipment and his employees sat idle and revenue fell as the huge demand he counted on was never realized.
These founders are then forced to dust off their pitch and go at it again. But with each fundraising round the exercise gets harder; they have less equity to give, until one morning they wake up to the harsh realization that not only are their investors in control, but they have their own agendas. That's when equity becomes very, very real.
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Control or freak
One founder we spoke with had a great product; we would have been interested in partnering with her. But an investor who controlled 75% didn't want others involved. In fact, he seemed to have no interest in growing the business at all, at least not in a way that would promote its long-term viability.
Another saw her business battered at the hands of investors who didn't understand the nature of the product and had no manufacturing experience.
Though we haven't partnered with these founders, we're always happy to give them our two cents on how they should proceed. They've already learned some invaluable lessons on what not to do.
Hopefully, in their next business they'll seek advice from experienced business people, make a strong business plan, and cling to their equity. Because even when it might seem like nothing, it's everything
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