I have been offered some pretty bad deals for equity in my company. The worst one offered monthly advice for 10 percent of my company. Then there was $100,000 for 25 percent of my company, but paid as services. And who can forget the 51 percent I was offered to leave my CEO role at The Resumator, but still essentially do all the day-to-day work.
The sad truth is I actually considered every single one of these deals because I had no clue how to identify them as bad early. Only by luck and a last minute voice in my head did I walk away from these deals years ago.
I don’t want to paint the impression that deals for equity in your company are always bad deals, but many are horrible for new, inexperienced entrepreneurs. We get excited because someone wants to invest in us, or a seasoned employee wants to join our team. Some of these folks have good deals to offer, and others are trying to get the whole kit and kaboodle. New entrepreneurs don’t know how to discern between the two, so we use defensive posturing during negotiations as a disguise for our insecurity. We’re determined to not give up too much of our company, even though we don’t really know what “too much” is.
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The best piece of advice I can provide is one that was given to me recently: change your mindset from “give up” to “trade." This gem was given to me by a prospective investor in the middle of a negotiation. I kept using the words “give up” when trying to explain why I did not think the suggested terms were fair. The phrase “give up” automatically puts you in an extremely defensive mindset. I don’t want to “give up” anything to anyone, especially a piece of my company, and this mindset was getting in the way of me negotiating a deal. As soon as the investor suggested this change in thinking to me, I realized two things: a) it was an awesome way to take the ambiguity out of negotiating and b) the “trade” he was proposing was not a trade I needed to make at the time.
We’re all extremely comfortable examining trades that involve things familiar to us. Can I buy your house for $2,000? I’ll trade you this hamburger for that hot dog. Give me $10 and I’ll give you this T-shirt. You probably formed an instant opinion about each of those trades. The house trade was horrible. The food trade was a fair deal if you want a burger. The last deal really depends on the T-shirt (and my hygiene), but it could be fair.
These instant conversions disappear from your brain when examining investment deals like, “$25,000 for a 25-percent stake” or “$300,000 at a $2 million pre-money valuation." We don’t trade pieces of a company that often, do we? That’s why it’s harder to evaluate investment deals, and we end up getting way too defensive as if we’re hawkishly negotiating the price of a souvenir off the Carnival cruise ship in Cozumel. Nonetheless, when you think “trade” with your company, you gain access to the tools inside your brain to think more mathematically and less emotionally.
If I walk into a convenience store desperately needing a drink, I’m more inclined to trade $5 for a bottle of water. But if I had half a bottle in my car, I’d probably decide against the purchase, hoping for a better deal down the road. You never want to be desperate for water, or money. The trade will usually not be in your favor. If you have some cash in the bank, you’re not as thirsty, and you need to make sure the investor knows that. If you know you have 10 months of cash on hand, why trade half your company for simply another 10 months of cash? A better trade probably exists out there, and you have 10 months to find it. Like the bottled water, you should only make trades that match your actual needs. It’s business, so don’t do favors—do deals. And if you know you can walk away, politely make sure everyone knows that.
Negotiating with prospective founders and employees should be no different. They are trading their time for a piece of equity (or options, but that’s a detail for another time). If a prospective employee wants a full salary and 20 percent of the company (a fifth!), remember that you had to trade a lot of your time—probably unpaid—to get the company to the point you can even pay employees. Your reward was equity. What is the employee willing to trade for that much equity? Less salary? Overtime? Anything? When you explain the concept of “trade” to founders and employees, everyone can start to have a frank discussion about what they can contribute that matches a fair compensation.
The greatest benefit of getting everyone in the negotiation to think about the deal as a “trade” is it takes the ambiguity out of the process because everything suddenly has a value. A great potential co-founder can explain they will work for free when they could be earning $90,000 elsewhere. An investor will clearly outline how their $500,000 can help your business grow along with their resources, knowledge and connections. A potential employee will be fine with taking $10,000 less salary for slightly more options. Heck, your lawyer may offer $7,000 in legal services for a very tiny fraction of equity–that’s a great deal for a new company! Using the “trade” principle actually empowers everyone to quantify their true value and negotiate more fairly.
It’s going to take time, but start shedding the words “give up” from your vocabulary as an entrepreneur. But if you wish to give up a three-bedroom, contemporary home on a cul-de-sac in northern Pittsburgh...well actually anywhere...for $2,000, please get in touch with me immediately. I’m in the market.