The Most Expensive Equity Doesn't go to Investors

The most expensive equity we give out isn’t to investors — it’s to everyone else.

I listen to Founders stress all the time about how much equity they are going to give to investors (and they should stress!). They pine over whether they are giving up 12% vs. 15% in a Pre-Seed round, because they are so afraid of giving up too much equity.

Yet when it comes to giving out equity to everyone else — Co-Founders, Advisors, and Employees — they give that shit away like it’s Monopoly money.

If Founders are really worried about dilution, it’s not investors they should be worried about. At least with investors, we know what we’re getting. If they give us $1 million for 15% of our company, we know we got the value. But for everyone else, it’s kind of a crap shoot.

Co-Founders are Famously Overpaid

I get so much grief over this statement. I get it. The idea that a Co-Founder, someone who was there from the very start, and sweated out all those early days with you, could possibly not earn their keep is almost heretical.

I mean, it is. Until you run the actual numbers.

Remember, we’re comparing to what we’re willing to give to investors here. So if an investor comes to us and says, “We’ll give you $1 million for your pre-seed, but we want half the company!” you’d probably say, “Hell no!” And you should. But let’s talk about that very point.

Think of a potential Co-Founder as an investor — someone who has to contribute real market value to get your equity. Not a day goes by that I don’t see a Founder say, “I’m willing to give a potential Co-Founder up to half the company.” With zero pushback! Zero. None. They are thankful that someone is willing to join them on this journey, and they revel in the “fairness” of it all.

OK. But what is that person’s value? If you had a million dollars, would you pay them that to join in addition to paying their future salary forever? I’m guessing not, but it’s the same outcome. Think of how quickly and easily we made the decision to dilute half of our stock to someone who offers zero guarantee of a cash equivalent.

Early Employees get Paid for Time

We run into the same issue with early employees, who tend to receive very generous equity incentives. Now these are smaller numbers, but some of the same principles still hold up. We’re still paying real equity for “potential” value.

The fact is that most equity comp plans for employees are not based on performance. Really, all an employee has to do to earn their stock at the same rate as everyone else is not to get fired before their vesting expires.

If you show up first and you don’t get fired for 2+ years, you’re getting equity.
Now imagine if that were an investor with the same proposition. Here’s the pitch:
“I’m going to take 1.5% of your company as an early investor. At this time, I may contribute up to $150k (with a $10m valuation), but I may not. But either way, after 2 years, I want my equity.”

That sounds like an awful deal.

Of course, the argument is “But an employee contributes real value every day — they don’t just sit around!” Yes, hopefully. But if they are also getting paid for their contribution (not always the case), then what’s the extra equity for?

If it’s subsidizing their market comp, that makes sense. That’s real value. But if it’s in addition to what they would be making otherwise, how do we realize the value of that equity we just gave up?

More importantly, how do we quantify if we ever really got paid that value for the stock we gave up? We expect investors to pay it. How do employees get equity without ever proving they contributed?

The Most Expensive Advice Ever

Of all the people to whom we gladly hand equity, I still think Advisors are the ones who are the least accountable - and that’s our fault. Advisors don’t take a huge cut; the average advisor gets only 0.10% to 0.25% for their contribution.

At a $10m valuation on 0.25%, that’s $25k. Best case. If that valuation goes lower, that might be $50k. But that’s not the biggest issue.

What are we getting for $25k — $50k of value? Not much. Maybe some great advice, maybe some introductions. But what is that really worth? At Startups.com, we’ve run a pay-for-advice service called Clarity.fm, and we can tell you exactly what startup Advisors charge per piece of advice given — hundreds of dollars.

Advisors are almost never asked to validate their contribution. They get a token amount of equity, which we write off as “not material,” but we never stop to ask, “What value did we actually get?”

I sometimes wonder how many Advisors got paid the equivalent of $5,000 per hour in equity to provide a total of 5 hours of useful advice. The math is silly.

Treat All Equity Fairly

The point here isn’t that we shouldn’t use equity to pay people, or that everyone is overcompensated. It’s that if we’re going to be stingy about our equity, and we absolutely should, hold everyone to the same account that we hold investors to.

Say what you will about investors, but at least their deal is very clear: “You give us 10%, we give you $1m.” That may be a good or bad deal in your eyes, but at least you know what you’re getting, and you actually get it.

Comparatively, all of the other places we spend even more equity, our deal looks like this: “Give me a huge % of your company, and maybe I’ll give you something back. Or not. Either way, pay me.”

We need equity as a currency to pay for the stuff we don’t have. That’s how startups work. But paying for something that doesn’t return value is just a bum deal.

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