Startup Therapy Podcast

Episode #27

Ryan Rutan: Yeah. Mm hmm. Paying people with equity is a time honored tradition in perennially cash starved startup land. However, have you ever stopped to consider the real cost? It might feel like you're buying real resources with monopoly money at the time. But what if I told you it was perhaps the most expensive currency you will ever lay hands on On today's startup therapy podcast. We'll talk about the real cost of treating equity like cash when it represents 100% of the future return on your efforts. Well, we know it's a really common scenario where startups at the early stages often treat equity like a replacement for cash. You called it monopoly money where they're going to use this as a method of compensation at the early stage where they may not have cash to pay somebody. Um, but one thing I think that's not talked about enough is what the downside of that can be. And so let's dig in a little bit like in european. What's, what's wrong? What are some of the downsides of paying with equity?

Wil Schroter: I don't think we value it properly, especially in the early days, you know, Ryan, you and I start a business today. And all of a sudden we've got 100% of the cap table in life as well. And then we want to bring on a designer, let's say, And she's, she wants to charge us 5% of the company in order to design our website and our early brand collateral and all that great stuff. And we're looking at each other saying five minutes ago, we didn't have anything right now we can find an entire designer for for this monopoly money. Yeah, sure. Because if you don't design this website, we're gonna have nothing anyway. So what's 5% And it's that thinking that is so dangerous. And I think today when we talk through why you should by all means avoid paying people with equity. I think by the end of this episode, if you still think you should pay that person 5% then Ryan you and I have failed calamitously. Alright,

Ryan Rutan: alright. There's our mission. We'll we'll make this very real.

Wil Schroter: You

Ryan Rutan: know, it is, it's interesting because I think that we think of equity, especially the early stage, right? We like to your point, we don't value it enough. We've discounted the future value down to very little at the beginning of business and we treat it like free money. The reality is that depending on what happens with that business, that may be the highest interest money that you could possibly tap into right? As the future value that goes up. It gets exponential.

Wil Schroter: Let's start there Imagine for a moment that I was 18 years old. So so long ago in the paleolithic era. Uh but that paleo diet

Ryan Rutan: was just called the

Wil Schroter: diet. Exactly, right? And someone comes to me and they said, well I'm going to give you $10,000. But for that I would like 10% of your earnings for the rest of your life. And at first like $10,000. All the money in the world. I'm 18 years old, right? I'll take don't even make $10,000 in a year. Right? That, that sounds wonderful. Sounds like the greatest deal ever. Well, we don't think about is that will probably make more money later hopefully. And so as our career begins progressing and we start making more and more money That 10% that we gave away or you know, took in exchange for cash in this case so easily become so expensive. In fact, it may become the most expensive line item in the entire pie chart. That is our expenses, right? And we think of how short sighted that decision was. And at the time When I was 18, I could have thought of a lot of reasons why that money would have worked, why that would have been a good investment. That $10,000 could have helped get a car that I'm going to need, could help pay for college that I'm going to need. It could have done all kinds of things, but 10% for life, Huh? That's what people are doing and that's what startups are doing. That's what founders are doing. It's one of the most rookie mistakes you can make and founders make it every single day.

Ryan Rutan: Yeah. Yeah. And I think that they, they underestimate the future value of it. I also think that they incorrectly assume that at some point they could probably just, you know, replenish that take it back. You know, that there would be some other options. And of course there could be right depending on how you structure the equity grants and all that stuff. But again, we don't see that executed on very well in most cases right. I think you and I could probably take off 10 founders we've talked to in the last year who have dealt with some equity issue that's based on a really early decision that in hindsight, they know was a really horrible decision at the time, they probably would have fought tooth and nail to defend. No, we have to do this for this reason. You know, we don't have cash, We don't have other resources. We have to do this. Otherwise we're dead in the water. Um, and that becomes the justification right. If I don't have other options, I don't perceive having other options, then this becomes a great idea.

Wil Schroter: You know, Ryan, as we get further into the podcast, I think we should definitely dive into what your alternatives are. So for the folks listening, just understand we will walk through alternatives before we get there though. I really feel like we can't drive home this point of how expensive a unit of equity is. So I really just want to start there. We, we definitely covered the point that, yes, you'll be paying for that debt for the rest of your life. But here's the more important part. A dollar of equity that you give away doesn't get replenished. If you spend a dollar, you can then make a dollar, your dollars replenished. Equity doesn't work that way. It is a one time willy Wonka ticket that once you spent it, not only do you pay for it for the rest of your life, you never get it back. And I don't think folks are thinking in those terms because initially in the formative stages we're such short term thinkers. Right? Again, we kind of have to be, but because we've never done this before, we think of, hey, this stuff we're getting is for free because we're paying it with equity later on. We'll learn later on. We'll learn, we paid for with the most expensive dollar we will ever spend. And the fine print

Ryan Rutan: On this one is, is real.

Wil Schroter: Oh brother. It's so, it's so real. Now what folks will say and I get this, I understand why they say they're going to say what you said a moment ago, which is, well if I don't spend with my equity, then I'm not going to get this website that we need and the product will never come to fruition to begin with and therefore it's a good use because it's going to help get me to that next level. And there is some truth to the argument problem is it's not necessarily, the only way you can pay for this. And it's also not necessarily the cheapest way you can pay for it. Right? Sober. So it's, it's actually probably the worst decision you could possibly make. So I think with that probably worth talking a little bit about what some of your options are. What do you think?

Ryan Rutan: Yeah, I think we should dig in. We definitely think otherwise. We're just presenting a problem here. Just don't pay with

Wil Schroter: equity and good luck.

Ryan Rutan: Really short podcasts.

Wil Schroter: Yeah, Okay, so we get it equity super expensive. I'm going to pay forever, you know, over and over for the rest of my life, but what else could I do? Well, here's some interesting points. Here's some interesting ways you've got to think of how people receive equity. First thing is when you say to somebody I'm interested in paying you with equity, the first thing they're going to think of is, well that's not money. So you're paying me in risk and therefore I need to get paid a lot for that risk. So that's one. Okay, so, so let's just kind of bucket is I have to get paid a lot for the risk bucket B is if you don't value how much your company is worth or how much the equity is worth, etcetera, If you don't value the currency, how do I know how much to take? Here's how I know I want 10% of the company,

Ryan Rutan: right? Nice and arbitrary. Not as egregious as a quarter or a half sounds sounds perfectly acceptable to anybody that would offer that too. Right?

Wil Schroter: 10% of the company and and here's the funniest thing about 10% funny in the worst way possible, Funny in that it doesn't sound like a lot. 10% of a thing. Does't sound like a lot. Yeah, But the moment you call it 10% of anything valuable, It sounds like all the money in the world. I don't remember how much of Amazon Jeff Bezos owns. I think it's 7-10 or 20% at most and he's the richest man in the world. Yeah, a lot. 10% of anything that will ever have value is all the money in the world. So you, as the entrepreneur, you think, okay, well all the money in the world, okay. The stakes are pretty high. What are my alternatives here? So again, bucket A was, we're looking at it and saying how much risk is involved, bucket B is, How much is the currency worth and Ryan? Would you agree? Probably there's some combination of those two, how we make our equity decisions.

Ryan Rutan: Yeah, for sure. You have to, you have to keep some balance between those two.

Wil Schroter: Right? So let's address both separately. Let's address how we tackle risk with with the, the person we're going to pay and then secondly how we tackle value, which is essentially what bucket B is when we talk about risk, risk means will this asset, this equity ever turn into cash to reward me for my contribution? Well, Ryan you and I had the idea of nine seconds ago, Right, So as at present it's not going to,

Ryan Rutan: you want to talk about a small number that is a very we decimal lot of zeros, but they're on the wrong side of the point,

Wil Schroter: correct. But let's talk about the part Where we want to convert it to cash as the recipient? Actually no, let's role play here, right. If you will, you're the recipient, you're the person that's going to receive this, this equity and I'm the entrepreneur trying to give it away when I come to you and say here's 100 shares in the company. What are the first things that come to mind as far as how you're trying to evaluate it?

Ryan Rutan: Alright, my rent's due in a week and a half. How many of those will I need to give my landlord to pay my rent?

Wil Schroter: Right. Yeah. And basically will any of this ever convert to cash? Right. Yeah. So if if what you're looking for Ryan is cash then why not give myself and my way that you the optionality to convert that to cash at a later date on some kind of multiplayer and what's important, what's important here is the first thing I have to do is value your contribution? People overlook this all the time. Right,

Ryan Rutan: what will it take me, what will it take to get you to say yes to joining? Right. And they don't factor in, what is it worth paying for this person to say yes. So valuing that contribution is so, so important. It gets overlooked because you just know like, well, we we need to design because we have to get the site launched or well, okay, but what is the real value of that? All right, what does that unlock and try to get down to like just literally a cash equivalent? Right? Because if you don't understand what it's going to cost you from a cash equivalent, how in the hell could you possibly determine how much equity to give away?

Wil Schroter: That's exactly it. Okay, let's start there. So, Ryan, you come to me and you say, Hey, you want to design my website and you say normally I would charge, let's say $10,000 a fair amount for this service. Right, cool. Now we've started to fill out some of the variables in this equation here. We didn't just say Ryan is going to participate. So for Ryan Amorphous li participating, He deserves 10% of the business. Sounds right, Negotiations falling apart already, right? But we said Ryan's contribution, his investment in the company is $10,000. So we can start to wrap some metrics around that. We can start to fill out some of the other variables. We can say if Ryan's contribution is $10,000, then how much stock would it require In order for us to get him paid on $10,000. Well, If what we're saying is we're going to give him $1 million $10,000 investment. Great for Ryan Ryan, you killed it, you won this negotiation. But but let's talk about the part where you're saying, hey, my rent's due etcetera. What you're talking about is an evaluation, not just the, the value of your contribution but evaluation for risk. Right. I'm going to spend $10,000 worth of time that I could have otherwise gotten paid for. So we may come to you and say Ryan, we're willing to give you $50,000, not shares dollars worth of stock. And well we can get to evaluation later. We can give you $50,000 worth of stock with the option at any point To buy that down with cash at $20,000. It's essentially a convertible note, yep. What that does. It gives us the option that if for whatever reason we want to pay you in cash, we're gonna pay you twice what you could normally get. Again, you can, you can manage any kind of multiplier you want. I'm just using an example. Sure. If we never call on that cash option And it's just equity, it's $50,000. It's a very specific amount of equity. It's not a percentage of the company I wanted kill that noise right away. That's that's such a bad idea. Never, never think about

Ryan Rutan: They scale with the value of the company, right? $50,000 will forever be $50,000. 10%% of the company might be $0 now and it might be Jeff Bezos money 10 years from now.

Wil Schroter: But if I'm the entrepreneur Ryan, I'm screwed. Either way. If it's worth nothing in the future, things failed. I'm screwed. If it's worth a lot in the future, I made the worst business decision of my life. Just as bad. What I'm looking for is I need to build in some optionality and I need to set a fixed price for the contribution. Now if you're looking at the reward bucket Ryan and you're saying, I'm saying the risk bucket bucket a and you're saying, hey man, there's a lot of risk. I mean this thing is nothing but risk. You're so unproven. I normally get paid for this. I won't get paid for this. We can monkey with the multiplier. Right, yep, you can say, hey, I don't think a five X multiplier. Inequity is enough. I want a 10 X. Multiplier. But now we're talking about multipliers and you know what you're not going to say, I want 100 X. Multiplier. You know, I want hundreds of thousands of dollars and millions of dollars from my $10,000 contribution. We've locked in some variables grounded in some reality while still giving you the optionality to get both cash or equity. Sure without that mechanism, Oh, Things come off the rail so fast. How many entrepreneurs have you talked to that have been saying, Hey, I'm gonna give somebody 10 or 20% to get involved in the company and kind of see how it goes.

Ryan Rutan: Oh, at least twice a week we're hearing some story like this, right? And, and, and every time it's, I feel the same physical pain. Um, just imagining what the future looks like. Should they go through with that decision? Right? And like you said, the, there there are a lot of outcomes where that still becomes a bad outcome. And at some point in the course of this, I do want to talk about some of the costs of equity. Some of the things that giving away equity can cost you beyond just the obvious value in the company, right? So they're, there are costs that occur along the way, depending on how you distribute equity that occur, whether it ever goes liquid or not. And so at some point, I do want to dig in on some of those because those are the ones that tend to be real, no matter what the final outcome of the businesses and they can, they can have a strong impact on the outcome of the business.

Wil Schroter: Yeah. In a big way. And let's talk about the part where you don't get it back. Yeah, we'll probably do another show just about what happens when you give away equity and how so hard it is to ever get it back right? There are some mechanisms and we can educate some folks, but suffice to say it's damn hard and it's probably not coming back. It also

Ryan Rutan: increases the perceived risk to people, right? So if you're going back to this, if you're trying to spend it and you're you're giving them a bunch of conditions under which you can clawed back, the perceived risk goes up and up and up and the value of that stock goes down and down and down, Right? And so you're at that point negotiating against the value of what you're trying to hand over in the first place,

Wil Schroter: right? Especially if we're paying for things that have a one time utility. For example, if we paid a lawyer a few points of the company to set up our company That has a one time utility, we're going to pay that lawyer for the next 20 years for something that he did in three months. That's absurd, right? It's with with everything that we're doing. Now. Often this translates not just to paying for a consulting service type thing that has a very fixed start and end. It has to do with bringing people in the company full time, right? Here's where that messes with me a bit and I'm all for people having stock in the company, everybody at nearly 200 people, every single person has stock in the company. So by the way, this isn't a an argument against giving people upside. It's an argument for how you value it. Once again, if someone comes on board And again, and you say we'd like to give you 5% of the company, that sounds like a token amount in the grand scheme of the whole cap table. Holy sh it, can you imagine what that person I can't possibly do to ever earn that back to, you know how much contribution they would have to make to earn 5% of the company for life. That's you

Ryan Rutan: also limited yourself to a 20 person company at that point. Like that's

Wil Schroter: sort of it because

Ryan Rutan: we can't hire any more people, we ran out of equity

Wil Schroter: because once we give it away, we can't get it back. Now I'll make a bit of a counter argument here. You could say, well, ha wait a minute, Investors make a one time contribution all the time. Right, investors come on and they give you $500,000 and they take 10% of the company, no one seems to have a problem with that, technically, it's a one time contribution that money has a fixed amount of value and I would agree. And with that, I would say unless you have a use case for that money that will create an ongoing exponential rise in the value of the company. It's a bad deal. A lot of introverts don't think about it that way. Well I need $500,000. I don't have $500,000. If somebody's willing to take 10% of the company, I'll take it. Like what I get it, you need it. But bear in mind that is a fixed amount of contribution that you're going to pay for for the rest of your life. So my point is be mindful how you spend it and that's the same. The same goes for all the people you bring on.

Ryan Rutan: Yeah. And it really doesn't really matter where you're spending the equity anytime you're spending equity. The evaluation needs to be based on the same criteria, right? Like what is this going to enable us to do? How far into the future does this carry us? Right? Is the lift such that it's worth? Because what you're trying to, you're you're accelerating, you're trying to increase your odds of winning while simultaneously reducing what you win in the end. Right? And I think that you have to be really clear on what the equities buying you, regardless of its, you know, a one off thing. Um an employee or an investor. I don't think that there's really a reason to draw much of a distinction between them other than the objectives that you look at in terms of what they bring to the table are different but the outcome is still the same. You're giving away a piece of the company in return for what they hope is an asymmetric return. That's the whole point of this. Right? So the reason we build these things is that we think with less resources then we put in, we get to withdraw more, right? We build a company and and we, we drive to profitability. Maybe we exit, we want an asymmetric return. The same reason that somebody else accepts equity. We're giving them a piece of that asymmetric return. That's what they want, right? That can never be in our direct interest, right? It may be justifiable, but there's always a cost,

Wil Schroter: right? And and for all the folks that are out there when I say giving away I quit, I'm not suggesting that folks aren't thinking about it, but when they're transacting equity in a way where the contribution isn't valued as we talked about in a way where maybe equity is not the best way to spend this money. Again, we talked earlier about having the optionality to be able to do a cash equivalent later on looking for more ways to move the transaction to cash versus equity. Again, deferred payments, loan style payments, installment of groups, I don't care how you get there anything you can do to preserve equity while deploying cash no matter how long it takes you is the right decision. That's right because again, you don't get it back. Now. I also, I don't want to let the audience think that Ryan that you and I feel you should hoard equity that you know, never let it go there. There are very good uses for deploying equity. It's just how folks do it. one. Like we talked earlier in the episode just doing it to quickly another, like we just talked recently about folks doing it without valuing it properly. But I think there's a third part in thinking we have plenty left to go. You know, Hey, we've only distributed 15% of the cap table. We've got another 85% to go. You know, we got plenty of dry powder here.

Ryan Rutan: Ask anybody that's gone public how much dry powder

Wil Schroter: they had left by the time they exactly, exactly the moment you think, hey, I've got plenty leftover. You probably haven't made it very far in the company because the folks that are gonna come in later, they're going to be taking swings off of this thing are going to be taking much, much bigger chunks. Now. I'll also sort of add to that, I'd say the most expensive equity you'll ever spend is the moment you've found the company and pick a co founder, right because at that moment you're going to say, Hey Ryan, you and I love each other, Each of us gets 50% by far. Yeah. The most expensive decision either of us will ever make in the probability that we got it right, it's damn near zero, yep, that's here nor there? But when we move on and we start chipping away at that cap table, if we make it through two or three years, let's say where we've given up, Let's say 30% of the cap table odds and ends between employees, some early investors, etc. In all fairness, we've probably done pretty well. If we haven't increased the valuation of the company substantially, by then it sort of doesn't matter because the next folks are going to come with bigger checks are going to gobble up the cap table in 10, chunks and it won't matter how stingy you were with it right all along, we've got to be playing this game and Ryan, you alluded to this, of trying to spend some equity, but really trying to make sure the overall value of the company goes exponentially higher than what we just gave away,

Ryan Rutan: yep. Okay, so, you know, obviously we want to make sure that, you know, the equity is well spent, but we did promise that we're gonna talk about some some options, right? So when I if I we don't have the cash right now and we realize that equity is not a good option, let's let's get specific, like maybe let's let's go back through this scenario whereby we're like, hey cash sounds good, we don't have any right now. So what do we do about that? Like what realistically, let's go back to that same negotiation. How do we how do we turn that into into cash from the beginning, how do we avoid the handover of equity knowing how expensive it is, let's get real practical here. What do we do?

Wil Schroter: Sure. So if you think about it, If your contribution Ryan was $10,000 and we we know that's the cash equivalent, we can do some really interesting deals here. We can say if you're willing to take five X that inequity then that's already a given. But why don't we give ourselves at least the option and by way of that you the option to get some cash out of it. So if we were to say we have to pay you back in one of two mechanisms Either $20,000 in cash preferably within a certain period of time, we can even stretch it out, let's say it's three years Either $20,000 in cash or convert it to $50,000 of equity and it's our option as to whether we want to convert it. Now when you say our option

Ryan Rutan: whose let's let's be real specific here, who's option?

Wil Schroter: It's my option, here's why because from my standpoint If I end up paying you $20,000 then I have more than paid for your services, yep. But if I can't or don't want to pay essentially two X market value, then it should be your option to be able to get the default payment which is equity again, this is sort of how convertible notes work. You could say, hey Ryan, you could say, hey I'd really like to have the, I'd like to have that option between doing the two, yep. However if we give you the option then we really didn't do our jobs in as the company and making sure that we can buy down our equity contributions. That's right. Yeah. If you put the

Ryan Rutan: option in the hand of the of the pay it it becomes problematic, right? So in this case we want to retain the option to be able to say now that we're at that point in the future where we have the cash to pay, it's not time to pay. Do we believe That that $20,000 in cash that we're gonna hand over for? Let's remind ourselves for $10,000 in services. Right? So we are paying above and beyond. They had some asymmetric benefit to this. We got it when we needed it. They're going to get paid. Well, I'm gonna get paid well in this in this scenario, guess I'm the, I'm the recipient here. So for me, um if the decisions and I as the company we want to decide Which one of those is more costly, right? It's $20,000 in cash right now more valuable to us than $50,000 worth of stock. Right? And that's the couch

Wil Schroter: And we could do some interesting things with that. We could essentially put ourselves on the equivalent of a payment plan, right? We could then say, look, we can't afford $10,000, but we can afford $500 a month. That we're essentially going to either squirrel away in a bank account, you know, escrow style and pay to you in some future lump sum payment when it hits $20,000. Uh, and that's one way we can do the math. We could literally send you $500 every month. Like we were doing layaway and pay toward the service or except in this case we got it ahead of time. There's lots of ways we can do it. What matters is we've enabled ourselves the option to put equity down as almost collateral, but then apply cash as the ability to get that damn equity back. If we never choose to use it. Okay, Equity is the collateral. We've already got that. It's already kind of committed in the cap table. You're good. You already agreed to get it. But if we can choose to pay you back some of that cash at some later date and we can talk about what the the exercise period is that we can say, look, we've got up to four years to pay it right? And we could even do it with interest if we wanted to, you know, to sweeten the deal for you. The point is we can keep it simple, but we can also give ourselves the option that if we overpaid, right, If we end up paying a whole bunch of equity for ship that we never actually needed later or didn't pay off the way we wanted to. We've got some stopgap method to kind of make up for our sins.

Ryan Rutan: Okay? So let's look at it from from my side of the table. Now, let's as the provider, right? So I'm the one who's, who's being offered to be, you know, paid in cash for equity. And of course, there's another area of risk here, right, that I'm looking and I'm saying, ah, well, you know, they believe it will be worth more in the future and they get the option to decide which way I'm compensating, right? And so on one hand, that can be perceived as a bit of a negative, but on the other hand, I'm looking at him going, but no matter what, I'm either going to end up with twice what my market rate would be for this service right now, twice what I'm asking, I'm asking 10,000, they're offering 20 in the future or I'm gonna end up with $50,000 worth of a company that I at least believe at this point has the potential to to reach that value, right? I think the other thing that's really important to talk about here is what the profile of the individual that we're talking about here is as well. So we're talking about me in this situation. I'm probably not. Somebody who's paycheck to paycheck or only has one source of income, right? I'm not, this isn't the only website of my design this year and I'm just going to sit around hoping that either get $10 or $20,000 or $50,000 in stock. Right? And so I think it's important to consider that as well, right? Like what does this person actually need? And is this deal even right? Because I know you and I have both seen situations where equity hiring works out really poorly because the cash doesn't come soon enough. So it's maybe you hire somebody with equity and maybe it's not a one off project. I think the one off projects skews our perception on this a little bit if this is an ongoing employee engagement, right? Maybe we've we've created a scenario whereby there is some cash compensation, but we're making up for the difference in that inequity and all of a sudden that difference becomes unmanageable for this employee. We as the company have not taken on some really serious risk. We've given away equity and we've given away equity and we've spent time with this human, they've built capability within our company. They become an important part of what we do and now this is no longer working for them. And so I think that there's another layer to the assessment of whether this is the right choice or not that has a lot to do with the individual on the receiving end

Wil Schroter: agreed, agreed. You know, just Ryan as I'm hearing you lay this out, this is just so timely. Not two hours ago I was at lunch with a good friend of mine, a founder and he just sold his company. I was on the board of his company 10 years ago when they were forming and I spent two years on the board. It was one of the most well run companies I've ever seen. So I just, I'm saying that because I want to point out that not only was he super smart, not only was the company super solid, I was on the board, I was, you know, every month they're talking through the financials, the execution. I've never seen a better run company at the end of my tenure. He said, look for your, your investment, this is me being, being the the service provider. In this case You have two options. We can give you stock in the company Or we can give you $20,000. I remember thinking to myself, I mean, yeah, the company will probably do something at some later date, but I don't know, I maybe I'm too close to startup companies, but they never seem to work out and they were generating a fair amount of cash. So the $20,000, you know, wasn't gonna break their bank or anything else like that. So, so I said, you know, I'll take the cash killing me,

Ryan Rutan: can you do the math on this for us? What what would that willy Wonka ticket have been worth today

Wil Schroter: About $300,000. And I didn't even think about it until we just started saying this and it was it wasn't two hours ago I was kind of taking him to a celebration lunch and congratulating him for selling for a massive amount and I was so proud of him. It didn't even occur to me until we were sitting here that well you know I actually would have had stock in that company. I would have cashed that out. But but to be fair to be fair for every one of those that I never took the check, I've got 100 of them that I decided to take the equity and it's worth exactly zero. So I guess regardless of this being a quote bad decision um I think that take the money and run isn't the worst decision either. However I'll also say this, I felt that was pretty well compensated. Like I felt you know for the time that I put in the effort that I put in the $20,000 that they gave me. I thought it was incredibly generous and I was more than happy to take it. Did I forego 10 X. Return on that etcetera. Yes but I don't feel bad about it.

Ryan Rutan: No and you shouldn't write, you shouldn't you were you were well compensated for what you did. And uh, and, and things worked out just fine for everybody. Uh, speaking of board seats and, and giving away equity for these at least a couple of times a year. I get some kind of an offer from a startup company to join their advisory board. And, and they will, they will gift me some equity. And this happened about a week and a half ago, very, very inexperienced founding team. Uh, we're we're super excited to talk to me and, you know, we had a great conversation, give them some what they thought were some some great ideas and just some some very valuable perspective having been through this a lot And they came back after the call and said, Hey, you know, we've thought about this a lot and like we talked an hour ago, so no, you haven't. But uh, I'm glad that you think you've thought about a lot. We'd love to bring you on as an adviser and we'd like to give you 5% of the company

Wil Schroter: for

Ryan Rutan: my that was literally the first words out of my mouth and and they said, you know, but like if if you feel like you need more, I'm like, no, I was like, you're actually going the wrong direction now. Like just by making that offer, tells me that you don't understand the value of the equity, the value of your company And that you're going to create a lot of other problems along the way. And so therefore I can decide very easily right now that no, I, I don't need or want 5% of your company in exchange for any small amount of my time. And I was kind about it and I explained why and like all of the barriers that this could raise for them, like now go raise some funding and explain to the investors Why there's a 5% ghost in your cap table. Um, who isn't actively involved that you talked to once a month or once a quarter or whatever, why that person sitting with 5% right, explain that decision to them because they're going to evaluate that decision the same way that I was, they're they're looking at that and saying, I'm going to use this as a proxy to understand how you think about your business and making mistakes like that costume. We talked about this earlier, I said I wanted to bring up some of these additional costs in equity. It's these type of costs, right? These things can become barriers, right? Like we talked about this in the last podcast actually having somebody who is no longer active in the company who now represents like, you know, 30% of the company, and and they're no longer active. That's a huge huge problem for a lot of reasons

Wil Schroter: it is. And I think for folks when they're first giving it away just like that the young founders, you're probably talking to In their mind if if it takes 5% of this monopoly money that they created five minutes ago in order to get someone as smart as you on the team. that's money well spent because again, they haven't been around the block yet. They don't understand that. It's very hard to make your equity well spent. It's more likely that you're going to give it away in these sinkholes of value that you'll never get it back from and spend the rest of your career at this company trying to figure out how to not make that decision. Again, then the probability that you're going to make that equity investment and it's going to reap all the benefits that you're gonna be paying for for the rest of your career. It's just not like,

Ryan Rutan: okay, so to wrap all this up and put a bow on it, like, let's remember that equity is the most expensive money we're ever going to spend. It is 100 of the future return every little bit of that that we spend reduces that future return. So if we don't believe that we have this potential to create this future value, why are we spending it at all now today? In any case, I think it's really important to maybe even imagine the future value of that equity because we have to believe that its founders, we have to believe that there's a future value, that equity, Otherwise we shouldn't be building whatever we're building. Imagine that future value of the equity and imagine that's what you're spending today. That to me is how this should be approached.

Wil Schroter: Absolutely.

Ryan Rutan: That's a wrap for this episode of the startup therapy podcast. This is Ryan Rutan on behalf of my partner Wil Schroder and all the startups dot com family thanking you for joining us and we hope you'll continue to join us. Be sure to subscribe, rate and comment on itunes or wherever you love to listen to startup therapy. You can find all of our episodes at startups dot com slash podcast. If you're looking for more amazing resources to launch or grow your startup, be sure to head to startups dot com and check out startups unlimited. It's everything we have to offer from our online university to our amazing community of experts and founders and even all the tools we've built like biz plan, fungible and launch rock. It's everything A founder needs visit startups dot com slash begin that startups dot com slash b E G I N. You'll thank me later.

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