Startup Therapy Podcast

Episode #80


Ryan Rutan: Welcome back to another episode of startup therapy. I'm Wil schroder founder and Ceo of startups dot com with my co host, Elliot's near the ceo of startups dot com today. We're going to talk about a topic that sadly a lot of our listeners actually understand too well, and that's the point at which we're no longer really big shareholders in our own business anymore. In fact, at some point we're looking at the cap table and we're just employees. In fact, some of the people on our cap table, people that were just joining the company might actually be getting more stock than we do. We've been at this too long. We've been crammed down time and time again, we can't see the future because again, no matter what happens, we kind of got a tough stake in this company and we can't get out of the past because we've got so much invested in this thing. When we get to this point, when we get to the point where we feel trapped, what's going through our head, you've talked to lots of founders, you've been through this yourself. What's going through your head at which point you look at the cap table and you say, I'm fucked,

Wil Schroter: it's a really, really tough situation and happens probably more often than people appreciate. But when you get to that point, you know, 7-10 years down the line and you've worked so desperately hard to build this and solve this problem and at the end, your reward is going back to being an employee. Oftentimes something that you really didn't want to do to start with. It's devastating. It's gut wrenching because you're in this state of paralysis where in some cases, from a metric standpoint, you did your job and grew this thing, but circumstances compressed down your equity and now you're kind of just another employee,

Ryan Rutan: right? Which is weird because you're more tethered to it than anybody. I mean, you you are tied to the cap table and to be fair, employees share this same issue to write. You know, hey, I've been with this company forever. I've got some stock, I wanted to pan out, but I've got so much invested. I don't want to leave all these different things. But when employee leaves, there's not that much friction. I mean, they can leave, they can go get another job. People kind of get it when the founder leaves, that's an extinction level event. Some cases, you know, that ripples across the entire company can affect valuation, can affect recruiting, can affect media perception, customer perception. Not to mention very awkward conversation with the board. If you're getting this far into it. If you're getting this far into building your company and at that point, you're saying to yourself, this just isn't worth it anymore. What do you see your options as well?

Wil Schroter: It's tough man? I mean, there's outside of, you know, the time you've put in, there's a level of identification and we've talked about this before. You know, this is your baby, you know, this, this was your problem. You've let it for seven years and you've really built an exceptional relationship with this startup. So to your point earlier, look, people that work for the company can leave, right? You're C 00. I'm not going to do that. You can leave and in some cases getting even better gig because they just worked for a venture backed startups, right? But as a founder you can leave, but there's a significant cost to it. The second you say I'm out, you're folding the tents and, and that's a whole another, you know, that's a whole another thing to kind of roll around your head. But right, given the fact that this has a few different flavors, let's talk about. And you've actually been through this, sadly, let's talk about what actually happens. How does somebody get in that situation and kind of, what are the mechanics around what they're dealing with on a day to day basis when they're in it?

Ryan Rutan: Well, we see this a lot because we help people raise money on fungible and it happens in a few junctures. We get that first pass when we do that early seed round as a founder were by far our most vulnerable, right? So, you know, we have this idea and we're excited about it, but we present the idea to investors and they get excited about it. And right now, all we can think about is I want this idea to succeed. I don't have money, you have money. Those terms are a little bit, you know, tough, but I'll take them because I just need to get this thing going And so you take a 30, haircut right out of the gates and maybe have co founders. So you already took a 50% haircut right out of the gates or whatever your, your split was. Now you take that haircut again, but you're thinking that's okay. The companies funded, you know, we're often running, we got this going, but it doesn't occur to you yet is that this is going to keep happening. And if things go extremely well, you'll need even more money now you might get better terms or anything else like that. But what we don't consider is that every one of those slices, you can't get it back. So you're stuck with whatever that decision is. And in the future if things just go decent, not amazing, you're still going to get crammed down over and over late stage rounds, you name it. And no matter who you are short of a handful of companies where you had some disproportionate slice of the equity and were able to kind of manage the vulnerability, your position, you're gonna wind up in the single digits and at some point, not every single digit company is going to go out like Uber, right? I mean a lot of single digit company's best case are going to do a small market acquisition, Which means no matter how you multiply that it's not going to be what you had in mind when you're 100% of it. Absolutes.

Wil Schroter: And you know, the other consideration is is time lost. And I'll give you know some relatively real examples of this, but I have a close friend who look, It's not the worst salary in the world, but given his kind of his pedigree and what he's been able to accomplish, he's making $120,000 a year and will likely never see liquidity or meaningful liquidity because he's been so crammed down in this startup that he devoted the last almost decade too. That's hard to get excited about

Ryan Rutan: now. Here's the thing though, from an outsider standpoint looking at this, oh, it's a viable company, you're taking a great salary, et cetera, you have no idea how long you had to work to get that salary right? So a pretty common kind of Netherworld for a lot of funded companies looks something like this. And if this applies to you like lean in a little bit because you are not the only one, it looks like this, you're in year 5, 6 7, maybe further, You're getting a decent executive compensation. And again, I always, I'm always mindful when I say decent because for some people $100,000 is decent for other people. It's $250,000, but it's not that much and it's certainly less than what you could otherwise get in the market and you're in this weird spot, you can't take distributions even if you're profitable because somebody else owns the cap table. And that's not the way venture funded deals work. You can't get more money in salary because the company is not doing so extraordinarily well and everybody's still expecting you to invest in the company and you can't leave because all of your equity is tied up into this one thing. It's not like if you leave you all of a sudden get that and take that with you right? And you're also wondering if I leave, will I put torpedoes in the very boat that I built?

Wil Schroter: Yeah it's the unlike in a big corporate job it's the golden anvil versus the golden parachute in this situation.

Ryan Rutan: That's a good way to put it like that a lot. And so you know I think let's walk through a few cases of how founders get here. And let's also talk a little bit about what to do about how to think about it. And so let me throw out a couple examples that I've seen from friends firsthand in a little bit that I've actually gone through myself of where and how that this this cap table discussion breaks down sort of how we get here first thing again, just what I described before. We do the seed round, we take a big haircut, we do the A. Round, we do a big haircut, we do the B round would take a big haircut. We keep waiting for that valuation or more importantly liquidity to kind of catch up with that haircut. We just took, we keep saying smaller slice of a bigger pie. What we lose in that translation is every time we grow, every time we take that other haircut, every time we add another capital partner, what we do is narrow our window even further to how many outcomes we can possibly have. At which point I own 3% of the company and I'm in my D. Round. The only outcome we can have is either massive or an I. P. O. Nothing else will back out for me. And yet it's all of my salary. You know what I mean?

Wil Schroter: The challenges. And I think one of the things you're articulating well is every time you take money in your valuation goes up, you move the goalpost that much further for yourself, right? You raise a growth round and now all of a sudden a $20 million $20 million dollars run rate, right? So you keep moving the goalposts further and further which is you know, it's it's it's hard to rationalize. Now the other side and this is this is tough is this is how the model typically works, right? So you're following the same path in a probably a different outcome as Uber and Tesla and other, you know, unicorns and deck acorns. This kind of is the process. But I think part of what we're trying to illustrate here is not everybody is Tesla or Uber.

Ryan Rutan: Well, that's the thing. Most companies when they're in this spot are doing single, maybe double-digit revenue, right? People forget like, look, if you've got something that's doing 100 million and this is your issue, you'll probably be OK 99.9% of people are not having that issue. Most of us look something more like this. I've been at this for 7-10 years. You know, maybe less, but more likely this. I've raised doesn't matter how much money, but The company isn't far enough along that I can see any kind of meaningful exit. That's going to translate to my percentage. That's going to translate to me ever getting out of this thing. And also really at some point, let's say you've got a $4 million $6 million dollar company. If it doesn't get any bigger. There's also a limited number of places you can take that to an exit in the multiplier. There just doesn't really work in your favor. And here's the thing. It's not like nobody's thought of this. The investors know it the rest of your team knows it. The only person coming to terms with this is you and I think that's what messes with people don't you think that like that they're the only people that can't do something about it.

Wil Schroter: It's such a catch 22 because it's almost that the further along you can take. And I agree, by the way, if you're if you're doing $100 million in your rocket ship, Good on you and good luck. But again, for most people, the catch 22 comes in as a company typically progresses and it's a little lumpy er and a little slower your steak goes down, But your leash doesn't, your leash continues to tighten, right? Because to your point earlier, your you were 100% tied to this thing. I did like what you said, if you bail the company's just optically the company's probably done. So, you know, you're you're constantly taking your medicine at each phase as this thing grows or doesn't grow or gets, gets flat and then maybe it has a little bit of an uptick. But what I was talking when I was saying earlier, you get to a point where you're this thing that you were so desperately excited about and it kept you up at night in the right way, right? Like I can't wait to solve this problem, I can't wait to put this in place that's gone. And that's a really, really tough pill.

Ryan Rutan: It is. And what's amazing is how many people don't understand it. And so let me share a quick story with you of where I didn't understand it, even though I was a founder, even though someone was having a conversation with me about somebody else in the cap table. So years ago I'm running this company. And what happened is, you know, I started this company, I had the bulk of the equity and I brought in a partner to get it started and he ended up running the company, But I had like 75% of the cap table. He had 25. Now at first that made sense because I was funding everything and I was putting the team together and he wasn't working on it. You know, he's working part time on it and I was working on it full time. So at the time it made sense. Then we took on a few investors and you know, we, we got, you know, Perretta diluted and I'll never forget this. A couple of years later, you were fully into this. He's committed, He's running at full time. I'm off doing whatever it is that I do. And I'm at this event with one of the investors and the investors comes up to me and he said, look, we need to talk about the cap table. And I said, okay, what do you want to talk about? He said you have too much equity. You can imagine what my first response to that was right, but I was like, okay, you know, this really shocks me that you're saying this, like, walk me through it and here's what he said, he said, there's no way we're going to keep this person engaged as the ceo if they have the smallest stake in its outcome. And I said, well, you know, they've got a pretty fair stake given how much time they've put into this and and the lack of cash they put into it so on and so forth. He says, I get it, I get it. But what we're doing every time we cram him down is we're taking his, his head out of this. We're actually at some level, you cross a point, we're dis incentivizing an employee. Now, here's what I'm most embarrassed about. I didn't agree. I get it now, right? That's what I'm telling the story. I was 1,000% wrong. But at that moment I was kind of the investor, right? And I looked at it as like, you know, part of my french chuck this guy, like, I love me, a good friend of mine and I was like, I worked so hard for my steak, why should he get to take my steak just because he's, you know, because he doesn't feel like he has enough. And I remember being really angry about that. I I felt like something was getting taken from me and I just didn't get it. Well, I get it now, and when I see it from the other side, I had a friend reached out earlier this year and he said to me, look, I'm in the opposite side. You know, I'm in the past end of the cap table. I'm in a point now where I just don't have enough incentive to move forward even though I'm, you know, 77 to 10 years into this thing. And he said, I don't feel like I can get out of it, but I don't know how to approach my investors to tell them that they basically dis incentivized me by cramming me down over and over. It is so funny because at that moment I'm watching both sides of this equation remember exactly how I felt when I was the investor. I remember exactly how he feels when I'm the startup. So here's what I asked him to do. I said, go to your investors start with the one that's your most friendly investor. And say to them, here's where I'm at. Just be very honest. Here's where I'm at. I understand why I got here, how I got here. This is on me. These are all my decisions. This isn't a finger pointing or anything else like that, but just numerically, here's what I've got to live with right now. I'm taking a below market salary. I have, you know, probably another five or six years that I have to ride this thing out. I'm at a point in my life where I've got, you know, family, etcetera that I've got to take care of. So I can't make the same decisions I could make before. And there's no version where we move forward, where we raise more capital, no matter how well we do, where I actually come off in a better situation. So I'm basically, I'd be better off quitting right now than staying around for another day, but I want to stay here. So what can we do to kind of make me whole? And he had that conversation with the investors and and lo and behold if he had not had that conversation, no one would have had it for him. You know what I mean? Absolutely.

Wil Schroter: And the problem here is most founders don't realize that that conversation can even be had, Right? And I think part of that is we get so used to trailblazing this process and taking all of the risk that we forget to work with our investors and or other people in the company as partners, right? And if your investors and or whoever you have to have the conversation with is worth their salt. They should be appropriately receptive to kind of what you say. There's such a, here comes a really esoteric reference. There's such a lone ranger attitude for a founder that I think there's an aspect and you can correct me on this. But I think there's an aspect that we're embarrassed to admit defeat or ask for help. You know what I'll say this. I'll say this. Clearly, I would be embarrassed. I shouldn't be, but I would be embarrassed because at that point I have admitted failure. Right. Okay. I put seven years of my life into this thing and I told everybody in my life that this is what I was pursuing. I certainly was loud and proud about every round we raised in every metric that we hit. And at this point I have to basically go to investors and or whoever else and call uncle and say this thing is over. And here's, here's the problem. There's no version of a founder separating that. The company failed versus they failed.

Ryan Rutan: Yes. Especially when it's not, it hasn't officially failed. We're making payroll, we've got revenues, we've got customers. We've got the things that we set out to do. It's just not paying me. And I think what's interesting is there may be some version where we assume that the investors are going to have this conversation for us. They're going to sit around and say, you know, Elliot really isn't getting the kind of compensation he deserves. I think we should really dig in and uh, and, and make sure we recap him. Right? And you know what? And again, that's, so that's why I told you that story because even at that brief moment when I essentially was the investor as far as the hat, That's exactly the way I felt, I felt like I deserved. Mind you deserve yours. And the conversation and the truth is that was such a weak move on my part. Right. I lacked total empathy. And it wasn't it in again, which is honest too. Because this was actually one of my friends, this guy, I actually like a lot. So it wasn't, it wasn't an indictment on him. It was more about how I felt about my own stick. But you'd think if you're an investor, you'd look at all the investments that you make and think really long and hard about, you know what the incentive and calm structure would be for each of these investments and try to make sure they're optimized. If you're an investor and you've been doing this long enough, you're probably on the other end of the spectrum. We were thinking to yourself, you know what these, these founders are overpaid to begin with. I'm the one putting in all the money and you know, they get a huge swath of stock just for, you know, filing inc, you know, it's kind of bullshit. And again, there's some argument to that. But the truth is if the founder doesn't take command of this situation, if the founder doesn't present it in a way that's just Numeric kind of, here's where I'm at, here's my outcome, etcetera. You know, here's what are my options. They're not great. I need a new plan. No one will ever do it for them. So essentially we are in purgatory until we fire that bullet. I mean, there's really no other way around it, You know what I mean?

Wil Schroter: Yeah. And, and I think one of the important parts of having this discussion and getting the concept out there is to create a level of sobriety with founders knowing that this is the typical process. And if they don't say anything, this will likely be the process that they have to adhere to, right? So whether you look at this and say, I'm never raising venture capital right? Which, you know, is neither here nor there. Sometimes it's, it's an incredible asset to a company. But on the other side, if you do choose to raise, start having these conversations early. If you feel like something's a little sideways, you know, maybe it's your around and you feel like you've been totally pushed down and you feel like your, your compensation from an equity standpoint or from a base salary standpoint feels off, have that conversation, don't stick your head in the sand because there's no version of the investor to, and you said this before having a light bulb go off and saying, you know, I think we need to change, uh, change things around a little bit with

Ryan Rutan: will wright

Wil Schroter: says nobody ever Yeah, it

Ryan Rutan: says nobody ever, well, you know what, it's, it's at that point, the coral area, I think is kind of the boss to employee, right? If you're an employee that never asked for a raise, How often do you think your boss would come in and say, you know, you just wouldn't do such a great job. You haven't asked for any money, but here's money. What do you think?

Wil Schroter: What do you what do you

Ryan Rutan: say? That sounds awesome. And yet as founders, it doesn't occur to us that the boss, our bosses aren't us anymore. The moment you saw saw off your equity, you have a different boss. It's called your investor and that's who you ask for more money from it. It's not unreasonable To come back to the board and say, look, this was my complaint up till now. It's been a long time. I think we should talk about what's my complaint over the next 3-5 years. And even if the board were to say forget about it, not interested, you got what you got, you have to finish it or not. At least you start that conversation. Worst case you get nothing. Best case you start to open up the conversation around. You know, I need to be able to kind of see an upward path no different than anybody else that works here.

Wil Schroter: And let's let me flip to the the investor side of this thing when you come to them with that. Unless there overly principled on this. And I use that word a little bit loosely if you come to them and you have a valid point and let's just use annual compensation as a peace. let's not even use, let's not even use equity here. If they can say, okay, this person needs to make another 5200 K a year for me as the investor to feel like I can, we can see this bet through. Not a huge deal,

Ryan Rutan: right? Let me build them that can I. What people forget about is that people negotiate comp deals on companies that already exist. Elon musk negotiated a pretty good comp deal with Tesla that made him like 100 billionaire practically steve jobs, negotiated a freaking G five when he came back to Apple or $100 million jet as part of his comp package. Right? Neither of those were necessarily the biggest shareholders, but they negotiate comp packages based on milestones. What happens in a startup though is we forget like just too much time goes by and we forget that we're also employees were shareholders, but we also have to show up as employees and just to stick with that for a second are investors do not, they have stock just like we do except they don't have to show up as employees. So what we should be thinking about if we want to kind of reset our, our plan is what do milestone based objectives look like for me, You know, what is my com plan if I to X the company and here's why even if the stock price goes up, so to speak, at Apple or Tesla et cetera, What really matters is that those massive payouts, those massive bonuses go directly to the founder, go directly to the Ceo. And so there's no reason that if you're making say 150 k. That you couldn't create a milestone plan that has you make 500 K. Assuming you're driving certain milestones and obviously driving the revenue that would pay for that. There's no reason not to have that conversation.

Wil Schroter: And it's amazing how rarely that conversation takes place. I was thinking about a specific story in and again, I think that there there is a bit of a flaw in the founder's mentality around what they can ask for and what they can do. Do you remember a good friend of yours that reached out to you that had like five million in cash sitting in his bank because they've done so well And do you remember what your feedback was to him at that point? Take

Ryan Rutan: it right, it's your money but take it.

Wil Schroter: But I think he said something to the effect of, can I do that?

Ryan Rutan: Yeah. Well actually he's not the only one I've had this happen over and over and over where you know, a company makes money, you know, makes a few million dollars more money than it kind of needs for its stage, let's say because it's profitable. Like you know, the cash reserves aren't quite the same issue, they're not looking at Bern. And you get into this weird spot where you're like, huh? You know, investors own maybe not that big of a percentage of the company, but isn't this all investor money? It's kind of not my money, right? And you forget that, that's not the way they look at it. They don't look at it like it's, it's your money or you know, their money in years. They're saying, hey, I expect exactly my Perretta out of this. You know, whatever the caches and you should be expecting yours. It's tricky as hell. There's a million bylaws in between. But I think from a founder standpoint, it makes sense at some point to just rethink how you get paid.

Wil Schroter: I think that the common thread continues to be, founders don't necessarily need to be greedy. I mean to an extent, but you've got to take care of yourself and you and you've got to feel good about asking those questions. It's funny anytime our company grows inevitably because it's, it's usually pretty loud and proud. We will. This is so true. We'll have people come to us and I get it and they'll say, okay, you know, we just went, you know, I saw that we, we just launched this product and it's kicking ask, I want to talk about a raise, right, right. A founder would never ever think about that to say, okay, we're doing much better. I want to talk to the investors and maybe change my complaint a little bit. It's diluted.

Ryan Rutan: Yeah. And initially the idea is that you're a huge swath of equity back when you had one was your complaint and you know, you increase the value of equity, you increase your comp. But what nobody tells you about what's kind of not in the manual is that at some point when you shift from idea to full fledged company and again, it sometimes depends on what the trajectory in economics of the business are. At some point, you actually have to step back, hit the reset button and say, okay, I had just equity and maybe a crappy salary for a very long time when we thought it was going to be all upside. But now this story is played out a little bit now. I kind of know how big or not big this thing is going to be and it's time for me to reset what my expectations are because here's the funny thing, Everyone else already has. The employees have, the investors have, everyone else has figured out how much investment they're going to make in this thing except for the founder. The founder is still stuck in their previous era where it was going to be a billion dollars or bust. It's sometimes, I think you, you nailed this. It's sometimes an emotional, maybe embarrassing moment where you feel like if I admit that the company isn't what I thought it was going to be, that I've failed in some way, But that's also tantamount to saying, I was 100% sure I could predict the future, which would be amazing, you know what I

Wil Schroter: Mean? Right. And the irony is, it can be a company doing $7 million dollars a year. That's relatively healthy. That might not have as an expansive as of a tam as they bet on. Right, Right. So, solid company numbers are pretty good. Their equity is almost nil. I'll say this, if you're a founder, put yourself in a position where you want to keep working there.

Ryan Rutan: That's a great way to put it. Also put yourself in a position where It can be lucrative for you. So in other words, let's say you're at that $7 million dollar run rate and which is a good place to be. You have to kind of recalibrate and say, look, working for all equity made sense when I thought this was going to be 100 million or a billion dollar company, but it's not, it's seven million this year, might be eight million next year, etcetera. I've got to look at this and say if this isn't going to pay out big inequity, which it may or may not, what are my cash options. Now, to be fair, maybe there are none. Maybe the company doesn't make enough money that you can make a, you know, have any cash options, But why not at least set some milestones to say, look, if I'm going to put it another 5-7 years, whatever it takes to be here, what do I need to do in order to hit some milestones in order to kind of level up a bit and maybe the answer is nothing in which case you should be able to look at the opportunity at that point and say I'm either all in or I'm not.

Wil Schroter: 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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