We’ve all seen the stats around women and equity. Despite generating 63% more value and twice as much per dollar invested, female founders are giving up at least 20% more equity than male founders. What does that mean? Even for the 2% of venture dollars that go to female-founded businesses, the founders are still exiting with significantly less cash. There is not one easy fix here, but there are ways we can all do better. These are the most common equity-sucking mistakes we see.
One caveat: we say all of this without judgment. Being a founder is hard. You can’t do everything. You will mess things up. You will regularly make minor and major mistakes. You will miss things. What we’re trying to do here is flag a few key areas for you in the hopes that, when these situations arise, a lightbulb goes off and you’ll give it just a little extra thought. We’re all in glass houses here.
Not reading your documents. We know legal documents can be long and dense and boring and tedious. They practically beg you not to read them. But no matter how dull they seem, they are legally binding on you. While it’s true that not all businesses can afford an attorney to walk them through all the terms, all businesses can afford to read their documents themselves. You may not understand every piece of it, but you’ll understand more than you would have if you hadn’t read it at all. What we’re trying to avoid here is a situation where that document gets enforced and you are surprised by what’s in there. Raise your hand if this has happened to you or someone you love. It’s so common and so lousy. Read your docs.
How do SAFEs and convertible notes work, anyway? Another thing we often see are founders who are surprised by how little of their company they own after their SAFEs and notes convert. This makes sense. (See note above). Those documents are difficult to understand. Plus, you can't know in advance exactly how they will convert. This is because the conversion depends on future variables: what happens during your priced round. So what is the fix here? Whenever we work with a founder that is raising a SAFE or convertible note round, we put a model together that demonstrates how the notes will convert under different priced round scenarios. That’s when you see how terms like valuation cap, discount rate, and pre- or post-money really work. These numbers that are often selected at random can dramatically impact your ownership. Best thing to do is be really educated on the implications of those decisions.
I don’t need an employment agreement. I’m a founder, why do I need an employment agreement? Isn’t that just more unnecessary paperwork? Plus, I’m a founder, not a mere employee. Don’t belittle me like that. . . . Okay, we hear you. But let me tell you why this matters. If you are a corporation, you have a Board. That Board has the power to fire you. Yes, again, how could anyone fire me from a business that I founded? They can. The purpose of an employment agreement in this situation is to make sure you are crystal clear on what happens if you are terminated. Do you get severance? What if you are fired for no good reason? And, most importantly, what happens to your equity? Did you know that plenty of restricted stock agreements give the company the option to buy your shares back at par value (read: $0) if you leave the company for any reason? If you have a Board that can fire you, think about an employment agreement.
Whose Board is this anyway? As noted above, the Board of Directors can fire you. They can remove you from the company you founded. They also approve (or not) all major corporate decisions, including things like raising more money, hiring other executives, compensation, etc. All those things that directly impact your equity in the company. The Board is a very real, very big authority. To clarify, we’re talking here about the Board of Directors, not a Board of Advisors. Advisors don’t have any power—they are just there to help you. With this in mind, you want to be really thoughtful about who has the power to select Board members and how Board members (including you, the founder!) can be removed.
Sometimes, it just can’t be helped. The things I’ve talked about already are things you can control. But we all know that we don’t control everything. Sometimes we find ourselves in really tough financial positions and we have to take a deal we wish we didn’t. It happens. When it happens, try to protect yourself as best you can. Even if someone is requiring a big chunk of equity, you can still negotiate on things like: your compensation, additional equity awards, how the Board is voted in and voted out, etc. Even if you’ve taken on a rough deal, the better the company does, the more leverage you’ll have. Most investors understand that founders are usually key to a company’s success, and they want those founders incentivized. So take the deal, don’t beat yourself up about it, go out and kill it, and get more shares.
-- Jessie Gabriel