Sweat equity, the non-monetary contribution that team members make starting a new business, is often presumed but seldom well calculated. Founders with substantial shareholdings need not concern themselves, but other team members would be well served to break out their calculators sooner rather than later. Even in successful companies, working for equity can be a losing proposition.
Consider the hypothetical example of WiqMoCo, a promising new company with a category defining product. WiqMoCo is pitching itself with five year projections showing a $2.5 million EBITDA in Year Five. Considering industry norms (sales multiples; EBITDA multiples), the business might be worth about $20 million half a decade from now. Not bad … if you’ve done the math and negotiated accordingly.
Joe COO did not.
Joe left a promising mid-level executive position at BigCo, where he was earning $150,000 annually, with generous benefits. He’d been working there for nearly ten years and felt that it was “now-or-never” if he was to demonstrate his (presumed) entrepreneurial talents. After learning about WiqMoCo’s technology and meeting its charismatic founder, Joe joined the team; he took a substantial pay cut and left the corporate world behind. Joe became an $80,000 per year startup COO, with 4% of the company, pre-funding. Five years later, with WiqMoCo entertaining an acquisition offer, Joe was now earning $120,000 annually; he appeared to be sitting pretty.
Sitting? Yes. Pretty? No.
I forgot to mention that WiqMoCo raised $1.0 million after Joe arrived, ultimately giving control of the company to new investors. Joe’s 4% stake was now a 2% one. Additional stock option grants never materialized. Equity, after all, is a currency that investors tend to hoard. That hadn’t mattered to Joe. He was sure that WiqMoCo was worth at least $100 million.
WiqMoCo sold for $20 million after all. Joe’s “big payday?” His investment of over $250,000 in lost salary and benefits earned him $380,000 five years later:
|Total Proceeds ($000)||$20,000|
|minus: Initial Investment Return||(1,000)|
I won’t elaborate on the net present value of Joe’s investment. The simple math is bad enough. So bad, in fact, that it may seem hard to believe that anyone would make such a decision. More often than not, they do. Why? Most “Joes” just don’t do the math; others do it, but assume a much more lucrative exit event. Large successful deals tend to loom even larger in the collective unconscious. Too many zeros can throw off the average, Joe. Don’t be that Average Joe.
Peter has spent the past twenty-plus years as an acting/consulting CFO for a number of small businesses in a wide range of industries. Peter’s prior experience is that of a serial entrepreneur, managing various start-up and turnaround projects. He is a co-founder of Keurig.