“Sweat equity is the most valuable equity there is. Know your business and industry better than anyone else in the world. Love what you do or don’t do it.”
When we first started operations in the last company I founded, my job was to go find people to hire us. I couldn’t sling code like my co-founders could, and, ostensibly, the reason that we banded together was that I was supposed to be able to find bigger projects so that we could bring on more people and, with a little magic dust, grow to the size of IBM.
There was no magic dust, in case you were wondering.
We were in Charlottesville, Virginia, which isn’t a very large place. The city and surrounding areas have about 90,000 people in total. There aren’t many large employers or businesses there.
Because of its proximity to the University of Virginia and because of a failed dotcom called Value America, there were, though, a lot of startups.
Over time, I got to know a lot of these startup founders. Several of them were people like me – non-technical founders with technical ideas. Those founders didn’t have the one thing that I had going for me: geeks.
Most of my conversations went like this:
Them: “Our company is based on [FILL IN THE BLANK WITH GREAT IDEA].”
Me: “Cool. How much traction do you have?”
Them: “Well, you see here, we haven’t actually developed the website/software/widget/whatever yet. We’re still in the ideation phase. That’s why we’re talking to you.”
Me: “Great! We can help you get there.”
Them: “We also haven’t raised any money yet, so we were hoping you’d be willing to work for equity.”
It would also usually include “…and I want you to sign this NDA,” which I refused to do.
So, let’s stop the conversation there. I was a startup owner trying to get revenue for my company talking to startup owners who were trying to hustle me to get free work from us to see if their idea would fly.
I don’t blame them for trying.
What do you do when someone asks you to work for equity?
How you answer that question really comes down to two questions that you have to answer for yourself first.
Question 1: Can I afford to do the work and get zero return?
Let’s face it, the most common return on an equity deal is going to be -100%. You’re going to get $0 for whatever work it is that you put into the project. Your return won’t be -100% every single time, but let’s assume that there’s a 90% chance that you’ll see zilch out of your time investment.
If you have the cashflow to take those shots, then perhaps it’s worth investigating more deeply.
However, the temptation really occurs when the opposite is true.
When you have no cash coming in, then it’s tempting to think “well, this is something, and there’s a chance that it could lead to actual paying work.”
That was the line that all of these entrepreneurs would throw at me.
If you do a good job, then it will lead to more and we’ll tell everyone about you and when we get funding, we can pay you.
The part about it leading to more was true. It would lead to more free work.
The problem with doing free work is that it creates two anchors in the customer’s mind.
The first anchor is $0. That’s what they paid for you, and that’s what they’re going to continue to want to pay you. I’ve never seen a customer volunteer to raise the pay rates for ongoing work.
The second anchor is on the value of the work that you’re providing. If you don’t value your work enough to charge for it, then why should the person for whom you’re doing the work?
Remember, when Monkey Brain has to pay for something, it causes pain. There’s a lot more pain when it’s cash or a check, but even when you pay with a credit card, he feels pain. Equity has no such pain associated with it for a startup. You can’t trade in equity for a hamburger. It’s amorphous, nebulous, and has no value. Startup founders can give away equity all day long without that sense of parting.
But, it can still be tempting to take the job, because it might be worth something some day, and it’s better than doing no work, right?
You could pass on the opportunity and continue to look for paying work. Eventually, your work there will lead to fruition or you’ll not succeed and have to close up shop. In either case, you’re going to take a step down the terminal path. If you work for equity and then have to close up shop, you’ll be left wondering what might have been had you spent the time continuing to chase after clients who could potentially pay you.
As a startup owner, time is precious. You only have so long to prove out whether or not you can be profitable before you run out of runway and have to go back to get a job.
So, assuming that you can get through the first question, you must then ask yourself the second question:
Will this equity ever be worth something some day?
I have a MBA. From a top 10 school, even. And I had no idea how to value the plethora of ideas that were thrown out at me. Almost all sounded Good. With a capital G. Mostly, it was because they were in industry where I hadn’t a freakin’ clue what was good and what wasn’t, so if there was spin, it sounded Good.
Therefore, I was not an impartial evaluator of the potential of ideas. I was easily swayed, and I knew it.
Additionally, doing a proper market analysis of an idea is time-consuming. You have to research the market, the competitors, the financials, the cost of goods, comparative overheads, multiples, and a lot more before you can come up with a reasonable valuation for a company that is in its infancy. After that, you have to discount your number heavily because of the other variables that come into play – luck, competency of the team, economic conditions, and potential competitors that aren’t yet even on the horizon. The best ideas in the world probably never got off of the ground because of a confluence of all of the other factors conspiring to cause failure.
As an entrepreneur, is that the best use of your time?
Or, would you rather be finding clients and customers who can pay you cold, hard cash right now for work that you can do or products that you can deliver?
Additionally, even if that equity is going to potentially be worth something someday, is it enough to be a game changer, not just for you, but also for your partners and your employees, who should, by rights, have a claim to some piece of the profits? If the answer, based on the equity stake that you’d receive and the value that it would someday attain, is no, then it’s not worth pursuing. Why build up someone else’s company and their equity value when you could spend that time on your own?
As a result, we finally came up with a stock answer to the question:
We’re willing to work for payment of our costs and equity if you have raised beyond a seed stage in venture capital or private equity funding. Otherwise, while we appreciate the opportunity, we’ll take payments in cash.
Venture capitalists and private equity investors were in a much better position to evaluate the long-term potential of a startup than we were, so why not let them do their jobs? If they deemed a company worth investing in, then we’d consider it too.
By then, we had sufficient revenues and profits that we could occasionally take a swing, although we only wound up entering into such an agreement once.