One of the many talents that successful entrepreneurs possess is the ability to use what they have to get what they need to start and sustain their businesses. Since early-phase entrepreneurs often lack cash, some variation of the question \u201ccan I pay for this with equity?\u201d often surfaces.<\/p>\n
Unfortunately, there is no one \u2018right\u2019 answer to this question. Here are a few of the challenges and issues to consider:<\/p>\n
The value of your equity is unknown. Common wisdom is that 90% of startups never become sustainable businesses, so the equity results in nothing. On the other hand, maybe you are hatching the next unicorn<\/a>. In which case, equity is a very expensive way to pay for services.<\/p>\n The total amount of equity is 100%. I\u2019m frequently surprised by the number of people who are ready to offer 10, 15, as much as 20% in equity for everything from accounting services to a \u2018full-stack\u2019 programmer. In the same breath these entrepreneurs declare \u201cI will never<\/strong> own less than 51% of my company\u201d.<\/p>\n The difficulty with these positions is a matter of simple math.<\/p>\n Just because you receive 20% in equity doesn\u2019t mean you will have 20% of the company when the equity can be converted to cash. Since total equity can only be 100% \u2014 though early equity deals can sometimes feel more like a remake of The Producers<\/a> <\/em>than a business transaction \u2014 bringing on new investors means dilution<\/a> for current equity holders.<\/p>\n The challenge here is at least twofold:<\/p>\n The volatility and risk of early-stage equity makes for ample opportunity for misunderstanding and disappointment. This can lead to hurt feelings, damaged reputations, withheld services, and fails deals.<\/p>\n Having equity is no guarantee that you will ever<\/em> be paid.<\/p>\n You can\u2019t pay your rent, buy a car, or get groceries with equity. Equity only becomes valuable when some kind of conversion event occurs. But what will trigger that conversion?<\/p>\n Generally, equity converts on the influx of some cash. But there are a few challenges: If you are an investor, do you want to see your investment go to building new capabilities or paying off old debt?<\/p>\n About 80% of the companies on the INC 5000 are completely self-funded (no external investment). When and how will there equity value be calculated? convertible?<\/p>\n Working with limited funds is always a challenge \u2013 doubly so in early startup phase. Handing out equity can lead to a confusing and unattractive (to future investors) cap table<\/a>. At best this can lead to contention over dilution<\/a> rates among current equity holders. At worst it can completely scuttle a deal.<\/p>\n Convertible notes<\/a> have long been a staple of the startup world, but they can make the balance sheet unattractive to investors.<\/p>\n The folks at Y Combinator have developed the safe note<\/a> as a means of overcoming many of these difficulties.<\/p>\n In the end, funding startups is difficult \u2013 and one size never fits all. The point is, it\u2019s probably best to avoid a \u2018knee-jerk\u2019 \u201cwill you do this for equity\u201d and consider all of the options \u2013 then make sure you have adequate input from financial and legal professionals.<\/p>\nYou can\u2019t make more equity<\/h2>\n
Equity Dilutes<\/h2>\n
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Equity is not debt<\/h2>\n
Equity is Worthless<\/h2>\n
There may be better options<\/h2>\n