The Liquidity Option for Equity Based Plans

“Winner must be present to win.” – common note on many raffle tickets

How many times have you participated in a raffle and noticed this “condition” boldly printed on your ticket?  I have been at more rubber chicken events than I care to acknowledge and I always cringe when I notice this warning.  My immediate reaction is always the same – is this event so bad that they have to bribe me to stay until the end?  We all know the winner is never announced before the very end of the evening – and once that lucky person stands up, we all head for the exits.

I think the parallel in business is ownership liquidity and in particular, the quandary many owners face to provide some cash to minority shareholders as they exit the business.  I have advised many long established enterprises and it does not matter what life cycle stage they are in, there is always this “Sword of Damocles” hanging over their head.  What happens if one of the owners leaves or passes on?  The remaining shareholders feel burdened by the commitment to buy out the departing party and it is this very concern that causes many shareholders to be silent about liquidity in their buy/sell agreements or not establish an equity sharing plan in the first place.  Perhaps the uncertainty as to growth and/or success also plays a role here.

Up until a few years ago, I had only seen this issue and mindset at more established businesses; usually in legacy type industries. Enter the current tech early stage growth phase (one of a few in my lifetime) and equity sharing is back with a vengeance.  However, this round, I have seen a different mindset sprinkled in with the plethora of discussions on stock options, restricted stock, etc.  There have been a good number of equity based schemes that really only have value upon a defined liquidity event.  No vesting or granting of ownership – simply stated – the holder of the ownership instrument must be present at the time of the liquidity event to benefit.  In essence the “winner must be present to win.”

Now, I do not mean to imply that equity in an early stage growth company is like a raffle ticket (actually, I think the raffle odds may be better) or that such an instrument should be seen as a bribe to keep you someplace that you do not want to be.  But, many would espouse that it is the team that creates the true value and unless the team stays until the end (liquidity) there may be no value.

So, if you are a young entrepreneur, you may want to think about this approach as one of the alternatives you consider.  As usual, please consult your professional advisor before reaching a conclusion.  While there might be some tax cost involved, think about the time, effort and expense you may have to endure to address that equity owner who has vested and now wants to leave and get fair value for what they feel they contributed.


There Are No Dumb Questions

Harry Dunne: Just when I thought you couldn’t possibly be any dumber, you go and do something like this… and totally redeem yourself!  –  From the movie Dumb & DumberDumb-Dumber-s-Harry-Lloyd-Laughing-At-A-Burger-Joint

I think of this scene when I am in a meeting and a client or prospect raises a question and prefaces it by saying  “this might seem like a dumb question, but . . .”  So, let me be clear; as an owner  you have the right – I might even say the obligation – to ask whatever questions are on your mind about any issue being discussed.  This is particularly true when you are dealing  with any of your professional advisors.  You should feel very comfortable being open and honest about any doubts you have and if you are not, find a new advisor.  The response to that simple question may prove to be the most important point of the discussion.  Let me give you a few examples to get you more comfortable with the idea.

We work with many of the companies at ERA in New York and TechLaunch in New Jersey.  They feel free to ask us all types of questions.  They have ranged from, “Is the investment ERA or TechLaunch makes in us taxable income?” to “Is my product taxable?”  Some are pure business basics (should my people be employees or independent contractors) and some are just nagging concerns (I promised my people some ownership, but, I am not sure how or when to give it.)  Trust me, there is no professional worth their salt that does not live to answer questions their clients may have… so, please take advantage of this relationship.

I can think of loads of situations over the years where audit staff thought something did not make sense and they asked a question that they thought reflected poorly on them since they thought it indicated a lack of knowledge, only to find their observation uncovered a significant problem.  I was consulting on an IPO and the CEO, who had his doctorate in engineering plotted certain items on the P & L only to find the graph of one of the amounts did not make sense.  The result was “counter intuitive” in his words.  Well, guess what – in the last draft, someone had dropped the brackets around a rather large expense and proofreaders had failed to pick up the error.

But, what prompts raising this subject now?  Well, I recently had a meeting with a new client who had a term sheet they were considering signing.  I asked a few basic questions and then the obvious one – did they know the terms of the deal?  The two owners looked at me in a sheepish way and admitted they relied heavily on their attorney.  The deal had a participating preferred and also indicated it would contain “standard” antidilution provisions.  While not always bad, these are red flags to professional advisors.  We decided to call the attorney for clarification and while one provision was fine, the other was definitely not what they thought.  We managed to get it changed and the deal went on.  The entrepreneurs conceded they had talked to some fellow owners who admitted they, too, had relied on legal advice for deal terms.  I had heard of this before, but this was my first live encounter.

So, please keep in mind that if something does not seem right, ask to get clarification.  I cringe when I think of the trouble entrepreneurs have gotten into by abandoning this basic instinct.  A clarification trumps a giant “oops” every time.  Good luck.

Top 10 Reasons Why Startups and Early Stage Ventures Fail

Quote: “Houston, we have a problem.”  From the movie, Apollo 13


At the risk of sounding like a David Letterman skit, I would like to present my Top 10 List for this category.  By the way, apollo13-box-art-front_GGIDu_28802there is no scientific research to support this and I realize many others have published similar lists.  I just reflected on my 35+ years of experience with startup/early stage entrepreneurs and where I have spent the most time working with them to rectify some significant shortcomings.  So, you might say this is my “if I only knew then what I know now” list.  I hope there is a nugget or two for you to use… so, let’s see what the list brings:

10. Loving the product/service more than the customers.  This is the infamous “build it and they will come” syndrome. These ventures are usually DOA – it’s just that the entrepreneurs do not know it.

9. Unaddressed bad equity splits.  Cutting up the pie is tough enough – giving it to the wrong people for the wrong reasons is often fatal.  It is tough to move forward when you are focused on significant internal matters like equity distributions.

8. Going it alone.  This is the equally infamous “no man is an island” syndrome.

7. Talking more and listening less – to customers, potential financing sources and advisors.  God gave us two ears and one mouth…

6. Ignoring warning signs – there is a reason your body feels pain – it tells you something is wrong.  Problem signs in a business are the same and at times we react the same way we do to that pain in our body – ignore it and it will go away.

5. Bad acquisitions (usually the first one) – either deals for the wrong reasons or good deals with poor execution.

4. Growing too fast – probably saw more ventures go down because of this than those that had a fall off in business. Growth makes you feel good and can hide strains on your venture like not enough people or funds.

3. Not knowing when to get out – never get in without an exit plan

2. Inadequate financing – what was the last thing you did personally or in a business that came in on or under budget?

And the number one reason why startups and early stage ventures fail? – PEOPLE – usually the wrong ones in the wrong roles preventing execution of the vision.  Every financing source I have ever spoken to looks at management over product. When picking your team avoid the “yes man” syndrome.  I had a client who was a real control freak and his favorite saying was “I always admired a subordinate who could stand up and say – you said it chief.”  His venture hit the dirt nap trail pretty quickly.  So, spend sufficient time developing the best team possible.

So there you have it. Good luck and keep on innovating.


Money, Money, Money, Money – Money or Business Pitch Fatal Flaws

Quote: “It’s just business; nothing personal” – Mario Puzo from The Godfather


iStock_000016249315XSmall-425x272I had the chance to review five pitch decks this week (a bit slow; it is the summer) from startups looking for funding.  Now, if you are assembling a “pitch,” there is an abundance of guidance available about basic contents.  Many financial sponsors and angel investors have them on their websites and if that fails, you can use our “Perfect Pitch.”  You can find this by clicking through the Entrepreneur Power Play Book tab on this blog (just follow the “Rookies” string.)  Many startups ask us to critique their “deck” and offer our comments and observations.  We are always glad to do so (gratis) – our standard caveat is like the quote from The Godfather – the comments are just business – nothing personal.  Almost all are taken in the spirit in which they are offered.

I must admit, I am usually impressed by the passion and creativeness of theses presentations, but I also focus on their principal purpose which is to raise money.  So, what surprises me the most?

Very often, it is the lack of two elements which I think are fatal flaws – and both revolve around what the O’jays proclaimed – money, money, money, money.  First, “how much do you need?” and second, “how are you going to make it?”  Why a startup thinks any investor, at any level, has no interest in these two points remains a bit of a mystery to me.  Now, I know what you are thinking… he is a CPA and, of course, he wants to see detailed financial projections.  Not so fast, grasshopper, what about even a half-baked conceptual discussion?

If you are asking for money, why not make three simple basic points – how much you need, how you are going to use it and how it will help get you to the next level.  By the way, the odds of all of this working out as you planned are slim to none, however, investors want to know that you thought about it and have some fiscal discipline to, at least, venture how you will manage these precious resources.

The old “if you build it, they will come” theory of a business model is also DOA in the eyes of an investor.  Let them know your estimates of market size, unit sales and revenue per unit.  If you are providing a transaction based service and think you can get $5 as your “take” on each deal, let an investor know what you are thinking and why.  Some undeveloped thoughts alluding to how this may one day become a revenue stream are not going to help your cause.

So, keep those creative juices flowing and please continue to dream and innovate.  Just remember that while it is great to fly at 30,000 feet – keep in mind you do have to land the plane every once in a while.


Don’t Suffer from Premature Equity Distributions

Quote:  “He chose poorly” – Knight guarding Holy Grail in Indiana Jones & The Last Crusade


The title got you, didn’t it?  There is nothing more frustrating for an advisor than to be faced with an entrepreneur (young or mature) who is challenged by having distributed ownership to the wrong people early on.  The quote above is the first thing that comes to mind.  But, if you face this issue, you are not alone and I can tell you the issue is decades old.  A quick story…


I was actively involved in a leveraged buyout in the early 80’s (yes, they did exist back then as did leveraged recaps).  The CEO founder (an experienced executive) recieved 51%, the financing source 30% and 4 key executives split the rest. Everything was fine, except all the financing source did was ask the CPA (who shall remain nameless) for a banking contact.  That contact ended up financing the entire deal (with no equity at all.)  Receiving 30% never sat right with the rest of the team, and when some equity was needed for expansion, the 30% financing source did not participate or help in any way… resulting in lawsuits and failure.


So, what are the two big mistakes that entrepreneurs make?


The first is what I call, “let’s give everybody a piece of the pie.”  Now, trust me, I am a big fan of sharing equity, but when owners start a company, they seldom see the growth and changes to come.  They reward everyone who starts with them, creating an “all for one” culture, only to find certain people are not up to the task and often other resources need to be added with little or no equity left to share.  We see this in more than half the startups we counsel, regardless of the experience of the entrepreneur.


The second is the “we know who the owners are” issue.  In this scenario, equity is granted to the three or four key “founders” without vesting.  Then, lo and behold, things do not work out (like the story above or the tech guy that can’t get the website or product to work) and wasted effort is spent negotiating out the party who has not performed to make way for the resource that can.  A major time and cost distraction, usually with a major emotional toll as well.


So a few helpful hints:

  1. Everyone vests.  If a problem does arise, it is better to address it when someone only owns part of their piece of the pie instead of all of it.
  2. A shareholder agreement is your friend.  It is best to determine what happens if things go awry at the beginning, when all are on the same page vs. trying to solve it when tensions and emotions are at record highs.
  3. Consult advisors first.  They have experience with who should get equity, ideas on %, etc.  Once you give equity, unless you build it into the deal, it may not be easy to get back.
  4.  Ownership is a state of mind.  It has to be a two-way street and someone getting equity has to embrace ownership, not just economic rewards.  Use your “gut” as to core values here.
  5. Avoid using your stock book as a checkbook.  If you believe in your business, protect your most valuable asset; your equity.


Premature is rarely used in a favorable context, don’t make it define your equity strategy.


Ownership Writes – The Purpose

“I am thankful for all of those who said NO to me. It is because of them I’m doing it myself.” – Albert Einstein

I have had a passion for entrepreneurs since I was young.  My first exposure to entrepreneurship was as a teenager working for a neighbor (Teddy) who, believe it or not, actually recycled cardboard in the 1960s.  The concept was simple.  Large stores and factories had to pay to have garbage removed including cardboard packaging.  Teddy took away the cardboard for a cost below what the garbage haulers were charging and took it to certain paper mills.  Virgin paperboard was at a premium so certain mills took used cardboard and used it to make non virgin paperboard.  Teddy also got paid for the cardboard he collected.  Ingenious and, trust me, Teddy was not attending MENSA meetings.  Everybody else I knew in the neighborhood had a job; Teddy had a business and that is where it started.

As time went on, I got to know more business owners.  I worked in delicatessens, as a painter, in factories and on Wall Street and always enjoyed understanding how businesses started and how owners were handling the issues they faced.  I remember talking to Teddy as we drove from stop to stop and finding out about all the things that were on his mind – – including asking me to talk to his son about joining the business.  (I think that was my first succession planning assignment – and it was a success).


So, for 35+ years, I have been consulting with owners of companies at every stage of growth – – from startup to high growth to mature.  I realized early on at times owners just needed someone to talk to about what was on their minds.  (I will cover overcoming the loneliness of an entrepreneur in the future.)  I learned something from every one of them and started to organize my observations and use them in my practice while maintaining confidentiality.  People techniques, funding advice and most important of all, studying how owners dealt with their own unique world.  Very often isolated and misunderstood, I had the privilege of consulting, comforting and guiding them throughout my career.  It allowed me to develop tools, processes, tidbits, etc. to help them along the journey. There were a lot of successes and some failures; more than a few life lessons and some “Dutch uncle” advice but my goal was always the same; to help the entrepreneur to succeed.

My instinct was to collaborate with others to convey some of what I had learned, but I could not seem to get any takers.  So, true to Mr. Einstein, I decided to strike out on my own to share my thoughts; thus the idea of this blog was born.  I call it “Ownership Writes” – a name developed by my sister who is the pun master extraordinaire.  The name uniquely captures the purpose of this blog as only she could do.

I hope that over time I will be able to share some ideas, stories, lists or other insights that might help just one entrepreneur to move forward in some way.  As the Chinese proverb goes, “A journey of a thousand miles begins with one small step.”  My hope is for many successful journeys.