Most people have no idea what it takes to own a piece of a startup. They think that simply showing up for work entitles them to an ownership stake in the business, just because it’s a startup company. Others vastly undervalue stock options because they appear to be abundantly available.
This cannot go on. In any typical startup, the only way to earn a piece of the company is to write a check or give up a chunk or yours! The only other way anyone should be able to get a piece of a company for nothing involves dirty pictures and blackmail – and here’s why:
There’s no such thing as a free lunch
The first step to understanding why writing a check is necessary to own part of a business is to understand that it takes capital to create value for the company’s stock. That can be tough to grasp in the formative years of a business because it’s either not making any money or there’s no secondary market in which to sell your stock.
While the stock may not have a liquid value today, the whole point of starting this crazy company is so that it will have value. For this very reason, owning a piece of that stock has real potential value that needs to be appreciated.
As an employer, if you don’t think your options have value, you’re essentially betting against yourself and should not give options out at all. If you’re an employee and don’t believe that options have value, you shouldn’t ask for them nor should you work for a team you don’t believe in. Until everyone understands and agrees that the company’s stock has value, you can’t divvy it up.
Value earns value
Stock options and equity shouldn’t be treated like a trick-or-treat offering handed out to anyone that shows up at your doorstep. The amount of stock given should match the value of the work performed. For instance, you wouldn’t give someone with a market value of $50,000 a $400,000 stock offering – that doesn’t make any sense.
If someone is paid $50,000 in cash (and that’s their market value), there’s no reason they should get any additional compensation in stock.
Try showing up at Apple and telling the CEO that you want a big stock grant in addition to your market wages. Explain how you think stock is just an intangible asset that he should start handing out freely. I would bet by the time you finish your first sentence he’ll be calling for security to have you forcibly removed from the building!
In order to make a fair assessment of what someone earns versus what the company is worth, you need to settle on a valuation of the company as early as possible. If you set a valuation of $2 million, then someone doing $50,000 worth of work could earn 2.5% of the company, not 50%.
Just showing up =/= stock options
For those of you that plan on getting into a new business as a partner, you had better show up with a check in hand. Partners don’t get stock for agreeing to be a partner, they get stock for agreeing to share in the financial liabilities of the business.
Anyone would agree to taking on 50% of the business when it comes time to split the profits. However, startups are rarely splitting the profits – the more likely case is that they will be splitting the costs (at least for a while).
When you miss payroll for the first time and you need to come up with half of the liability, are you still excited about being a partner? How about when the business runs out of money and you have to mortgage your house and drain your savings to keep it alive? That’s the true definition of being a partner.
And that’s exactly what business ownership is – sharing the liabilities as well as the successes. If you plan on becoming a partner in a business, you need to be able to share all sides of the business, not just the upside.
The saga continues
Getting two parties to agree on the value of someone’s time and efforts as it applies to stock options is never an easy proposition. Inevitably, the business owner will always think the stock is worth more, and the partner or employee will always think they should get more of it.
Setting expectations early in the game is the best way to make this discussion easier for everyone. As long as employees and partners don’t expect more than they have earned (and owners don’t expect to get something for nothing) everyone should be on the same page.