Don’t Give Away Equity!

Most employees’ views about equity have been shaped by stories about secretaries at Facebook becoming millionaires or something to that effect. Maybe it’s NVDIA now.

This is Silicon Valley bullshit seeping into the culture again.

If you work for a normal business ask an employee these two questions if they ask for equity:

1. Would you like to take a below market salary to get equity?

2. Are you ok if I run this company for 50 years and never sell?

I’m guessing most will decline the equity offer and take the market wage. I would in their shoes.

One of the big problems with the Silicon Valley way of thinking is that they’ve confused equity with compensation.

Equity is for ownership. Money is for compensation. I sell equity to raise money. I pay money to hire employees.

Silicon Valley perverted this division.

Equity makes sense when you are:

1. Asking people to make a below market wage: I’d just pay market but in a tech start up you are going to 100x or go broke so you are asking an employee to take owner type risk.

2. Focused on an exit in a definite period of time: Even if you can 100x the company, if you don’t liquidate, the employee will never get the value. You see VC backed companies trapped by lackluster IPOs allowing for secondaries to make up for this.

3. In a situation where you either create tons more value or shut up shop: Equity grants also make more sense when there’s enough value being created that everyone will be happy despite giving up some equity in the beginning.

Equity doesn’t make sense in a normal business because:

1. You are most likely a pass through company: VC funded startups don’t do dividends so no one will ever exercise their option grants before sale. A normal small business will distribute profits to owners periodically. Do you want an employee that quit 5 years ago collecting distributions from your company?

2. Legal Stuff: If someone exercises their options and becomes a minority shareholder, you are open to all sorts of legal hassles. You potentially might have to share financial information with them and are subject to minority suppression lawsuits. I don’t think you want people asking why you expensed this or that through the company. Plus if the employee has exercised, any buyer is going to want them signing off on the deal. It might not be absolutely required but it’ll be a hassle.

3. Pressure the Sell: As soon as someone has stock, they are going to start planning for when you are going to sell. As I mentioned above, you see this in Silicon Valley as exit timelines extend given the tech downturn. You might want to sit on the company for decades or even pass it down to a family member. That doesn’t align with an employee’s equity expectations.

Next week I’ll talk about some of the potential substitutes for straight equity.

Remember: money is for compensation, equity is for raising money.

Keep growing.