Archive for September, 2014

Dead Equity is a Killer, Really

Ever heard of “dead equity”? That’s the equity that is held by founders or others who are no longer participating in the business on a daily basis. This doesn’t really matter so much until you try to get outside investors interested in putting money into the company. Then it moves from “non-issue” to serious impediment to progress.

If you are considering investment, an event that puts a value on the company either has occurred or is about to occur. This changes the psychology of the non-participating shareholders. What was once a shareholding with an indeterminate or seemingly negligible value now has a numerical value attached to the shares that a non-participating founders own.

I can understand the position of the founders who aren’t in the business anymore:

“I was there when the idea was created”.

“I put a lot of hard work into the company”.

“It wouldn’t have gotten off the ground without me”.

There’s of truth in all of those. That doesn’t mean that these arguments will carry the day.

• The average successful company takes a long time to reach its goals. It usually has to raise money several times in the process. Getting your first investment with material amounts of equity in the hands of non-participating founders increases the probability that the remaining founders will be diluted down to levels that don’t provide enough incentive for them to remain committed to the start-up.
• The original founding group, those that departed and those that have remained, have their original equity stakes. Those that have departed the business will not be there to do the bulk of the hard work necessary to create a successful company. This creates incentive distortions that are a concern for anyone thinking of investing. Why should those who are no longer there have the same holdings as those who have moved on to other endeavors?
• Most importantly, investors will seldom invest if a material amount of shares are in the hands of people who are not participating in the business on a daily basis. They want the rewards to be distributed to those who “make it happen”.

Given the length of the journey to success, the typical company has moved a few percent toward their success goals when investment becomes a possibility. In my experience, this is where the non-participating founders overestimate their contribution to the enterprise. It’s easy to understand the psychology of this; no one wants to part with something that has just become more valuable in their eyes. But this can be an absolute bar to investment in the company.

Most investors are willing for the non-participating founders to have some stake in the company as it goes forward. This stake needs to be in the single digit range in the aggregate. This leaves the departed founders with something to recognize their contribution and leaves the company with sufficient equity to compensate its current and future employees.

The issue can easily be dealt with in advance, when the company is formed. All founders can “re-vest” their shares so that if they leave they may vest a portion of their shares but return a portion to the company so that enough equity remains available for the team members who are continuing with the company. This way, the founders are all protected against unforeseen circumstances affecting their co-founders and there’s no difficult problem that has to be resolved before a financing can occur.

My Evening With Robin Williams

The recent passing of comedian turned actor Robin Williams reminded me of one of the most interesting  nights of my life. It was September of 1987 and I was living in San Francisco. My girlfriend and I decided to see some comedy that night. We looked through the Bay Guardian and found a show called “Three Guys from New York” at the Holy City Zoo on Clement Street.  That sounded like the ticket.

We went out to dinner at a Vietnamese place in San Francisco’s Richmond District, not far from the comedy club.  We met up with one of my business school classmates after dinner and walked over to the Holy City Zoo. We got there early, bought our tickets and sat down on the row that literally touched the stage.

Now, the Holy City Zoo (which is gone now) was not a big place. It seated 60-70 people in total and had a small stage in the back left of the establishment.  I believe it was an off the beaten track folk music club in a prior existence, so the setting was truly intimate. There were no more than 10-12 seats on the front row and I was right in the center!

Eventually, the Three Guys from New York show got underway and they were pretty funny. Obscene, in your face and loud.  But, pretty funny.  All during the evening, the proprietor kept telling us not to bolt early because they “might” have a surprise for us after the New York guys. During the third guy’s routine, my friend pointed back at the bar and said “who does that look like to you?” “That’s Robin Williams” I said.

Williams was standing at the bar with a drink and seemingly analyzing every line the third guy from New York laid on us. He seemed to be critiquing them as he watched and offering encouragement at the same time. When the New York guy ended his routine the proprietor bounded up on stage and said – “Now welcome Robin Williams!” The place went nuts!

The mike stand was close enough for me to reach out and grab it and there was Robin Williams right behind that mike.  Williams proceeded to tell us that Holy City Zoo was his proving ground, the place where he tried out new stuff and assessed whether it was funny enough to become part of his routine. Tonight he said that the audience would be part of the test.

“I’m going to show you guys how good I am”! Shout out a topic, any topic. And then it started…….

First, someone yelled out “Jim and Tammy Bakker”. Williams spent about 10 minutes skewering the fallen televangelist and his then wife. He was an unbelievable mimic; he walked, talked and acted just like the Bakkers. He was especially hilarious with his rendition of Tammy Bakker’s huge eyelashes.

Next, he looked at my business school buddy and his date.  He asked about their relationship.  Joe made the mistake of admitting that it was their first date.  Another five minutes was spent on an incredible tale of how the night would end for them and the probability of them being on speaking terms by Monday morning.

The next topic was “The Harmonic Convergence”. This was a big deal in California in 1987. The Harmonic Convergence was a globally synchronized meditation event which also coincided with a rare alignment of the planets.  It was associated with “all things Californian and new age”. Williams pranced around the small stage expounding on crystals, the messages he was getting from the universe and what those messages were telling him about the people in the audience.

The final topic I remember that was  shouted from the audience was Phil Donahue, that era’s reigning king of daytime talk shows.   At front row center, I was right in Robin’s sights. He looked right at me and said – “you look like Phil Donahue, give me your glasses”.  I didn’t look like Phil but I loaned him my glasses nonetheless.

Now Phil was a prideful and preening kind of guy. This offered rich opportunities for Williams. He replicated Phil’s on stage walk and mannerisms perfectly. At the end of his impromptu routine, he returned my glasses and asked the crowd: “What do you think”? The crowd was ecstatic.

It was beyond funny! I actually injured myself laughing; I woke up the next day with a pulled muscle in my abdomen.  I’ll never forget that 45 minutes!