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Equity Know How for Founders with Jeff Erickson

Zoom recording
1 views|4 months ago
💫 Short Summary

The speaker, a successful entrepreneur and investor, shares insights on equity, ownership, and structuring companies for success. They discuss the differences between common and preferred stock, the importance of aligning incentives, and using stock options to attract talent. The video emphasizes the significance of vesting schedules for founders, employees, and advisors, as well as the role of convertible instruments like safes and convertible notes in fundraising. Understanding valuation caps, 409a valuation, and managing cap tables is crucial for startup success, with tools like Carta recommended for simplifying processes and saving costs.

✨ Highlights
📊 Transcript
Speaker's Background and Experience
The speaker founded a consumer products company and has experience in startups, tech space, and cap table management with Carta.
Transition to Forecaster
The speaker joined Forecaster, a company specializing in financial modeling software for early stage startups.
Angel Investor and Mentor
The speaker is an active angel investor with over 30 investments and enjoys mentoring and advising startups.
Insights on Equity and Ownership in Companies
Owning 51% of a company does not guarantee full decision-making power, especially when bringing in investors with board seats.
Founders need to be aware of implications when giving up control to board members and potential voting rights.
The focus is on economic ownership and the importance of understanding how decisions are made within a company structure.
Lessons learned from trying to sell a company during the 2008 banking crisis.
Economic conditions during the crisis impacted plans for a big exit.
Company's revenue declined, leading to a roller coaster of ups and downs.
Emphasis on aligning incentives and structuring ownership correctly for long-term success.
Importance of avoiding potential conflicts among owners highlighted.
Difference between Common Stock and Preferred Stock
Common stockholders receive leftover proceeds after preferred holders in a liquidity event.
Preferred stockholders have preferences that guarantee them getting their money back first if the company liquidates.
This protection ensures investors receive a return on their investment and are not disadvantaged if the company is sold for a lower value.
Preferred stock provides security for investors and prevents scenarios where common shareholders walk away with more money than investors who put in significant capital.
Overview of Preferred Stock and Common Stock in Startup Investments.
Preferred stockholders receive returns before common shareholders, offering a safety net.
Convertible notes and safes convert into preferred shares in the next investment round.
Stock options for employees help attract top talent to startups with limited funds.
Founders are advised to incentivize employees with stock options to align interests with company success.
Stock options can incentivize employees and non-employees with different tax implications.
Incentive stock options (ISOs) offer special tax benefits for employees.
Non-qualified stock options are for non-employees.
Stock options allow the option to buy shares at a fixed price, potentially leading to significant gains.
Stock options can be valuable for startups to attract talent and incentivize employees to contribute to the company's growth.
Determining Stock Options for Employees and Advisors
Benchmarks can be used to determine appropriate amounts for stock options.
Incentives should be built in to ensure alignment with company goals.
Advisers typically receive around 0.1-1% of the company, with industry standards around 0.25%.
Stock options should be based on the fully diluted number of shares and include a vesting schedule to incentivize long-term commitment.
Balancing Stock Options and Salary in Business Startups.
People often work for options or stock when starting a business due to lack of funds for salaries.
Co-founders typically work for equity and sweat equity, while employees may opt for equity over salary.
Negotiating a split between salary and stock options based on belief in the business's success is common.
Vesting schedules for advisers may vary from those of employees and founders.
Importance of implementing vesting schedules for founders to prevent unfair situations.
Vesting involves earning equity over a period of time, typically four years with monthly vesting.
Cliff periods, such as a one-year cliff, require employees to stay for a specific period before earning any equity.
This approach protects companies investing in employees by ensuring they contribute before receiving ownership benefits.
Reducing potential losses and maintaining fairness within the team are key benefits of implementing vesting schedules.
Importance of Vesting Periods in Employee Engagement and Performance.
Vesting periods usually last four years with monthly increments and a one-year cliff for employees, while advisors typically have a two-year vesting period.
Milestones can be tied to vesting to reward employees for performance or achievements.
Calendar-based vesting provides better control over employee retention, while milestone-based vesting can still incentivize employees even if milestones are not fully met.
Negotiation is crucial in determining the specifics of vesting agreements.
Backdating a vesting schedule for founders or employees based on individual contributions and negotiating on a case-by-case basis.
Understanding convertible instruments like safes and convertible notes is crucial for investors.
Safes, or Simple Agreements for Future Equity, are increasing in popularity and allow for funding without immediate stock issuance.
A safe agreement typically includes terms such as discounts and valuation caps.
Overview of Convertible Notes and Valuation Caps in Investments
Investors can provide funding through convertible notes, which convert to equity later based on funding rounds.
Early investors look for benefits like discounts on future valuations to reduce risks associated with early investment.
Valuation caps establish a maximum valuation when converting investments to equity, ensuring investors receive a significant discount on the company's value.
Investors typically prefer lower valuation caps to maximize returns and protect their investments in the long term.
Importance of valuation caps and convertible notes in investments.
Speaker shares personal experiences with valuation caps and risks of not having one.
Differences between convertible notes and safes, emphasizing the debt aspect of convertible notes.
Discussion on interest rates associated with convertible notes and investor expectations.
Valuation caps are essential for investors to protect investments and ensure fair returns.
Overview of Convertible Notes in Funding Rounds
Convertible notes offer protection for investors by allowing them to request their investment back with interest at maturity if the company underperforms.
Founders may need to find new investors or consider liquidation if the company is not performing well and investors request their investment back.
Investors can renegotiate terms after 12 months, potentially gaining more equity in the company.
Convertible notes also carry the risk of default, where investors could take ownership of the company's assets if the investment is not repaid, highlighting the importance of founders being aware of potential outcomes.
Importance of 409a valuation for setting stock option strike prices.
Founders should aim for a low valuation to benefit employees with more upside.
Investor valuation should align with the company's actual worth.
Factors like liquidity risk can impact valuation.
Third-party services like Carta can provide 409a valuation.
Importance of managing a cap table for startups.
Cap table management provides organization and clarity for founders.
Resources like Carta and other tools are available for cap table management.
Utilizing these tools can simplify processes and save costs for startups.
Offer for further sessions on tips and tricks for managing a cap table.