Monday, August 14, 2006

Lesson #4 - Gas Money : Everyone needs to chip in

When you start a new venture, it doesn't take long before you look around the room and ask "How are we going to pay for all this?". For some entrepreneurs (who have had success) they may be able to fund the first leg of the trip, but for most - they need to find a way to get "Gas Money".

Much like a road trip, it would make sense for everyone to chip in equal share for the gas. No free rides, right? Unfortunately, it rarely happens when starting a company. This is where I feel most entrepreneurs make their first critical mistake. The classis example, is three guys get together, form a company and split it three ways - 33% each. They work hard (sweat equity) for a month or two and build a nice business plan, perhaps even put together a rough prototype, and then realize they need some more money. At this point, they all should put out their wallets, and invest equally the seed capital to fund the next phase - but this rarely happens. Usually, it will be one of the guys who gets a second mortgage, or begs friends and family for cash.

Now I understand not everyone can write a check for $10,000 or afford to take the risk associated with a new business - and this is why we call them "employees" not "entrepreneurs". If an individual is not willing to invest real money into the company, then the terms of the relationship MUST change. He or she needs to earn their equity, and not be given 33% of the company, just because they happened to spend a few long nights searching for a domain name. Money is not just "gas" for the business, but it is one thing that keep people motivated and invested in the business.

Ofcourse, dividing up equity in a startup is not an easy task. Its like measuring the value of each person at the table. It can become very personal, and at some level insulting for some. However, this is what partnership is all about. This is the first big test in setting expectations and having everyone understand what they bring to the party.

My solution is simple. Give everyone fair share of the company. Make them earn the equity over time. For example if Jon is given 33%, make him work for 3 years to earn 11% per year. And if Jon invests cash, then set a price on the stock, and let his investment be treated like a venture capitalist investing in the company. This will dilute those shareholders who are not investing with Jon.

So next time, when you pick up a hitchhiker, and you pull over to get gas, and he looks at you and says "I ain't got any cash on me" - either kick him out, or make him wash the van and earn his ride.

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