I've seen founders get an early share of the upside using this strategy--without putting their companies in danger or angering their investors.
It's front-page news today: Founders are getting rich. When is it your turn? It could be now before you exit--but there are several factors to consider before you even think about trying to cash out early.Be Realistic.
Yes, despite all of the talk of a "bubble," the venture-funding environment is still hot. And yes, founders continue to enjoy increased negotiating leverage. But don't kid yourself—most founders are not in a position to cash out early. Even though we are seeing an increasing number of founder early liquidity events, they are still for the most part rare, outlier transactions. In order to take money off of the table now, your financing round needs to have a significant amount of momentum behind it. Founder liquidity is a lot more likely when the company is doing extraordinarily well and there are competing financing offers on the table.Leave it out of the Investor Pitch Meetings.
Going into a possible founder liquidity opportunity, you've likely been running a lean start-up and paying yourself modestly (if at all) for at least a few years. Taking some chips off the table now would be a life-changing event, for you and your family. No matter how important your sale of shares could be, you should leave your liquidity aspirations out of the initial VC discussions. I've literally seen founders include a bullet point about cashing out in their pitch deck. Don't do that.
Create some genuine heat around your deal--and then once an investor has agreed to terms in principal or laid down a term sheet, make the ask. Don't muddy the waters in the early stages of the negotiation--or you run the risk of sending mixed signals about motivation and commitment to your start-up.You Need a Solid Justification--and a Way to Stay Motivated.
If you talk to anyone familiar with founders taking money off the table, you'll hear one consistent message: Giving founders liquidity is intended to relieve financial pressure and allow founders to focus on the "home run exit." This justification should be the central component of your ask. You need to convince investors and your board that you are fully committed to the company. Show them that a small payout now can help alleviate fears and encourage you to take bold, calculated risks in your efforts to create a wildly successful venture.
Don't try to set any precedent here. I am usually seeing founder liquidity in the $250,000 to $1.5 million per founder range. Founders generally sell between 5 percent and 15 percent of their holdings. Stay within the current market expectations. Your post-sale holdings need to be large enough to keep you interested in the company.
In later rounds, if and when your company is making incredible progress (like $50 to 100 million-plus run-rate progress) then there may be some opportunities for dramatic pre-exit cash outs. Investors often simply "want in" at this stage--and the need to force you to stay motivated has decreased. Realize that this kind of liquidity event is extremely rare. Unless your company is on the path to IPO or $500 million exit, this is probably not you.Consult with Counsel--and Get Your Own Accountant.
The sale of stock by founders raises several issues relating to taxes, corporate governance, stock-option pricing, redemption rules and the impact on investor aggregate liquidation preference. The cash-out mechanics can be implemented in a handful of ways. Founder liquidity can be carried out via direct sale to investors or through redemption of shares by the company. We even saw an unusual dividend method in the well-publicized Airbnb founder cash-out.
In any case, company counsel needs to be intimately involved. Good start-up lawyers will have a strong grasp of the various implications--as well as a solid set of data points around what is "market." Finally, you also need to get your own tax advisor. This will be a significant income event for you. You want to avoid inadvertent tax structuring mistakes and optimize your return (legally of course). Uncle Sam wasn't there at 3 a.m. helping you ship product--why give him a disproportionate share of the proceeds?
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