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Recouping equity after giving too much away in the early stages…

Our product took years longer to develop so we took a number of small investment chunks, $200K-300K at a time, from the same investment group – an angel group that we, 5 founders, were personally friendly with. The result is that we’ve been diluted approximately 35%. Now the product is complete, customers love it and more are lining up. We’re doing our first preferred round where we’re giving up approximately 12% for a few million $ from one of our customers (net dilution at the completion of this round of approx. 40%). We have no option pool yet and are about to begin hiring additional engineering and development staff. Is it common for founders to participate in the option pool and if not, how can the founders put together a plan that would allow us to recoup equity? I think it’s important to point out that all investors are very happy with the founding team and would be open to this rejiggering…

  • Investors open to which kind of rejiggering? Giving back equity? Certainly not! If you put your own money in the company, it is welcome. It derisks investors so they are happy (see the signaling theory). But if you can’t keep control, you are cooked.

    What you can do to regain equity: transform your company in a zombie startup whose unique goal is to give the highest wages possible to founders. Keep this money and after a while, invest it back in the company to gain equity. It takes years and the chances to renew with startup growth are tiny. And the chances to get funded again become zero.

    In my experience, if you gave too much in early stages, it’s done. You became your investors employees and you can have a nice corporate career but you won’t control your company ever. If your goal is social position and money, it’s ok. If it is control and freedom, you should think about the future.

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    • +1. Clawing back equity without joining a funding round is precisely equivalent to getting money for free.

      12% preferred is also too vague: is this preferred stock or preferred participation? There’s a huge difference and this potentially affects angel investors very heavily.

      The lack of an option pool is also interesting – I would wonder just how sophisticated this angel group is if said option pool wasn’t carved out to start with. Doing so now means a straight out dilution on top of what already is there from angel/seed and series A.

      It is certainly possible to award from this option pool, but unless you’re going to suck it dry personally, it is just about mathematically impossible to offset the dilution from the option pool by drawing from the option pool directly, and either way this will have to be approved by all/most investors.

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  • The board could give the founders restricted stack grants. It’s something that is sometimes done when founders are diluted to very little equity and they need something to keep them incentivized but I’ve not heard of a case where founders just felt like getting more because they “deserve it”.

    There is tax consequences though since it counts as income to the founders so you should talk to an accountant.

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  • I’ve definitely seen founders claw back equity based on milestones (tho rare). Just have an open conversation with your investors. If you set an audacious goal, ask them if they would reward you with additional equity.

    If I were an investor, I’d see that as a positive signal. (better than founders asking for ridiculous raises & taking money out of the company)

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