The Pitfalls of Deferred Compensation

I have recently been asked if I would "jump-in" to a start-up for 100% "deferred compensation" or equity. My answer was a definitive "NO".

My experience (on both sides of the coin) is what drives my agreements for "jumping in". I have found that unless there is at least minimal salary paid ($2k-$4K month) plus long-term, success-driven compensation (stock, equity, profit sharing, etc.), one or more of the following things WILL happen (usually all of these to some degree):

1. The company will not fully value the energy and investment the individual puts in (particularly before it creates revenue, when all the hardest work happens).

2. The individual will not full value the company and invest their time and energy fully (driving the company to revenue as rapidly as possible). This is inevitable and can kill a company (I don't care how motivated either is).

3. The company will probably lose a key individual at a critical moment because they got a great offer from a later stage company that brings their personal finance to a high cash flow positive (instead of cash flow negative). As a result, the company could lose the contract (or investor).

4. The company founder gets tired and folds. The partner/employee is left with nothing.

You could get lucky and find someone with great personal resources that will work for deferred salary/equity. In fact, it happens often. See number 2 again. It will happen. Let's say I have $7 million in the bank, but I like work, so I get involved with you. Then my daughter gets married. And I invest in an exotic resort in the Caribbean that I like to visit. I buy a new boat to play with. My energy involvement in the company slows; the company's growth slows. You may find a capable executive that has a reserve of cash or a severance agreement. See number 3. The chance of one of these two being the case is about 90%.

A minimum salary creates commitment and loyalty between the company its contributors that an equity stake just can't create. I have seen this happen both ways time and again.

I've been the start up guy with "my" company. On the part of the company, we want to take the smallest risk possible. We want our employees to take that risk with us, though they will not reap nearly the reward we will when success is reached. (Their ROI is not as high for the risk) In doing so, we create more risk around our success. With limited resources this seems necessary, but there are often ways to create a little cash flow to create this commitment. The key is to make the commitment in the right areas first.

A better path for business/corporate development is to allocate a small salary for that individual to pay their household bills (hence creating loyalty). Compliment this with significant bonuses associated with sales/investment milestones. Then ice the cake with a long-term vesting equity stake. This would interest me, and I could bring some a great wealth of experience and talent to bear on both business development and corporate development.

I am so clear on this that I won't get involved any other way. This may be tough for a founder to hear, but any talent looking for a great opportunity will probably say the same.

If the time to grow your business is right now, you may also look to your board of directors for help. At this stage, you should have picked board members that can provide limited resources part time, but can commit to a number of years. This is significant talent. These people will be contributors of one or more primary pieces of success. They will be strategic partners, possible clients, or experts. They will bring resources to the table. Standard practice for board members of a start-up is to compensate these board members with vesting equity. However, if you need someone to hit the phones, visit clients, or create documentation- you will need to hire.

Entrepreneurs are brave and courageous. They deserve respect and loyalty. But they must also grant this to those that help them realize their dreams. Properly executed this will pay dividends to the success of the business over the years.

The 4th Component of Entrepreneurial Success: Capital

In the first article on this site, I wrote "Energy can be defined as four things in this case (and in most cases): time, capital, action, and commitment.... A successful entrepreneurial enterprise needs high levels of all four components. With these investments- and a decent idea- any business can be Manifested." The time has come to address the most sensitive and mysterious of these: Capital.

I am often approached with the request, "Can you help me get some money?". My answer is, "Sure, how are you selling?" The reply is usually, "Well, I am not selling anything, but I have a great idea!" That's swell, really neat.

There is a series of articles that I will write on this point and I am here to say that I am not the authority on raising money, but I get it. I know how to do it. Let's cover the basics in this article, and we will digress after that.

The bottom line is this: If you want someone to invest money in your business, you MUST show them how they will make a RETURN on that investment.

I am now going to repeat that in many other forms. An idea is worth nothing. Revenue is worth everything. It doesn't matter how great the idea is, you have to be able to sell a product to create value. An idea creates no returns, revenue creates returns. An investor wants to make more money on their money. They do not invest in a great idea, they invest in revenue. If you can't show how you are going to create revenue, your idea is worth nothing.

OK. Now that we got that out of the way, I am betting that at least half of you don't get it yet. The single biggest problem with a start-up is the entrepreneur only builds half the business. Most entrepreneurs start-up with a passion for creation. I don't discount this. In fact, I applaud it. I don't have it. I have a passion for the other half. Taking the business to market. In order for any business to be successful, you have to be able to take it to market.

Therein lies the twist, the mystery and the key to success. In order to be successful, you don't need to have money, you need to be capable of making money. If you can demonstrate this capability, or at least show me a great plan, I can find you investment capital. Angel funds, angels, and private equity will flock to your business.