In the immortal words of Yogi Berra, “When you come to a fork in the road, take it!”
I’ve often spoken about raising equity as a fork in the road for startups. Why is that?
Because almost all angel investors and venture capital firms provide what I sometimes call “Exit Capital.” It is designed by contract in the form of preferred shares to provide the equity investors with a return on their investment by selling the shares, hopefully at a much higher price, some time in the next 3 to 10 years. That is the investors’ “exit.”
For entrepreneurs, the form of the share selling is nearly always selling the company in its entirety. Usually that’s to a larger company. Sometimes, if the company is generating cash but isn’t yet huge, it’s a sale to a private equity firm. Sometimes just the assets are sold and the company is liquidated if things didn’t go so well.
Rarely but importantly, the company is able to go public – issue more shares through an Initial Public Offering (IPO), in which case investors are able to sell their shares on the public markets. Typically that’s after a “lock up period” following the IPO when, again by contract, the “insiders” including all investors as well as employee-owners, are not allowed to sell their shares.
The path towards an exit takes you in a particular direction, and it’s not possible to change your mind as an entrepreneur after that.
You can no longer say “I want to run the company, keep it private, and share some of the profits as dividends.” Although some individual angel investors may like that option, if it’s agreed to upfront.
You can no longer say “I think growing the company at 20% a year for the next 5 years is the right strategy.” Much faster growth is required by angels and VCs.
You can no longer say “I’d like to pass the company on to my kids.”
Or, “I’d like to sell the company to employees when I retire.”
Those are options some entrepreneurs might like to consider, but certainly not all. For some companies the equity fork in the road is the right path from the start.
Equity: A Permanent Fork in the Road
Bootstrapping doesn’t have to be forever.
Grants and prizes have relatively short lived strings attached – reporting requirements during and when the project is done, at most.
Debt can be repaid if you have the necessary positive cash flow.
But equity is a permanent fork in the road. Make sure you think about it before you go down that path!