Continuing with yesterday’s post Plan for Equity Dilution Over Multiple Rounds, there’s another element worth mentioning: entrepreneurs often sell some personal equity during a financing round. Selling personal equity, as different from the company selling equity, is often called “taking chips off the table.” Since the entrepreneur has taken a significantly below market salary (if any salary), and now he or she is signing up for at least 3 – 5 more years, the natural desire is to de-risk things and sell some equity.
Here are a few thoughts on selling personal equity during a financing round:
- Many investors won’t buy founder equity unless there’s at least a few million in recurring revenue (often, much more revenue, or being near cash-flow breakeven, is required)
- Entrepreneurs can usually only sell a small amount (e.g. ~5% of their equity)
- Investors are more motivated to buy founder equity if they have a target ownership percentage (e.g. they want to buy a minimum of 20% of the startup, but with existing investors there’s only room for 18%, so they buy 2% more from the founders)
- When there’s a more competitive funding round (e.g. competing term sheets from multiple investors), it’s more likely that the entrepreneur can sell some personal shares
Entrepreneurs selling equity and “taking some chips off the table” during a financing event is fairly common once institutional investors get involved (e.g. after the seed stage). Entrepreneurs would do well to know what’s possible and what the current market will bear when it comes to selling personal equity.
What else? What are some more thoughts on selling personal equity during a financing round?
David Cummings on Startups 
Thanks for your outstanding and interesting blog posts. Question for you on this topic: if a founder owns only common stock and a new round is preferred, what kind of discounts do you generally see in valuing the common in this scenario? Are many venture investors willing to buy common stock after just investing in preferred? Appreciate any thoughts that you have.
I’ve seen the institutional investors buy the common stock at the same price as the preferred stock, assuming they’re buying a large chunk of preferred stock at the same time.
My gut instinct from the investor side is that paying the founder a fair market salary and even back-dating it if they have not taken any salary, is a better idea than purchasing their equity. I would want to keep as much of their wealth tied up in the business as possible.