How to Maximize The Value of Your Startup Equity

What's up, everyone? Welcome back to another episode of Founders Journal. I'm Alex Lieberman, co-founder and executive chairman of Morning Brew. Today we are talking about maximizing your equity as a startup founder. Startup equity can be confusing and daunting, but it literally could be the difference of millions of dollars in your pocket or the government's pocket. You're not taught any of these topics in school, and typically what happens as a founder is you get close to selling your business. Having some liquidity event, and then you need to do an all-out sprint to try and retroactively fix stuff so then you can maximize the value of your shares. But that is stupid. There are tried and true ways to structure startup equity, and there are a handful of people that know exactly how to do it exceptionally well. I invited one of those people onto the podcast to give you every tactic related to protecting the value of your equity. My buddy Ankur Nagpal is the founder and CEO of Cari, a business that helps business owners build wealth in a number of ways, most notably with their Solo 401 product. Prior to Cari, Ankur was the founder and CEO of Teachable, a teaching platform for creators which sold to Brazilian education company Hotmart for $250 million. On this episode, Ankur talks about everything from the power of QSBS, a tax exemption that gives business owners $10 million of tax-free gains, to charitable remainder trusts and the impact that co-founders have on the value of your equity. Let's hop into it. Ankur, thanks for joining the podcast.

Excited to be here.

So I want to talk to you about, I feel like a taboo topic that founders are afraid to talk about, but it's wildly important. Um, and I know it's one that you've thought about a lot, which is Founder equity, and also how to basically set things up in the right way to optimize your wealth from building a business and ultimately having some sort of liquidity event or financial outcome. It's funny because I had no idea about any of these things when we were starting Morning Brew, and basically in like a 3-week period around selling the company, I had to do this like hyperdrive of learning these things.

Yep.

I'm sure you had to do the same thing.

Exactly what happened here, except I never stopped there and I've sort of continued learning over the last 2 years and it's incredible the sort of things in the US tax code, but most people have no idea. So it's clearly become something I'm passionate about now.

Okay. So take me through your TED Talk on founder equity and how to, you know, think about wealth building while building a business.

Yeah, absolutely. So the good news is honestly, there's not a ton you need to do upfront. The only thing that materially matters upfront is understanding how QSBS works, which stands for Qualified Small Business Stock. And this is the single biggest gift the government has given startup founders. The way it works is if you hold shares in a qualifying C corporation, and we'll come to that in a minute and what that means, for up to 5 years, when you sell your shares, you pay no federal taxes on $10 million. And in 42 states, including New York, you pay no state taxes as well. So it's incredible, right? This gift from the government, $10 million. It's crazy.

And by the way, it used to be smaller, right? Didn't it get expanded to $10 million at a certain point?

It used to be only a 50% deduction and now it's 100% deduction. So that's the change they made. And it's so generous. I have no idea how long it will last for, but honestly, it's, it's too good. It's one of the things you look at in the tax code and you're like, this, we're probably not the people that need this tax break, but you know, that's how the code is written. And, and again, I think the most important thing early on is to not accidentally mess it up.

So let's talk about what that is and, you know, how do you mess it up?

Correct. So one is your company needs to be a C corporation. Which most lawyers or anyone who will tell you to do when you're starting a company. But a lot of people accidentally start as an LLC first. So you want to avoid that because your 5-year clock only starts once you become a C corporation. So that's part 1. Part 2 is you can accidentally trip up QSBS status by doing a large buyback of shares. This is the most common way I've seen people accidentally mess up their QSBS status is let's say you have a co-founder that leaves the company and you want to buy back their shares. Talk to a lawyer before that to see it doesn't cross a very specific threshold that may just violate QSBS status. That's the biggest accidental way of doing it. But if you don't accidentally mess up QSBS, as long as you hold your shares for 5 years and the company was worth— company raised $50 million or less at the time you get your shares, You get to have this QSBS benefit.

And just to understand, given that this is such a big benefit from your perspective, when does it make sense to not just start your company as a C corp?

It makes sense to not start your company as a C corp if the goal is a business that pays you cash on the side, but you're not building enterprise value. So let's say you're running Alex Consulting Services LLC or whatever. I tell you it doesn't make sense to have a C corp election. But if the goal of your company is one day to sell the business or to go public, you should always be a C corp. And actually right now there's a few business owners after learning about QSBS that are going down the C corp route that would not otherwise. Such a big benefit.

Yeah. Super interesting. I mean, I've heard of it to the point where obviously like there's a lot of intricate stuff you can do with QSBS. And I don't know if you were going to talk about this, but like, I know, uh, for example, just a simple thing is I know people who, when they're getting prepared to sell a company, They reopen a new C corp to get the clock started as soon as possible.

Yep. That's a great segue into, okay, what happens if you sell your company in less than 5 years? You can do something that is called a QSBS rollover that actually lets you take the proceeds and invest it in another qualifying small company, and then your clock resumes ticking. So let's say you sold the company after 3 years. You only then have to wait 2 years before the next company sells. To get your QSBS benefit. And even better, if you're a founder, you can do that in a second company you own. So literally you can start your own company, roll over QSBS pre-tax dollars. It's the equivalent of what, you know, people in commercial real estate do where they have a 1031 exchange. You can take the entire dollar amount, roll it over, and your clock resumes ticking. So it's very, very powerful.

It's incredible. And then I don't know if you want to briefly talk about it, because I feel like this is like QSBS kung fu, but like there's this whole world of QSBS stacking as well, right?

Correct. So now let's level up, right? Next level. Let's say you're— yeah, again, this gets crazy. Let's say you want to— you're going to make $20, $30, or $40 million. There's actually multiple strategies you can use to multiply your $10 million QSBS limit to $20, $30, or $40 million. The simplest of which is honestly, if you have family members that you'd like to give shares to, the QSBS limit is per company, per shareholder. So What I've done this time around is given shares to my brother, my mom, my dad. So if the company were to ever have a successful outcome, each of them would have their own $10 million limit. So super powerful, super effective. That's part one. Part 2 is you can set up trusts, different types of trusts, each of which can serve as their own taxpayer that gets their own $10 million limit. For instance, you can set up— I set up 2 trusts. I set up a trust for the benefit of my future children and family, and I made a gift of my shares to the trust. And as a result, that trust got its own $10 million limit. And then I set up another trust, which is called a charitable remainder trust, which works by giving the shares to this trust that does not pay taxes. It pays me out an income stream every year for 20 years, and what's left over goes to charity. And that got its own $10 million limit. And you can kind of keep going. For me, 2 trusts was enough. At that point, I was like, I should pay taxes on this. Like, I've clearly gotten a lot of services from the government, but you can go real crazy with QSBS planning as a founder.

Yeah, I think the craziest thing that I've ever seen is there was an article, I believe it was about Mark Pincus. Have you seen this article?

I have not.

The Zynga founder, I believe QSBS stacked 10 or 15 times and it ended up on the front page of either the Wall Street Journal or the New York Times.

That's just not a good look, right? Like, I think, I think you want to, you want to do it to the point where it makes sense versus completely abuse the rule. A question I get from founders a lot is, okay, cool, when should I start worrying about this, right? Like, what do I have to think about at what stage? And my overall advice is upfront, just make sure you're a C corp and you don't mess up, you don't mess anything up. Like, have a lawyer double check that you buy your shares and it's clean and all of that. Then you don't have to think about this, I would say, till maybe year 3. I find ideally, like, between your Series A and B, It might be worth thinking about how to multiply QSBS if you were to get there. Any before and it's too soon because honestly, like, I know some people, they don't have product market fit and they've set up 4 trusts, right? And it's like, what are you— like, building a startup is really hard. Get to a point where the likelihood of you having an exit is, you know, 30%, 40%, 50%, and then it's worth the effort. So it doesn't make sense to do it upfront, but I would say before Series B, it may make sense to look into a lot of this.

Makes sense. Okay, anything else on QSBS? That's question 1. Question 2, is there— are there any other topics as it relates to thinking about your wealth and wealth planning as a founder that you think are really important for people to think about beyond QSBS?

Another question that comes up very often is how much should I pay myself? And a lot of people aren't very upfront about it. Um, I've previously been public about what we paid ourselves. I, you know, living in New York City, I think we started at $70K, eventually ended up by the time I sold the company to $150K. And in between, there were sort of levels in between. But my thesis, and what I tell all my portfolio founders, is I think the goal should be to pay yourself enough that you're not worried about day-to-day expenses, you're not compromising your quality of life meaningfully, yet you're not getting rich off it. You're not, you know, like materially, like saving a ton on it. And what that number is varies a lot by who you are, what your family situation is, where you live. But I think that's generally a good rule of thumb for how founders should consider paying themselves. But I'm curious how— what you tell people when they ask you that.

Yeah, I mean, just to again, use me as the example for Morning Brew, basically, when I quit my job, and Austin decided he wasn't going to go work full time in banking, I went down for a period of time to zero salary. And basically, Austin and I, We're fortunate enough where we had families that were willing to pay our rent for a period of time. Like, we feel very lucky for that. And that's not the situation that everyone was in. Uh, after we raised our round, um, we raised the $750K, Austin and I took $60,000 salaries. And I would say in New York City, that's like, you're really playing in the danger zone in terms of being able to afford a life. You know, luckily I was living in a 5-bedroom apartment with 4 people from Michigan.

Yeah.

And so like, we were, you know, amortizing the cost of an apartment across enough people. And then we just gradually kept bumping things up until, you know, until we sold the business. And candidly, like, things got pretty high because also I think the beauty of a media company is like we didn't really have to scale headcount that much and we were super profitable. So like, I can't remember, like our revenue basically went from $0 to $70K to $750K to $3 million to $13 to $25. But headcount absolutely did not grow linearly. It grew less than linearly. And so I think at a certain point, Austin and I got up to $350K that we were paying ourselves. Um, and, and, and my general rule of thumb is similar to you, which is like, uh, and this rule of thumb is really in the early days when you're most worried about like, what is an investor going to think of how you're paying yourself?

Yeah.

I think that's people's fear. And I think it's at the end of the day, you do a disservice to yourself. If you're worried about money in your life, because then you can't be fully present to your business. So get to the threshold at which you're not worried about money in your life, but also you're not spending frivolously and pay yourself that amount. The, the other question that I've been thinking about a lot, not for myself, but just in general in this world, like kind of the venture cycle we had. And, you know, you have a lot of founders who sold, uh, basically took a ton of secondary and then their businesses lost a lot of value. Not to say they're necessarily in the wrong. I think everything's on a case-by-case basis. But a question that I think a lot of founders ask is, when is it appropriate to raise a round and take some liquidity as a startup founder? What's your thought process on this?

Yeah, it's a great question. I think you can always, always, always take a secondary if someone offers it to you, with the caveat that you make the exact same offer to the rest of your team. I think that's a really important rule. But otherwise, I know a lot of investors are like, oh, you shouldn't take secondary. Bullshit. If there's a market for it, it's within your right. But ensure that every single person on your team with vested shares has the exact same opportunity. If you do that, I think, you know, power to you. Because a lot of VCs, frankly, are— they're the ones who kept telling the founders to take secondaries because they wanted to buy into these companies that they weren't able to, and now they're upset about it. So I think if you, if you have a buyer for secondary, Look, you already put all your eggs in this basket, so it's totally fair to be able to diversify some of it. Just take care of your team.

Totally. Last thought around this, and then I'll give you the floor on if there's anything else, is I think something a lot of founders think about, or you see people hyper-optimize for taxes. So obviously one way people do it is with QSBS. Another way people do it is literally moving themselves geographically, right? And you can like, you can stretch this from a little bit to a lot of it. Like I've seen people move to a different state because a certain state doesn't allow for a certain trust structure, all the way to people living in Florida for half the year. And there are people I know who live in Dubai now. Uh, what, what is your thought process on geographical location for tax optimization?

Yeah, so I personally hate it. And like, even though I do a lot of— I mean, I, I literally live in the highest tax bracket possible, right? New York City and all. I— the expression I really like is like, look, we talk about taxes, but don't let the tax tail wag the dog. So I would rather live where I want to, and then figure out my taxes. So again, to me, the whole point of having money is to be able to live where I want. I actually had a tweet go viral a while back. And this may seem like an attack to you where I was like, what's the point of having money if you have to live in Jersey?

I love that. Well, now my goal in life is just to make you love New Jersey. Yeah, no, anyone who wants to move to Hoboken, hit me up. I love it.

Yeah.

Any other thoughts around wealth preservation or tax strategies for founders before we hop?

Yeah, one final thought. And this is, again, a tweet I read from Imaad, the founder of Mercury, where he said, as a founder, sometimes you have multiple choices of like what to optimize for when fundraising. And I think it's what he said is it's best to optimize for the medium case scenario where things don't go absurdly well, but they also don't go poorly. So to ensure that you're protected, because if you do the opposite, right, where you just raise money at a super high valuation, thinking things will go amazingly, you could end up at a point where an exit that would have made you reasonably well off would not make you well off. So I think that's just wise advice in general, try and optimize for the medium case scenario, because there's a lot of times where if you build a business that you own more than 50% in, And you sell it for, you know, $50 million, which is a lot of money in most parts of the world, you want to ensure that, you know, you, it can still be life-changing for you. So.

I have actually one more question that I feel like is a huge consideration around wealth in a business and the value of your startup equity that people just don't think of this as an obvious way, which is like number of co-founders you have, right? Like number of co-founders you have actually is probably what the largest lever. Of what your equity is worth at the end of the day. How do you think about what is the optimal number of co-founders when you build a business?

It's tough, right? Like, if I— because I think, again, if you have a co-founder, if you have a co-founder that is incredible, they're more than worth the equity. But, you know, what I was able— what I did this time around is I, instead of having one equal co-founder, I took the same amount of equity and I distributed it to a founding team. And as a result, every single member of the founding team has substantially more equity than they would anywhere else. Yet it's just like what one co-founder would've been. If I'd, if I'd had a great co-founder, I would've not made that trade. But again, it gave me a lot of equity to be very generous with because of that.

Yeah, it's also an interesting tool to just diversify expertise if you don't think all of that expertise can be pent up in a single individual.

Yep.

I love that.

So yeah, so I think there's many, many approaches. I think Silicon Valley has finally lost its stigma a little bit against solo founders. For a long time, YC and stuff were like, you have to have co-founders. And I definitely think good co-founders are a game changer and massively help, but co-founder disputes are also the number one reason companies fail. So—

Love it. Ankur, thank you so much for the time. So much wisdom as always.

Thanks for having me.

I hope you enjoyed this episode of Founders Journal. If you like this format where I curate world-class entrepreneurs and investors to answer the most important questions or challenges for early-stage entrepreneurs, shoot me an email to alex@morningbrew.com to suggest a future question or challenge that you want answered, or a specific expert who's like on your wall of fame that you would love to see come on the podcast. As always, thank you for listening, and I'll catch you next episode.