Becki DeGraw on founder vesting, advisor equity & the 4-term-sheet play

All right, everybody. It's my favorite time of the year. I get to do Startup Basics. What is Startup Basics? Very simple. There are things you need to know that are simple and basic, but they're important. They're foundational in being a founder. And if you get these things wrong, whether it's accounting, product-market fit, sales, or legal, they can have downstream effects that you will then spend 10 or 20 times the effort to clean up than if you had just known your basics.

We keep all of these at thisweekinstartups.com/basics so that you can remember. And Becky DeGraw is back with me. She's from Wilson Sonsini Goodrich and Rosati. We call them WSGR here in the Valley. And we're going to talk today about founder and advisor equity. Becky, welcome back to Startup Basics. Thank you.

Thank you. It's good to be back. And Always, always love chatting about this stuff. And this is a fun one. This is always near and dear to our founders' hearts. So.

Yes. So let, let's get started here. A founder starts a company. They don't wanna be on the venture track. It's their company. You and I start, uh, Becky and Jason Enterprises and we're building software. All good. You own 50% of the shares. I own 50, probably you would own 41%. I think you'd probably out-negotiate me. I own 49% of the shares. And here we are. We're in business. We got all our shares on day one. We're rocking and rolling. We make a bunch of money. But at some point you come back to me and say, hey, you know, I got this venture firm, Acme Ventures, wants to put a bunch of money in. And now we have to reset the vesting of our shares and we have to have a whole nother discussion. And then they want an employee stock option pool, an ESOP. What's that? So let's take it like we do here on Startup Basics, from first principles, from the basics. When you're on the venture track, There is founder vesting. What is it? How does it work? Why does it exist?

As a founder, you buy your shares, you own your shares on day one, you get all the voting rights associated with the shares, but investors want to know that you're going to stay with the company. So we put a vesting schedule on those shares so that they vest over time. What does that mean? If you were to leave the company before the shares are vested, The company has a right to repurchase the unvested portion of the shares. And usually it's at the lower of whatever the original cost was that you bought those shares at or the current fair market value. For a founder, if you're buying your shares at the earliest of days, we're hopefully at the point where we can say these shares are worth a thousandth of a penny per share. You want to write a really low check to buy those shares. So the cost, right, is is nothing. And the company has the right to repurchase at that cost if you leave before the shares are vested. As you said, if you're going to go out and seek any type of institutional funding, particularly from VCs, you're going to have to have vesting on your shares. These are what we call the golden handcuffs, right? For the founders. And it makes sense in those early days, right? When investors invest in a company at the pre-seed seed stage, even at the A stage, there probably isn't much there at the company level. It's really the founders, their ideas, their vision that the investors are excited about and putting their money in, which means the investors want to make sure that those individuals are staying at the company to execute on that vision.

Hmm.

I would, I would also say that even if it's just you and I and we're, we're doing this Venture and we, we're gonna, we're gonna backstop it. We're not, we're not gonna take that VC money because there's all the, the bells and whistles that go with it. There might be a reason I would argue to include vesting to protect amongst the founders themselves, right? If you have 2 or more co-founders, one of them turns out maybe they're not pulling their weight or they decide, whoa, this startup stuff is crazy. That's not, that's not exactly, it looked like it was fun. This isn't what I had in mind. Or one of them gets lured away by some big comp package that one of the, the tech giants is, is throwing out. You don't want them walking away with fully vested stock owning 50% of the company. Right. So even if, even if you're not going to pursue investor money, you may want to think about it to protect each other.

And I hear you want it to be fair, right? You want it to be fair.

Yeah. Both people get it.

And we have this incredible, uh, illustrative, uh, example of this. There were 3 founders of YouTube. Most people say, oh yeah, you know, I remember Chad Hurley, and then there was Steve. Who's the third? And it was a really smart gentleman named Jawed Karim. I've met him a bunch of times, really smart, really thoughtful. And when he— this was 2006, 2007— he went back to school. He wanted to go back to Stanford and finish up. Okay, so he only got 1/5 of his founding shares. And the company was bought like a year or 2 later by Google, famously, for $1.6 billion in stock, in Google stock. And so Chad and Steve got $300 and, you know, $30, $40 million each. He got $64 million, a fraction, a 5th. Now, if you had kept that and you didn't sell those Google shares, if, in other words, if Chad and Steve hadn't sold their Google shares, and who knows, maybe they didn't, maybe they did, I don't know. That's about a $10 billion outcome.

And for Javed, it's like $2 billion.

So these numbers matter. These are very real numbers. And, you know, it's—

listen, I don't think anybody's crying for somebody becoming worth hundreds of millions or billions of dollars. It's an incredible payday.

But this is why it matters.

This is why the basics matter. Not just when you grow the company and it becomes profitable, you raise money, but then there's sale. And then what if that sale is in equity? Oh my Lord, these have compounding upon compounding effects.

Like I said, Becky, in the intro, get it right, folks, from the beginning.

So, um, what are some blowback from venture capitalists when a founder says, well, I've been working on this for 4 years, why do I got to get— do another 4 years? I'm willing to do 2. Is that a reasonable counter? And how do VCs typically take something like that?

Yeah, I think it depends. on where the company is at. Like, what have you done in that 4 years? You know, if, if you're now a Series B company and, you know, you're— you've got real revenue, you've got real metrics, you're on your way, we're probably not going to have a conversation at all about your vesting. But if you've been working on this for 4 years and this is your first priced round from first institutional investors coming in, why did it take you so long to get to this? Because it's kind of I understand that you might have vested, but we're really at stage 1. It just took you longer to get to stage 1 than it did some others. So I think that that's often how investors are going to see it is how much further do I have to go? Right. Does it, doesn't it kind of doesn't matter.

So if you bootstrapped to $3 million a year in revenue in 3 years, okay, that's interesting.

Great.

Yeah. Maybe we have a discussion about vesting is 2 years or 3 years or 1 year, whatever it is, or no vesting. Also, life is based upon the number of offers you have. A person can have multiple offers, and then these kind of nuances can suddenly become negotiable when they weren't previously negotiable. You've seen this up close and personal, and you have to, when there's multiple offers, you gotta sit with the founder and say, okay, this is a unique opportunity for you. You have 4 term sheets. These are the differences. Walk me through, not a specific instance, obviously you can't do that for confidentiality, but make me, paint me a picture, if you will, Becky, of what you would say to a founder with 4 different offers dealing with these kind of issues.

Yeah. I mean, one, you're sitting in a great spot. This is exactly your best opportunity to get the best terms, um, is leverage, FOMO, right? Everybody has it. Oh, you mean somebody, somebody else is interested in this? Oh, 3 other people are interested in it. Guess what? My best offer, I can do better. Right? So you wanna be able to be strategic about how you do that. You also don't want to burn bridges because as we all know, this ecosystem is small.

Still, still small, even as big as it's gotten.

It's still small. Yeah.

It's still small. People talk. People are always going to talk. So you don't wanna burn bridges, but That doesn't mean you can't be strategic about trying to get the best terms for what you're doing. So, you know, balancing that, but then it is, you know, going through and looking at the terms and figuring out where the differences are and where you might be able to have levers to pull. You know, I often say in founders, some of the early stage founders are like, well, valuation, I'm just gonna pick the one with the highest valuation.

Maybe.

But there might be other things to consider too, right? In terms of Who is it? Like, if they're gonna take a board seat, most often in these early stages, that term sheet is gonna be coupled with, I want a board seat too. Who is it that's gonna sit on the board? How valuable are they going to be to you? Are they gonna show up and not read anything before and, you know, not be very helpful? I don't know. Is that better than somebody who is like gonna roll up their sleeves, gonna be in there, gonna be helpful, gonna be making introductions? Like, they've got your back. You have the same vision, right? Like, Maybe that would be more valuable in the long term. What opportunities does that fund have to continue funding the company? Does this say, I can write one check, but then I'm out?

And then I have to rely on partners? Well, this is such a good point, Becky, because now you have the leverage to ask these questions, to even be able to ask without being nervous as a founder with one term sheet. When you got those 4 sitting there and you say, hey, you know what, I've got 4 term sheets. I just want to be straightforward. We're going to take a week to make this decision because sometimes there's a little pressure. Hey, this term sheet's going to explode. I can tell you when you've got 4 term sheets, ain't nothing exploding. You can say—

Exactly.

We're going to make our decision on the 15th. Today is the 5th. We want to really make a thoughtful decision. And yeah, if you want it to be exploding, then I guess I'm choosing between 3. So even that concept goes away. And then all of a sudden you're left with the ability to ask questions. Hey, I want to have a follow-up meeting. Okay, great. By the way, they're coming to you now. They're coming to your office. They're going to come on your time and they're going to bring 2 partners with them. So everything qualitatively changes. That's why we really try to get founders to, when you get that first term sheet, please try to get a second or a third. And the way to do that, we give them language.

And this is basic language.

Hey, we met twice. We just got a term sheet. We're considering options. We want to do our due diligence.

Wondering if you'd like to get together and just get an update on the business. I can come to you anytime, 6:00 AM to midnight. Just let me know where and when. I can get you updated in 20 minutes.

If you say it like that, How does that sound?

How's my— how's my—

That's great. I want to meet for coffee this afternoon. Let's go.

Let's go. And I'll meet you anywhere. See, this is where, like, I think we really have to give specific language to founders at this early stage.

I like to give them that. Don't get nervous. Just tell them honestly, and I could use your counsel. If you ask for advice, you get money. You ask for money, a lot of times you get advice. It's one of those nuances. And when I had Sequoia invest in my company, let me tell you something, you get a big, big firm with a great reputation. I got 3, 4 offers after that. I didn't know how people knew I got an offer. And I had funds asking me, can we meet? We would like to give you a better offer than Sequoia. And I was like, okay, how did you know I have Sequoia? Oh, well, you know, everybody talks. To your previous point.

Everybody talks.

Everybody talks. There's a lot of talking going on. And what I said to Roelof at the time was, listen, I've got an offer that's a third more because you signed this term sheet, and they offered to fully vest me. And he said, okay. And I said, none of that matters to me, but since I got 3 offers that are a little bit more, would you be able to go up like $1 or $2 million?

He's like, okay.

And can we— okay, can we close today? Because I just don't want to be going back and forth over and over again. He said, that's reasonable. He met me a third of the way or something, and I was like, okay. I'm good. I want Sequoia. I don't, I don't want like, you know, maybe this firm will be Sequoia if I make them successful. So now let's move on to the situation of advisors. Uh, now that I'm a successful investor, I get offered advisor shares all the time, uh, but I don't have time for that, and I— it's not really what I do. But there is this advice out there: get, get some advisors, um, that could help your credibility. But then there's this other side of like, am I just giving free equity away? And what if this person promises me they're going to talk about me on their podcast, social media, introduce me to everybody, help me get patents, whatever, and they don't actually do the work? So talk to me about advisor agreements. Like, do these actually help? And if they do help, how are you supposed to structure them in the most basic fashion?

I have seen companies give out advisor grants like candy, right? It's like, oh, I've got this advisor, that advisor, this advisor, and now I have 10 of them. And even if you're only giving away a quarter percent, maybe a half a percent for somebody that you perceive to, you know, give greater credibility, but are you maximizing the value of those advisors? I think is what it comes down to. You know, you can, you can add performance. based vesting instead of just purely monthly vesting onto advisors. If you go that direction, I would say you want to use a very simple, very clearly defined milestone, not subjective at all. Anybody could pick up and read this and say, yep, that has been met, or no, it has not been met. You put ambiguity around it of like, you do a good job. No, that's not, that's not, that's not a good milestone. Right? You, you, you have any ambiguity whether the milestone has been met or not, you now have ambiguity on your cap table, which investors don't like. So you just want it to be really crisp and clear. I would also caution about not going to overcomplicate things, you know, literally just the other day, I got a like 3-page performance vesting schedule that was clearly written by The AI model of their choice and was way too complex to where I'm like, I can't even understand this.

Machines aren't exactly ready to give you the best advice ever. I mean, better than a Google search sometimes.

Sometimes, right? But in this situation, I was like, this is not the way to go.

Yeah.

You know, you, so you can, you can, if you can boil it down to like, what is the value that you really want from that advisor? If they were to do X, if they were to deliver on Y, is that going to be the value that you're hoping to get that's going to help you do whatever it is, give you the credibility within an industry, open up doors, get you access to customer base, whatever, whatever it is that you're hoping to get, be really clear about that objective. And if they hit it, great, they, they vest. The other alternative, right? If you don't want to necessarily get into that or you're having a hard time agreeing on it, or maybe it's a little more wishy-washy. In terms of I can't concretely say I want 2 introductions to these 5 folks or whatever it is, you can use simple time-based vesting. The thing to keep in mind with that is just be active about taking a look at it and saying—

Then it's on you, right, as the founder to check in and be like, hey, you know, we've been doing this for 12 months and you were going to introduce us to a bunch of investors and customers and that hasn't happened. So maybe it's time for us to wrap this up. Obviously you're too busy or you just have your lawyer send them a note, hey, we're going to discontinue this. Agreement.

Um, if you want the details on it, you can go talk to Jason.

Um, exactly right. Like advisor agreements typically have anywhere from a 7 to 14 day notice period. Meaning if you're a founder and you're staying on top of it, you can probably in the first couple of months, maybe, maybe it is a little leeway, but at a certain point it's like, ah, 3 months have gone by, 6 months have gone by and I haven't gotten anything. You can terminate that relationship and you can get back, you know, your, your equity and not let it sit out there. But you got to actually send a notice. We get that all the time too. Oh, they stopped working for us a year ago. Okay. Did you send any notice? Well, no. Okay. Well, they're still vesting then is how most of the advisor agreements are drafted. Unless there is an active termination, it just continues, which means they've been sitting out there. You think you're not using them, but they're still, they're still earning their equity.

I had this situation happen to me.

I had a founder years and years ago. said, hey, I want to give you 1% of this new idea company. You've been an inspiration.

Here's what I want your help on.

I did all the help. And then this VC joined, looked at the thing, and convinced the founder that we needed to cancel this. He cancels it. I call him.

I said, okay, your firm, beep, we'll bleep it out here.

I said, this founder and his name, I told the founder, why would you screw me? I've done all this work for you, whatever. He said, well, he told me and it's not in my hands. He's the board. And I just told the guy, and I emailed the founders of the firm. I said, just remember my name, Jason Galaganis, I don't know what I'm going to be able to do to earn this 1% back, but every founder who mentions your firm's name to me for all time, I'm going to tell them in detail this story. So are you comfortable with that? And they did. And you know what? There are 3 or 4 deals that they probably are not in now because I said, I'm going to put it on record here, tell that story and let them make their own decision. And I think probably 3 out of 3 times, they just went with the other deal because they're like, yeah, this is a— This is an issue of morality and basic ethics and doing what's right. Why would you try to screw somebody else trying to help the company? Bleep out the name, please, but I'll keep it a little spicy here. That's why behaving at the highest character level matters in Silicon Valley. Always be on your best behavior, be your best self. And if you're not your best self, all this VC would have to say to me is, you know what? I regret doing that. I'm sorry. And I would've been like, okay, I'll stand down. Now to this day, we're sitting here 15 freaking years later. I'm still perturbed by it, Becky. It's like one of the few times I ever— somebody ever screwed me. And it was like, wow, this really feels bad. This makes me feel bad. And for no reason. No reason. Yeah.

Back to it's a small world. Don't burn bridges.

It's a small world after all.

Speaking of Disney, you and I were just talking about Disney.

All right, listen, character matters. Always be on your best behavior. If you make a mistake, hey, you, you can own it and like maybe you could, uh, make it right. You know, it's always these, the opportunities here. Given how hot the market is right now, this is also when you start to see maybe people get a little bit, uh, chippy. Uh, what's the best advice when you're dealing with this as a founder? Things are getting intense.

Uh, just broadly speaking.

What's your counsel to founders when everything starts getting intense and the investors all want more equity in your company and they want you to screw the other investors? Or, you know, it just gets very, um, intense like this. How do you counsel founders for dealing with that high-level engagement that can happen when people see a cap table and say, oh my Lord, I gotta get more of it?

I would say the first thing is take the emotion out of it. The emotions are the worst. Like, I can't believe it. Like, this person did this or said that. And then all of a sudden, it's like, okay, what are we even talking about? Do we know what the issue is here? Emotions first, try to, like, just get everybody to come down a little bit.

Yes.

And I am always reminding clients of— we said, I don't know, 5, 10 times now, it's a small world. All these people are going to talk. Like, however you handle yourself today in this situation will be remembered more than the, you know, last 10 board meetings you did or other conversations that you had with them if it appears to be kind of a more aggressive behavior or even perceived that way. So, you know, taking a step back, understanding it. Oftentimes it's okay if you can't do that. Like, I can help by providing talking points of how you, how you can approach it, what you can say, what you should try to avoid saying. But if the emotions are too high, it may be, okay, well, business person, you don't have the conversation. Just have the lawyers have the conversations. We can just talk about it and not have those emotions tied to it and really get to the bottom of it. Sometimes—

This is what I should have done in my situation.

People agree. It's not that they're not that far apart. Um, uh, when we can actually have the conversation, sometimes—

This is what I should have done, Becky.

I should have called you. I should have let my emotions calm down. And I should have let you just write that little email like you did for me in the other situation that was later. And we worked that one out because I calmed my emotions down.

I said, let's not take this personal. And I went to you and got a little spicy and we'll talk about the situation, but you cleaned it up for me. And, and this is where having the right partner matters. That's why Becky is my partner. Wilson Sonsini, WSGR.

Thank you, Dave.

Thisweekinstartups.com/basics.

Thank you, Becky.

Thank you. Thank you for all the kind words.

Hey, listen, it's just you've been very strategic for me. And you can— I'm an emotional person. Most founders are. A lot of people get into this, they, they have big emotions. That's part of the superpower, right?

It's a baby.

Yeah, and it's your baby. And that's why having good counsel, good attorney, you know, you got a good accountant over here, just good counsel to say, okay, What is the goal? What is the actual goal here? Let's work towards that goal and let's take the emotion out of it and let's give you the tools you need to get there. Becky, thanks again.

Thank you. Thank you.