Take (some) money off the table

I have been a multi-millionaire multiple times in my life. On paper. In hard tangible assets, I am currently worth not even a half million dollars, after four (or more) companies. How did that happen, and what did I learn? Read on.

One of the things you learn in spending over a decade as an entrepreneur is that you win some and you lose some. Of course you’re always hoping for the big wins. To sell your shares on the public market for tens of millions of dollars. And one thing that lets you stay in the game, even if you lose, is taking money off the table.

Taking money off the table

So what does ‘taking money off the table’ mean?

In gambling terms, it means when you’ve got a big pile of chips that you’ve won in front of you, taking some of them off the table and only betting with what’s left.

And it means the same in entrepreneurship. It’s risky to run a business. Even when everything looks like it’s going well, you never know what’s around the next corner. Often this is nothing to do with the business itself: it’s something that happens within the team, or poor management of the board by the CEO. (I have many lessons here. IncMind is the result of some of them.) When things don’t go as expected, people fight. When things go better than expected, people fight. (One of the biggest fights I ever had was when I succeeded in raising a VC round against the expectations of my co-shareholders. I digress.)

How do you personally manage that risk? By making sure you diversify your portfolio. By turning some of your shares into cash.

Note that I say ‘some’ of your shares, not ‘all’. If you believe in the future of the company, you want to own a big piece of it. And starving entrepreneurs who risk losing everything if the company fails aren’t in a smart position, either for them or their shareholders.

What happens if you cash out on, say, 10% of your shares for $100,000? And then later on you take another 10% off the table for $300,000?

In the ‘worst’ case, your shares if you hadn’t sold end up being worth, say, five hundred million dollars. And you personally only have $400M. You lost out on a hundred million dollars in return for only $400,000 in cash.

Oh no! How will you manage … with the only four hundred million you have left??!!?

In the ‘best’ case, your shares end up worth nothing. In this case, you walk away with $400,000 instead of pieces of worthless paper.

Clearly, taking money off the table helps. It turns entrepreneurship from an ‘all or nothing’ game into a ‘big something vs. a small something’ game. In a game where you have a high chance of failure, walking away with something every time lets you keep coming back to the table.

So this sounds great in theory. How do you do it in practice? How do you actually go about selling shares in an early stage company? There are three times to think about selling your shares: when you leave the company, when the company has a financing and between financings.

Selling shares on leaving a company

A sale on departure is what I did in my first company. This is still my biggest exit to date. If you think you are a key part of the company’s success, then it makes a lot of sense to sell shares, even if you think the company will do really well.

I still remember the agonizing I went through in selling those shares. I kept thinking of how much money I was missing out on, especially since I was selling my shares at something like 70% of their face value at the time. The honest truth is you don’t know what will happen with your company after you leave. I’ve very happy now that I sold what I did, when I did.

The best time to negotiate a sale is before you officially have left, when you still have some leverage. This is often a great condition to give to people. ‘Sure, you want me to leave? I’ll walk away quietly if you buy back (some of) my shares. You must feel the company is more valuable without me than with me: I’ll even give you these shares at a 20% discount to current market price.’

I’d say 30-50% of your shareholding is about right: as much as they will take, while still letting you keep some stake in a company you built.

Note: no matter the promises about involvement after you are gone, the reality is you are almost certainly not involved at all. That means that it is easy for later investors (some of who do that sort of thing) to say ‘he’s not a productive part of the team any more, why does he have shares, let’s squeeze him out’. Watch the Facebook movie to see this in action on Eduardo. So when you’re leaving, sell a big chunk. Even if the company does well, the shares you have left may not be worth much.

In fact, you may consider putting a buy-back of some shares on departure into your employment agreement right from the first day. Talk to a lawyer on how to structure it: probably it’s best as a fixed cash payment (which is easiest to enforce), with you returning a corresponding amount of your shares to treasury. This may be hard to enforce if you leave at a cash-tight time. And it’s worth doing everything you can to get enforced.

Selling shares on a financing

The time when cash is normally most available is when the company is doing a financing. At this point outside investors want to buy shares, and there is a clear market price.

Of course, if key team members want to sell shares, this is a bad sign. So keep the percentage of the shares you sell small, say around 5-10% of your holding. Make it clear that you are doing this for risk diversification only, and to allow you to focus on work without having the distraction of you or loved ones being stressed about your personal financial situation.

This used to be considered a very poor thing to do. Now it is becoming more acceptable among sophisticated investors.

Bring it up an early date with your board and/or lead investor, when the financing is first being discussed. And do everything you can to sell that small piece, as a general rule.

Your investor has a diversified portfolio, and can afford to lose 100% on your investment and still be fine overall. Your portfolio is not diversified: if the company goes under, you will feel major pain. (If you want to know why I am worth less than a half million today, the reason is I didn’t sell any shares in my last business. I wish I had.)

Selling shares between financings

Selling shares between financings is one of the hardest things to do. In theory you can always do that: you just need to identify a buyer.

The best buyer to get is typically one of your existing, larger shareholders. You’ll almost certainly need to sell them your shares at a significant discount (e.g., 25-30% to market price). And it’s still a useful way to take some money off the table if you haven’t yet.

Approach them carefully, and have a frank conversation. It’s not in their interest to have founders living with overwhelming personal financial pressure. And if you are only asking to sell a small fraction of your shares, they may consider it.

It can be an uncomfortable conversation to have … and you may end up thanking yourself later for having had it. Thanking yourself for having taken that money off the table.