The pros and cons of founder lock-in

by Benjamin Kuo

There's been a debate going around recently about how important it is for the founder of a startup to be locked into a company, and how much they should be living "hand to mouth" versus being paid well when running their startup. In particular, there are a fair number of investors, and startups themselves, who believe that founders should be paid well below market, basically enough to cover their basic living expenses, as an incentive to work as hard as possible to make their companies a success. The theory is that someone whose entire livelihood and future is dependent on the success of their business will be that much more committed to making a company work (ie, because you have to make the company a success in order to survive, you'll make it a success).

Although there are merits to the approach (highly paid founders are not a formula for keeping your burn rate down, for one), the problem in recent years has been that the time that founders–and for that matter, employees–are locked into a company has dramatically gotten longer in recent years, with lack of exit opportunities.

Mark Suster makes the argument recently that founders should be allowed some way to take money off the table even if a company has yet to hit an exit opportunity. It's a theme I've been hearing a lot lately, from such efforts as Startup Exchange–which allows founders to trade shares into a common pool and reduce their risk– and SharesPost, which allows founders to sell their stock on an online marketplace. Sometimes, for more mature companies, it's cash-out during a financing round. In any case, the debate highlights a bigger issue not just for founders, but for employees.

Long time employees of startups, are usually given some percentage of the company when they start, and usually in exchange take a lower salary. The problem is the formula isn't working like it used to, and cash out of a deal now is rarely "life changing," except in the rare, really big exits. The vast majority of startup employees, unless they are paid market wages, aren't going to see an equivalent return from their options. I've talked to numerous financial advisors specializing in startups, and they all tell me that–unless someone is a founder at the company, and it has not taken significant venture capital dilution–employees are not getting meaningful amounts from acquisitions today.

Perhaps it's all just another symptom of the changing venture capital industry, where there's just not enough big, IPO-sized exits, but it seems like this is one area where startups and investors are going to have to figure out a new business model, where both founders and employees feel like they have a reasonable chance of either an exit, or at least some minor reward and diminished risk, in order to commit the 5, 7, or 10 years of their lives it might take to build a successful company.