Overview

Equity Merchants

Most startup equity is worthless until ONE of these happens:

Successful exit (rare)
Acquisition (also rare)
IPO (even rarer)
Until then? It's just numbers on paper. No dividends. No real value. Just promises.And most startups never reach these milestones. I have advised over 500 founders and seen first-hand how the allure of equity can lead both entrepreneurs and employees down a dangerous path. Today, and over the next few editions of this newsletter, I will explore the equity dilemma facing early-stage startups. I’ll explain why the common practice of dishing out equity like sweets is a recipe for disappointment and conflict. From overvaluation to governance nightmares, from vesting schedules to dividend discussions, we'll cover the critical issues that every founder and potential equity holder needs to understand. Our startup ecosystem is overdue for a reality check. Whether you're a founder looking to build a sustainable company or an employee considering an equity offer, I am about to challenge everything you thought you knew about startup equity.

The Equity Illusion
Imagine promising your unborn child to marry someone's son when your wife is just one month pregnant. You don't even know if you're expecting a boy or a girl. You don't know if they’ll grow up to like each other. You don’t know if the pregnancy will be successful. There's so much uncertainty around it. But then, the other person who you are making the commitment to, you are asking him to give you clear assurances and pay the bride price in advance. This is what early startup equity often represents.

We've all heard the story: the person who painted Facebook's first office took equity instead of cash and became a millionaire. It's a great story, but it's also incredibly rare. For every Facebook painter, there are thousands of employees who accepted below-market salaries for equity that never materialised into anything of value. They traded real work NOW for potential value LATER, and often ended up empty-handed. But the harsh truth is that the vast majority of startups never reach the milestones that would make their equity valuable:

Successful exits: These are rare. Most startups don't make it to this stage.
Acquisitions: Also uncommon. Even if a startup is acquired, the terms may not benefit all equity holders equally.
IPOs: The rarest of all. Going public is a dream that few startups achieve.
Until one of these events occurs, startup equity remains just numbers on paper. No dividends, no real value, just promises of a potential future payoff.

The hidden costs of early equity distribution
When founders dish out equity like it's sweets at a children’s party, they're often unaware of the hidden costs that come with this approach. Equity-holding employees are equally unaware of

For Founders
Startup founders often fall into one of two traps:

Overvaluation: Caught up in their vision, founders might say, "My company is worth a million dollars!" But based on what metrics? This optimism can lead to inflated expectations and future disappointment.
Undervaluation: Some founders, eager to attract talent, might undervalue their company. "What's 5% now? We'll make it big later!" This can result in giving away too much control too soon.
Both scenarios lead to problems down the line. Overvaluation can lead to disappointed employees when reality doesn't match expectations. Undervaluation can leave founders with little control over their own company. Meanwhile, as your startup grows and takes on more funding, early equity holders often face dilution. That 2% that seemed so valuable at the start might become 0.2% after a few funding rounds. Have you communicated this possibility to your equity holders?

The Motivation Mirage
Many founders use equity as a tool to create a sense of ownership among employees. The idea is that equity holders will be more motivated to contribute to the company's growth. It’s all well and good, but what happens when years pass and that equity still holds no real value? What happens if:

The company is acquired before they're fully vested?
The startup shuts down?
They leave after the cliff period?
Most equity agreements don't clearly address these scenarios, leading to confusion, disputes, and often worthless equity.

For Employees
When you offer equity, especially to early employees, you're asking them to trade certain work NOW for uncertain value LATER. The employee accepts a below-market salary for equity, works tirelessly for years, only for the company not to break even.

Meanwhile, most equity-holding employees never see:

Audited company accounts
Regular financial reports
Annual General Meetings (AGMs)
So, as an equity-holding employee, you are an "owner" without owner's rights. You have no say in major decisions, no insight into the company's true financial health, and often, no real way to benefit from your equity until a major event occurs.

Equity in early-stage startups is not a golden ticket. It's a complex tool that needs careful handling. But what if there was a way to address these issues and provide more immediate value to equity holders?

Why startups should consider paying dividends
When we talk about “startup equity”, the conversation usually revolves around future value—the big exit, the IPO, the acquisition. Almost no one ever mentions dividends.

You might be thinking, "Dividends? In a startup? That's crazy talk!" But hear me out. Paying dividends as a startup is a good idea because:

It proves business viability: Paying dividends shows that your business model works and generates real cash.
It gives immediate value to shareholders: Instead of always deferring value to some hypothetical future, dividends provide tangible returns now.
It forces financial discipline: When you have to consider dividend payments, you're forced to manage your finances more carefully.
I believe that any startup serious about long-term sustainability should initiate the dividend conversation after five years of operation.

Why five years? Most businesses that fail do so within the first five years. Surviving five years suggests you've built a sustainable framework and your business is a "going concern" with reduced likelihood of major challenges. After five years, if you're not considering dividends, you need to ask yourself why. I can hear the objections already: "But we need to reinvest all profits for high growth!" In the next newsletter edition(s), I'll dive deeper into how startups can implement dividend strategies without sacrificing growth. We'll explore innovative approaches to balancing shareholder value and reinvestment, challenge conventional wisdom about startup finances, and highlight the legal considerations.

Credit: Omoruyi Edoigiawerie