How comfortable are you in funding your start-up?
The boom of the start-up scene globally have raised awareness on the saleability of skills which we once thought are better used for employment. Ambitious and dreamy, many start to build their business plans and go to the design board to start their dream enterprise following their ambitions. Definitely, that’s a plus in the global economy with enterprise monies flowing into the monetary system.
Problem starts to creep-in when owners realise that they don’t have the knowledge to start their business — often times when it’s too late. Funding schemes is one of the most common challenge areas for new entrepreneurs. Easy peasy — new entreps typically decide to go with incorporating their businesses as a corporation. However, confusion starts to kick-in when the would-be owners come to realise that they need to split the equity ownership in the business.
Funding structure is a critical concept that entrepreneurs need to understand when assigning equity allocations. The structure of the funding is not necessarily how profits can be shared among owners. In short funding is not equal to profit allocation.
There are theoretically two ways to fund your business — debt and equity. While debt financing can be easily understood as borrowings from banks or even relatives, equity financing is typically just equated to the issuance of ordinary share capital. In the context of the typical start-ups, the incorporators will be the founders themselves and the shares are divided equally among the founders.
Is that how things should be structured? I’ll have to say no. I’ll try to give three compelling reason why it shouldn’t be the case.
Funders deserve the icing
Not because the idea is shared among you means that all the business profits needs to be shared equally among you. Those who were willing to shell-out their wallet to fund the business needs are entitled to the icing for funding the business. Think of this just as a borrowing from the funders instead of the bank which would require you to pay for outrageous rates of interest plus the requirement to mortgage a tangible asset. Who doesn’t deserve at least the residual earning after all the investment made into the business?
Share holdings is not equal to profit share
The number of shares held by the funders entitle them only to dividends which would come from the retained earnings of the company. Meaning, there will be dividends on rainy days, but when the draught hits, they suffer far worse. Profit sharing schemes for start-ups should be a mix of salary, salary sacrifices and dividends. Isn’t it right to get salary when you’re working for the business?
Salary sacrifice
The ultimate question is how will the other co-founders who haven’t invested due to lack of capital get to invest in the business they co-founded? Easy — invest your salary into the business. There’s no free lunch, you can’t just take salary and expect that your bright idea will get you your fair share of dividends as well. Isn’t it just (fair) for you to invest if you want to own a piece of your business?
Managing the start-up founders expectation is a critical task for the lead founder and funder. How you structure your business is critical for the long-term success of your business. Now, how comfortable are you that you know how to structure your business for success?
