Should Founders Work for Free?

Reflecting on Salvatore Stella, Founder of Tessilo, Ltd.

Part of my study in the university is the (group discussion) which each student will need to write a small discussion (max 200 words).Please refer to the attached word doc for the questions and more information.Part of my study in the university is the (group discussion) which each student will need to write a small discussion. Following is the questions:

Should the founder work for free?

Reflect on the founder of Tessilo, Ltd., Salvatore Stella, and answer the following questions:

-Is it in the best interest of the founder and the venture for the founder to work for free? Explain your answer.

-Some term sheets specify that the founders need to give their shares to the company and then earn them back over time as part of a share-vesting scheme. Is it appropriate to ask founders to do this? Under what circumstances?

-Why are government agencies and pension funds choosing to invest in VC? I would assume it is linked with diversification of their portfolios and trying to balance returns versus risk. Perhaps they are choosing evergreen funds too, so the time horizons are longer in accordance to the pension needs. 

-How appropriate do you think it is for government and pension funds to invest in VC? Explain your answer. I would hope that there is a very careful Due Diligence on the funds and individuals in which the government and pension funds are investing. Although historical success does not define the future, it is still one of the main characteristics I would look for. I would also argue that it MAY be appropriate so long as the risk and returns are well calibrated. There is certainly an argument to say that the government in particular should invest in the future enterprises that will drive GDP in the future.  

-Why are government agencies and pension funds choosing to invest in VC? I would assume it is linked with diversification of their portfolios and trying to balance returns versus risk. Perhaps they are choosing evergreen funds too, so the time horizons are longer in accordance to the pension needs. 

-How appropriate do you think it is for government and pension funds to invest in VC? Explain your answer. I would hope that there is a very careful Due Diligence on the funds and individuals in which the government and pension funds are investing. Although historical success does not define the future, it is still one of the main characteristics I would look for. I would also argue that it MAY be appropriate so long as the risk and returns are well calibrated. There is certainly an argument to say that the government in particular should invest in the future enterprises that will drive GDP in the future.  

Is it in the best interest of the founder and the venture for the founder to work for free?

-Why are government agencies and pension funds choosing to invest in VC? I would assume it is linked with diversification of their portfolios and trying to balance returns versus risk. Perhaps they are choosing evergreen funds too, so the time horizons are longer in accordance to the pension needs. 

-How appropriate do you think it is for government and pension funds to invest in VC? Explain your answer. I would hope that there is a very careful Due Diligence on the funds and individuals in which the government and pension funds are investing. Although historical success does not define the future, it is still one of the main characteristics . I would also argue that it MAY be appropriate so long as the risk and returns are well calibrated. There is certainly an argument to say that the government in particular should invest in the future enterprises that will drive GDP in the future.  

-Is it in the best interest of the founder and the venture for the founder to work for free? Explain your answer

- Not every entrepreneur is financially able to withhold a salary. Founders with families or mortgages might be dependent on a specific income level. However, refusing to take a salary might ensure both investors that the founding team is highly dedicated to use any additional cash flow to secure company growth. In economic down-terms, these might be inevitable questions that could save the business (if the founding salary is seemingly too high). Overall, I think a good balance is a way forward. If the team is young enough and can withhold a salary for a certain time period, then receiving a pre-determined salary once the business is making a financial income sounds reasonable.

-Some term sheets specify that the founders need to give their shares to the company and then earn them back over time as part of a share-vesting scheme. Is it appropriate to ask founders to do this? Under what circumstances?

- To pick a side: I would disagree with this approach. Most founders are primarily motivated by the idea that they hold true. Their motivation and dedication to the concept involve seeing the business succeed for many years to come. Although some, might be motivated by a potential exit scenario, or some sort of monetary reward, others want to hold a certain share percentage to keep say in how the business should run and where it ought to go. Asking a founder might demotivate their ambition and keep them from being true to the team or business idea.

Share-vesting schemes and asking founders to give their shares to the company

-Why are government agencies and pension funds choosing to invest in VC? In recent years, Venture Capital has emerged as a way of investing to generate respectable returns, especially when the GPs of a VC Firm have a respectable track record of success. In addition, Venture Capital investments, in general, deploy their financial resources into start-up companies that show tremendous potential for returns. For example, some metrics used to evaluate a start-up investment utilise multiples instead of percentages vis a vis the Financial Markets for publicly traded companies. As @Ian Metcalfealso mentions, above, it can reduce the variance of a portfolio when a group of assets co-vary with one another, thereby reducing the beta of a portfolio of assets.

-How appropriate do you think it is for government and pension funds to invest in VC? Explain your answer Using traditional wealth management philosophies, a VC fund would not be suitable or appropriate for a Pension Fund or Government to invest in due to the risk return profile. While this may be true when evaluating the investment in and of itself. However, it is worth pointing out that when taken in the context of having a VC Fund as part of a portfolio of assets classes - Fixed income, equities, REITS, etc - it could be very well be argued that it adds Alpha returns to the portfolio while reducing the Beta of the portfolio as a whole. 

-Why are government agencies and pension funds choosing to invest in VC? In recent years, Venture Capital has emerged as a way of investing to generate respectable returns, especially when the GPs of a VC Firm have a respectable track record of success. In addition, Venture Capital investments, in general, deploy their financial resources into start-up companies that show tremendous potential for returns. For example, some metrics used to evaluate a start-up investment utilise multiples instead of percentages vis a vis the Financial Markets for publicly traded companies. As @Ian Metcalfealso mentions, above, it can reduce the variance of a portfolio when a group of assets co-vary with one another, thereby reducing the beta of a portfolio of assets.

-How appropriate do you think it is for government and pension funds to invest in VC? Explain your answer Using traditional wealth management philosophies, a VC fund would not be suitable or appropriate for a Pension Fund or Government to invest in due to the risk return profile. While this may be true when evaluating the investment in and of itself. However, it is worth pointing out that when taken in the context of having a VC Fund as part of a portfolio of assets classes - Fixed income, equities, REITS, etc - it could be very well be argued that it adds Alpha returns to the portfolio while reducing the Beta of the portfolio as a whole. 

Opinions and insights from university students

-Why are government agencies and pension funds choosing to invest in VC? In recent years, Venture Capital has emerged as a way of investing to generate respectable returns, especially when the GPs of a VC Firm have a respectable track record of success. In addition, Venture Capital investments, in general, deploy their financial resources into start-up companies that show tremendous potential for returns. For example, some metrics used to evaluate a start-up investment utilise multiples instead of percentages vis a vis the Financial Markets for publicly traded companies. As @Ian Metcalfealso mentions, above, it can reduce the variance of a portfolio when a group of assets co-vary with one another, thereby reducing the beta of a portfolio of assets.

-How appropriate do you think it is for government and pension funds to invest in VC? Explain your answer Using traditional wealth management philosophies, a VC fund would not be suitable or appropriate for a Pension Fund or Government to invest in due to the risk return profile. While this may be true when evaluating the investment in and of itself. However, it is worth pointing out that when taken in the context of having a VC Fund as part of a portfolio of assets classes - Fixed income, equities, REITS, etc - it could be very well be argued that it adds Alpha returns to the portfolio while reducing the Beta of the portfolio as a whole. 

Think it depends on the stage of the company and the amount of money that has gone in, but generally the founder should be paid. When getting the venture off the ground and before money goes in, the founder obvious cannot get paid, but once seed financing has gone in it would seem appropriate that the founder gets a small amount of money to pay for living expenses. Once VC money has gone in the founder should get proper compensation split between salary and stock options.

Don't think that founders should give up their equity as part of the financing round and then have to earn it back. Further incentives should come through stock options and the fact that their current equity position is meaningless if the company is not successful.

All in all, I think it's in everyone's best interest to keep the founder happy and focused. It doesn't do anyone any good if the founder has to worry about monthly bills. But the salary may be lower compared to working for a large corporation and the real compensation could come through equity and additional stock options. 

Is it in the best interest of the founder and the venture for the founder to work for free? Explain your answer As the Nobel prize winning Economist, Milton Friedman, used to say: there is no such thing as a free lunch. From the point of view of an entrepreneur that is bootstrapping a promising start-up, the founder may choose to take pay that is commensurate with the stage and lifecycle of the company. I think the question should really be when. In certain  instances, a founder may choose to take compensation as an advance to the company if the cash flows will not permit an actual distribution because it may still be in the formative period. When the enterprise is funded, however, I feel that founders salaries should be 80% performance-based. The incentives could come in many forms: Stocks, Bonds, Options, Warrants or other derivatives - depending on the financial sophistication of the company. ESOPs are also another good way to compensate founders in their capacity as employees. In their capacity as owners, they're compensated by the capital gains or unrealised gains from the shares they own.

Some term sheets specify that the founders need to give their shares to the company and then earn them back over time as part of a share-vesting scheme. Is it appropriate to ask founders to do this? Under what circumstances? A resounding "no". The only circumstance that I can think of where a share-vesting scheme is tenable would be when an investor buys their shares at a discount during the initial seed stage round. Insodoing, this ensures that the principle of value-in-exchange is sustained and that entrepreneurs are motivated to continue to perform if they intend to still be a part of the ownership of the company. In any other case, I think a share-vesting scheme without anything in return is a recipe for disaster.