A blog reader (one of three, as far as I can tell) asks:

I was wondering: do some startups only pay equity? I am thinking of launching a startup and I think I have a killer idea — there are very low equipment costs, etc, the only costs are labor and marketing, so I was trying to eliminate labor as an up-front since I have the personal capital for the needed initial equipment.

Yup, in some cases, people work for only equity (at least for some period).  Of course, any person in this “mode” needs some other means of cash support:  financial independence, a working significant other, or a willingness to dip into savings.

However, it gets tricky with multiple people not all in the same situation.  For example, if you’re paying Bob a salary, but not paying Fred, Fred can rightly ask, why are we carrying Bob’s salary and not mine?  You could give Fred more equity to make up the difference, but it can be hard to translate between equity and salary cash.  It can get delicate very quickly.

Also, in my experience, it’s very difficult to get folks other than your closest friends & co-founders (that already know you) to work for just equity.  Everyone else will need a lot of convincing the equity will be worth something.

A while back, my friend George (all names changed) hired someone who previously worked for Fred, another friend.  Unfortunately, the hire didn’t work out and left in a few months.  Later, Fred said something like, “Yes, George called me for a reference, and I gave him Really Big Hints to not hire him!”

I’ve written previously on hiring.  Within the hiring process, a set of deep, well-done reference checks is absolutely critical.  You can spend hours with someone  in multiple meetings, but there’s no substitute for talking to a previous manager, peer, or report who’s worked closely with the candidate.

In a reference call, you’re (a) validating the Good Stuff the candidate has already told you, and (b) looking for things that you haven’t been told but should know.  We’re all human, each with our share of imperfections.  But most folks don’t spend enough time digging for those imperfections.  It’s tricky, because social norms, psychology, and liability concerns make it hard for most people to “say anything bad” about a candidate.

Your job, when doing a reference check, is to dig deep, and to make it safe & OK for the reference to tell you what you need to know.

A common provision in venture funding agreements (it’s usually in the term sheet) is that the company pays the investor’s legal bill.  It’s annoying, but quite typical.

Let’s say you’re raising a $1m round, and have to pay the investor’s $25k legal bill.  So, in effect, you’re raising only $975k, but you’re giving up $1m worth of the company to get it.  Why doesn’t the investor just give you $975 and pay their own expenses?

By passing the expense through the company (by investing first, then having the company pay), the investor is getting additional equity for the expense, or equivalently, a small discount on the pre-money valuation (about 2.5% in the example above).  For this reason, investors are generally incented to pass as much company-related expense as they can through the company.

In most cases, the amount reimbursed by the company can be capped.  (And a low cap can help keep the investor focused on keeping the investment terms simple and the legal bill reasonable).