I had an interesting conversation recently with an experienced entrepreneur who recently became the new CEO at a promising tech-driven startup here in Wisconsin. He shared with me some of the “cleanup” needed when he arrived at the company, including several items that needed fixing before the company could seek needed additional financing. One of the items was an all too common mess that delayed the financing for several months, absorbed more than $7,500 of legal fees and, even more frustrating, cost the company a handful of additional equity points to cleanup. The problem? The company had blessed a prior manager with a “no-cut” employment contract: essentially, a deal that said the prior executive could not be demoted or let go other than for cause absent a hefty severance payment.
So what’s wrong with that, you ask. Well, the simple answer is that these kinds of agreements – as common (not really, but to some extent) as they may be for high level execs in the big business world, just don’t work in the early stage world, at least not if the business needs to raise venture or other risk capital. Absent some sort of very special circumstance – I suppose a situation where, say, the executive in question is someone like Bill Gates or Steve Jobs – venture investors (and even sophisticated angels) just won’t invest in companies that have “no-cut” employment deals with team members. Whether you think that is fair or not, it is what it is.
The obvious reason investors avoid deals where team members have “no-cut” contracts is simple: high impact startups are generally cash challenged, very stressful, very fluid environments that reward people – investors and managers – who can move, and be moved, fast and without material financial expense. Related to that, if perhaps more subtle, is another reason: an executive who wants a no cut contract in the startup environment (i) does not understand the “rules of the road” for these kinds of companies and/or (ii) is by nature too insecure to work in the high impact startup environment. Managers who want the kind of security that “no-cut” employment contracts offer just aren’t cut out for the rough and tumble world of the high risk/reward environment of the high impact early stage company.
The take home message here is simple: if you are a founder/co-founder of a high impact startup that will need outside capital, don’t expect a fancy employment agreement, and don’t give one to someone who says that is the price for coming aboard: you’ll regret it later, and just the act of insisting on such a deal is a very good predictor that the manager in question is not right for the job.