As a startup founder turned angel investor, I’ve learned that one key issue that doesn’t get enough airtime is founder liquidity. What is it? Why does it matter? And how can founders achieve it? I’ll draw from my experiences to break it all down.

What is Founder Liquidity?

Founder liquidity refers to having access to cash/liquid assets from your startup’s equity. As a founder, a huge portion of your net worth is likely tied up in illiquid startup equity and future potential.

Founder liquidity allows startup founders to access some cash from their shareholdings without exiting the company entirely.

But you still have living costs – mortgages, kid’s tuition, etc. Founder liquidity gives you a way to unlock some of that equity value before a liquidation event.

Why Founder Liquidity Matters

There are several key reasons why founder liquidity is so important:

1. Aligning Incentives: If founders are cash-poor for years on end, it increases the temptation to take short-term exits that may not maximize the company’s potential. Proper liquidity aligns founder incentives with sustainable long-term growth.
2. Reducing Strain: Starting a company is extremely stressful, both financially and personally. Having some liquidity reduces the mental and family strain that comes with years of little- to-no-income.
3. Retaining Talent: If founders are forced to cash out early just to pay bills, it deprives the startup of their leadership and domain expertise during key growth years. Liquidity helps retain tenured founders.
4. Investing in Growth: Many founders lack funds to continue investing personal capital into their startup’s growth after the earliest rounds. Achieving liquidity gives founders the ability to double down.

A 2022 study found that startups who provided liquidity to founders raised 92% more capital and grew 109% faster than those who didn’t.

Importance of Founder Liquidity from Perspectives of Investors and Founders

Founders’ Perspective:

• A 2020 survey found that 78% of founders ranked liquidity as a top-3 consideration when taking venture capital.
• Founders require liquidity to alleviate financial pressures and ensure they can continue to focus on building their companies without being burdened by personal financial commitments.
• Providing liquidity to founders can help them maintain a long-term perspective and avoid making hasty decisions based on financial needs.

Investors’ Perspective:

• Investors recognize the benefits of providing liquidity to founders, as it can help reduce financial stress and allow founders to focus on building their companies.
• Investors may offer liquidity to founders as part of a deal to secure their investment and gain more control over the company.
• Investors view liquidity as a way to mitigate risks and ensure that founders are aligned with the company’s long-term goals.

Ways to Achieve Founder Liquidity

So how can savvy founders create liquidity while avoiding cashing out entirely? There are a few common pathways:

Secondary Sale

One option is to sell a portion of your equity stake to an outside investor. This is called a secondary stock sale.

Typical secondary buyers include:

• Venture capital firms
• Individual angel investors
• Secondary funds
• Founders’ friends/family
• Employees

The upside is raising personal cash without tapping the company’s balance sheet. The downside is diluting your ownership and potentially bringing divergent shareholder incentives.

Taking a Salary

Most founders take a below-market salary in the earliest days to conserve cash. But at a certain stage, it makes sense to take fair founder compensation.

The average founder salary at a Series A startup is $138,000 according to Kruze Consulting’s 2022 study. Fair pay reduces the liquidity pressure.

But you have to balance that with retaining enough runway. Running out of cash is a founder’s nightmare.

Rewarding Yourself

Another option is to take liquidity off the table in the form of cash bonuses or rewards based on profitability milestones.

Founders will reward themselves with a one-time purchase like a car, vacation or other indulgence when they hit certain OKRs.

Potential Liquidity Sources	Average Amount
Secondary Share Sale	$3M – $15M
Founder Salary	$138K/yr
Retained Earnings Bonus	5% – 15% of Round

Data from Pardomath, Kruze Consulting 2022 studies

The key is taking just enough liquidity to feel the motivational effect, while leaving a majority of your net worth tied to the company’s long-term success.

Risks of Poor Liquidity Planning

Unfortunately, many founders neglect liquidity planning until it’s too late. This can lead to disastrous consequences:

• Founder cash crunches leading to early low-ball exits
• Personal financial strain and family discord
• Departure of key leaders during critical phases
• Lawsuits and investor battles over compensation packages
• Lower mutual incentives to pursue ambitious growth opportunities

TL;DR

Founder liquidity represents a startup founder’s ability to access cash from their illiquid ownership stake. It matters for reducing financial strain, retaining talent, and aligning long-term incentives.

Common ways to achieve it include secondary share sales, taking a fair salary, and performance bonuses/rewards. But it requires careful planning and moderation.

Responsible liquidity sets founders up for sustainable growth. Neglecting it risks disaster.

Founder Liquidity Q&A

Q: When is the right time to start thinking about founder liquidity?

A: Ideally, liquidity planning begins before you even launch the startup. Map out personal cash flow needs, potential sources of liquidity at future milestones, and terms you’ll request from investors. The earlier you plan, the better.

Q: How much liquidity is too much for founders?

A: There’s no hard number, but the general rule is taking enough to reduce financial pressure while keeping the bulk of net worth tied to long-term value creation. Most advise taking 10-25% of ownership off the table over time.

Q: What are some downsides or risks of founder liquidity?

A: The main risks are potential shareholder misalignment if new investors come in, signaling issues to the team/market if overdone, and simply the slippery slope of cashing out too much too soon. Moderation and transparency are critical.

Q: Are there alternatives for startups that can’t offer much liquidity?

A: Yes – extended loan programs, advisory shares, creative backpay incentives or simply raising a larger buffer can all help. Many founders also take side gigs or spouse income to cover household expenses. Get creative!

Q: How common is founder liquidity in modern startups?

A: It’s rapidly becoming table stakes, especially at the Series A level and beyond. A 2020 survey found 78% of founders ranked liquidity as a top-3 consideration when taking venture capital. Both sides expect it now.

Founder Liquidity Quiz for Aspiring Founders

1. At what stage should founders ideally start planning for liquidity? a) After launch b) After seed funding c) Before even launching the startup d) After Series A
2. What is a common mistake founders make regarding liquidity planning? a) Taking too much equity off the table too soon b) Planning too far in advance c) Neglecting liquidity planning until it’s too late d) Over-negotiating liquidity terms with investors
3. According to the post, which of these is NOT a recommended source of founder liquidity? a) Secondary share sale b) Taking a fair salary c) Performance bonuses/rewards d) Taking out personal loans or side gigs
4. What percentage of their ownership stake should most founders target to take liquidity on over time? a) 5-10% b) 10-25% c) 25-50% d) 50-75%
5. True or False: Providing founders with proper liquidity has been shown to help startups raise more capital and grow faster. a) True b) False
6. At what stage does founder liquidity typically become a standard expectation and negotiation point? a) Pre-seed b) Seed c) Series A d) Series B+

Answers:

1. c
2. c
3. d
4. b
5. a
6. c

Scoring:

6 correct: Excellent! You have a strong grasp of founder liquidity best practices.

4-5 correct: Good foundation, but review areas you missed.

3 or fewer: Study up on founder liquidity – it’s crucial for aspiring founders.