Thursday, July 22, 2010

Bootstrapping: Raise Debt From Your Employees

When we started Mixer Labs (acquired by Twitter in December) we were not paying ourselves and did not have any cash to pay others.  There were a number of people who worked for us part time while we were still figuring out what product to build.  We structured things with them creatively, and this ended up being a win on both sides.

Raise Debt From Your Employees, Not Investors
Raising money from investors can lead to a lot of value in terms of advice, ability to grow the startup etc.  but it is a good idea not to raise money too early.  We wanted to build a prototype of what we had before going to market, with the thinking that this would increase our valuation.  One way to be able to hire someone but not raise money is to effectively raise debt from the people who want to work for you.

The Option Vs Cash Approach
One of the things that was successful for us in the early days of Mixer Labs was to effectively raise debt from people working for us part time.  We structured the agreements as follows:
  • The people working for us as consultants would accrue $x per hour worked
  • Upon successful fund raising, we would pay the consultants either:
    • Cash if they did not join the startup (i.e. whatever we owed them)
    • Cash if they joined the startup and wanted to get paid in cash
    • Options if they joined the startup and wanted to participate more in the upside of the company
This gave the consultants a potential stake in the company without creating an instant shareholder -which paying directly in equity would do (we only wanted people committed to the long term success of the company to own equity and there are a number of other reasons to want to limit the # of shareholders you have).  It gave the consultant an additional reason to convert to a full time employee with funding.  And it made sure that whoever worked for us got to get paid in cash when we could afford to pay them (if that was their choice).

The True “Cash Only” Approach
Another option you can follow is the split payment method.  E.g. say a consultant wanted $80 an hour (using a nice round number for ease).
  • Pay the consultant $20 an hour now out of your own pocket.  The consultant will feel sure they will make something out of working with you.
  • Pay the consultant $80 an hour for accrued hours when you raise money.
This is more expensive then just paying $80/hour now, but if you don’t have the cash available you pay a little more in the long run but end up with much less personal outlay up front.

Any other creative ways you have seen to get employees or contractors on board?  Feel free to write it up in the comments – would love to hear other approaches….

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Older posts that may be of interest:
What sort of people should you hire for the first 5 employees
How to get your first 3 employees