How to Maximize The Value of Your Startup Equity

Alex: What's up, everyone? Welcome back to another episode of Founder’s Journal. I'm Alex Lieberman, co-founder and executive chairman of Morning Brew. Today we are talking about maximizing your equity as a startup founder. Startup equity can be confusing and daunting, but it literally could be the difference of millions of dollars in your pocket or the government's pocket. You're not taught any of these topics in school, and typically what happens as a founder is you get close to selling your business or having some liquidity event, and then you need to do an all-out sprint to try and retroactively fix stuff so then you can maximize the value of your shares. But that is stupid. There are tried and true ways to structure startup equity and there are a handful of people that know exactly how to do it exceptionally well.

I invited one of those people onto the podcast to give you every tactic related to protecting the value of your equity. My buddy Ankur Nagpal is the founder and CEO of Carry, a business that helps business owners build wealth in a number of ways, most notably with their Solo 401(k) product. Prior to Carry, Ankur was the founder and CEO of Teachable, a teaching platform for creators, which sold to Brazilian education company Hotmart for $250 million. On this episode, Ankur talks about everything from the power of QSBS, a tax exemption that gives business owners $10 million of tax-free gains, to charitable remainder trusts, and the impact that co-founders have on the value of your equity. Let's hop into it. Ankur, thanks for joining the podcast. 

Ankur Nagpal: Excited to be here. 

Alex: So I want to talk to you about, I feel like a taboo topic that founders are afraid to talk about, but it's wildly important and I know it's one that you've thought about a lot, which is founder equity, and also how to basically set things up in the right way to optimize your wealth from building a business and ultimately having some sort of liquidity event or financial outcome.

It's funny because I had no idea about any of these things when we were starting Morning Brew, and basically in like a three-week period around selling the company, I had to do this like hyperdrive of learning these things. 

Ankur Nagpal: Yep, yep. Exactly what happened here, except I never stopped there and I've sort of continued learning over the last two years, and it's incredible the sort of things in the US tax code, but most people have no idea. So it's clearly become something I'm passionate about now. 

Alex: Okay, so take me through your TED Talk on founder equity and how to, you know, think about wealth building while building a business. 

Ankur Nagpal: Yeah, absolutely. So the good news is honestly there's not a ton you need to do up front. The only thing that materially matters up front is understanding how QSBS works, which stands for qualified small business stock. And this is the single biggest gift the government has given startup founders. The way it works is if you hold shares in a qualifying C corporation, and we'll come to that in a minute and what that means, for up to five years when you sell your shares, you pay no federal taxes on $10 million, and in 42 states, including New York, you pay no state taxes as well. So that's incredible, right? 

Alex: Massive. 

Ankur Nagpal: This gift from the government, $10 million, it's crazy. 

Alex: And by the way, it used to be smaller, right? Didn't it get expanded to $10 million at a certain point? 

Ankur Nagpal: It used to be only a 50% deduction and now it's a hundred percent deduction. So that's the change they made and it's so generous. I have no idea how long it'll last for, but honestly it's too good. It's one of the things you look at in the tax code and you're like, we're probably not the people that need this tax break. But you know, that's how the code is written and again, I think the most important thing early on is to not accidentally mess it up. So let's talk about what that is and how… 

Alex: Yeah, how do you mess it up? 

Ankur Nagpal: So one is your company needs to be a C corporation, which most lawyers or anyone who will tell you to do when you're starting a company, but a lot of people accidentally start as an LLC first. So you wanna avoid that because your five-year clock only starts once you become a C corporation. So that's part one. Part two is you can accidentally trip up QSBS status by doing a large buyback of shares. This is the most common way of seeing people accidentally mess up their QSBS status, is let's say you have a co-founder that leaves the company and you want to buy back their shares, talk to a lawyer before that to see it doesn't cross a very specific threshold that may just violate QSBS status. That's the biggest accidental way of doing it. 

But if you don't accidentally mess up QSBS, as long as you hold your shares for five years and the company was worth, company raised $50 million or less at the time you get your shares, you get to have this QSBS benefit. 

Alex: And just so I understand, given that this is such a big benefit from your perspective, when does it make sense to not just start your company as a C corp?

Ankur Nagpal: It makes sense to not start your company as a C corp if the goal is a business that pays you cash on the side, but you're not building enterprise value. So let's say you're running Alex Consulting Services LLC or whatever. I tell you, it doesn't make sense to have a C corp election, but if the goal of your company is one day to sell the business or to go public, you should always be a C corp. And actually right now there's a few business owners after learning about QSBS that are going down the C corp route that would not otherwise. Such a big benefit. 

Alex: Yeah, super interesting. Yeah, I've heard of it to the point where obviously there's a lot of intricate stuff you can do with QSBS and I don't know if you were gonna talk about this, but like I know for example, just a simple thing is I know people who when they're getting prepared to sell a company, they reopen a new C corp to get the clock started as soon as possible.

Ankur Nagpal: Yep. That's great segue into, okay, what happens if you sell your company in less than five years? You can do something that is called a QSBS rollover that actually lets you take the proceeds and invest it in another qualifying small company, and then your clock resumes ticking. So let's say you sold the company after three years, you only then have to wait two years before the next company sells to get your QSBS benefit. And even better, if you're a founder, you can do that in a second company you own. So literally you can start your own company, roll over QSBS, pre-tax dollars. It's the equivalent of what, you know, people in commercial real estate do where they have a 1031 exchange, you can take the entire dollar amount, roll it over, and your clock resumes ticking. So it's very, very powerful. 

Alex: It's incredible. And then, I don't know if you want to briefly talk about it, 'cause I feel like this is like QSBS kung fu, but there's this whole world of QSBS stacking as well, right? 

Ankur Nagpal: Correct. So now let's level up, right, next level. Let's say you're, yeah, again, this gets crazy. Let's say you want to, you're gonna make $20m, $30m or $40 million. There's actually multiple strategies you can use to multiply your $10 million QSBS limit to $20m, $30m or $40 million. The simplest of which is honestly, if you have family members that you'd like to give shares to, the QSBS limit is per company, per shareholder. So what I've done this time around is given shares to my brother, my mom, my dad. So if the company were to ever have a successful outcome, each of them would have their own $10 million limit. So super powerful, super effective. That's part one. 

Part two is you can set up trusts, different types of trusts, each of which can serve as their own taxpayer that gets their own $10 million limit. For instance, you can set up, I set up two trusts. I set up a trust for the benefit of my future children and family, and I made a gift of my shares to the trust and as a result, that trust got its own $10 million limit. And then I set up another trust, which is called a charitable remainder trust, which works by giving the shares to this trust that does not pay taxes. It pays me out an income stream every year for 20 years. And what's left over goes to charity, and that got its own $10m limit. And you can keep going; for me two trusts were enough. At that point I was like, I should pay taxes on this. I’ve clearly gotten a lot of services from the government. But you can go real crazy with QSBS planning as a founder. 

Alex: Yeah, I think the craziest thing that I've ever seen is there was an article, I believe it was about Mark Pincus, have you seen this article? 

Ankur Nagpal: I have not. 

Alex: The Zynga founder, I believe, QSBS stacked 10 or 15 times and it ended up on the front page of either the Wall Street Journal or the New York Times. 

Ankur Nagpal: That's just not a good look, right? I think you want to do it to the point where it makes sense versus completely abuse the rule. A question I get from founders a lot is, okay, cool, when should I start worrying about this, right? Like what do I have to think about at what stage? And my overall advice is up front, just make sure you're a C corp and you don't mess up, you don't mess anything up. Like have a lawyer double check that you buy your shares and it's clean and all of that. Then you don't have to think about this I would say till maybe year three. I find ideally like between your Series A and B, it might be worth thinking about how to multiply QSBS if you were to get there. Any before and it's too soon, 'cause honestly, like I know some people, they don't have product-market fit and they've set up four trusts, right? And it's like, what? Building a startup is really hard. Get to a point where the likelihood of you having an exit is 30%, 40%, 50%, and then it's worth the effort. So doesn't make sense to it up front, but I would say before Series B it may make sense to look into a lot of this. 

Alex: Makes sense. Okay. Anything else on QSBS? That's question one. Question two, are there any other topics as it relates to thinking about your wealth and wealth planning as a founder that you would think are really important for people to think about beyond QSBS? 

Ankur Nagpal: Another question that comes up very often is, how much should I pay myself? And a lot of people aren't very up front about it. I've previously been public about what we paid ourselves. Living in New York City, I think we started at $70k, eventually ended up by the time I sold the company to $150k; there were sort of levels in between. But my thesis and what I tell all my portfolio founders is I think the goal should be to pay yourself enough that you're not worried about day-to-day expenses. You're not compromising your quality of life meaningfully yet. You're not getting rich off it, you're not materially saving a ton on it. And what that number is varies a lot by who you are, what your family situation is, where you live. But I think that's a generally good rule of thumb for how founders should consider paying themselves. But I'm curious what you tell people when they ask you that. 

Alex: Yeah, I mean just to again use me as the example for Morning Brew, basically when I quit my job and Austin decided he wasn't gonna go work full-time in banking, I went down for a period of time to zero salary, and basically Austin and I were fortunate enough where we had families that were willing to pay our rent for a period of time. We feel very lucky for that. And that's not the situation that everyone was in. After we raised our round, we raised the $750k, Austin and I took $60,000 salaries. And I would say in New York City, you're really playing in the danger zone in terms of being able to afford a life. Luckily I was living in a five bedroom apartment with four people from Michigan. And so we were, you know, amortizing the cost of an apartment across enough people, and then we just gradually kept bumping things up until, we sold the business. And candidly, things got pretty high, because also I think the beauty of a media company is we didn't really have to scale headcount that much and we were super profitable.

So I can't remember, our revenue basically went from zero to $70k to $750k to $3 million to $13m to $25m. But headcount absolutely did not grow linearly. It grew less than linearly. And so I think at a certain point Austin and I got up to $350k that we were paying ourselves. And my general rule of thumb is similar to you, which is like, and this rule of thumb is really in the early days when you're most worried about what is an investor going to think of how you're paying yourself. I think that's people's fear. And I think it's, at the end of the day, you do a disservice to yourself if you're worried about money in your life, because then you can't be fully present to your business. So get to the threshold at which you're not worried about money in your life, but also you're not spending frivolously, and pay yourself that amount.

The other question that I've been thinking about a lot, not for myself but just in general in this world, like kind of the venture cycle we had, and you have a lot of founders who sold, basically took a ton of secondary and then their businesses lost a lot of value. Not to say they're necessarily in the wrong; I think everything's on a case by case basis. But a question that I think a lot of founders ask is, when is it appropriate to raise a round and take some liquidity as a startup founder? What's your thought process on this? 

Ankur Nagpal: Yeah, it's a great question. I think you can always, always, always take a secondary if someone offers it to you, with the caveat that you make the exact same offer to the rest of your team. I think that's a really important rule. But otherwise, I know a lot of investors are like, oh you shouldn't take secondary bullshit if there's a market for it, it's within your right. But ensure that every single person on your team with vested shares has the exact same opportunity. If you do that, power to you because a lot of VCs frankly are, they're the ones who kept telling the founders to take secondaries 'cause they wanted to buy into these companies that they weren't able to and now they're upset about it. So I think if you have a buyer for secondary, look, you already put all your eggs in this basket. So it's totally fair to be able to diversify some of it. Just take care of your team. 

Alex: Totally. Last thought around this and then I'll give you the floor and if there's anything else, is I think something a lot of founders think about or you see people optimized for taxes. So obviously one way people do it is with QSBS, another way people do it is literally moving themselves geographically. And you can stretch this from a little bit to a lot of bit, like I've seen people move to a different state because a certain state doesn't allow for a certain trust structure. All the way to people living in Florida for half the year. And there are people I know who live in Dubai now. What is your thought process on geographical location for tax optimization? 

Ankur Nagpal: Yeah, so I personally hate it, and even though I do a lot of, I mean, I literally live in the highest tax bracket possible right? In New York City. The expression I really like is, we talk about taxes, but don't let the taxes tail wag the dog. So I would rather live where I want to and then figure out my taxes. So again, to me the whole point of having money is to be able to live where I want. I actually had a tweet go viral a while back, and this may seem like an attack to you, where I was like, “What's the point of having money if you have to live in Jersey?” 

Alex: I love that. Well, now my goal in life is just to make you love New Jersey. Yeah, no, anyone who wants to move to Hoboken, hit me up. I love it. Any other thoughts around wealth preservation or tax strategies for founders before we hop? 

Ankur Nagpal: Yeah, one final thought, and this is again a tweet I read from Immad, the founder of Mercury, where he said, as a founder sometimes you have multiple choices of what to optimize for when fundraising. And I think what he said is it's best to optimize for the medium case scenario where things don't go absurdly well, but they also don't go poorly. So to ensure that you're protected 'cause if you do the opposite, where you just raise money at a super high evaluation, thinking things will go amazingly, you could end up at a point where an exit that would've made you reasonably well off would not make you well off. So I think that's just wise advice in general. Try and optimize for the medium case scenario because there's a lot of times where if you build a business and you own more than 50% in and you sell it for, you know, $50 million, which is a lot of money in most parts of the world, you want to ensure that it can still be life-changing for you.

Alex: So I have actually one more question that I feel like is a huge consideration around wealth in a business and the value of your startup equity that people just don't think of this as an obvious way, which is like number of co-founders you have, right? Like number of co-founders you have actually is probably the largest lever of what your equity is worth at the end of the day. How do you think about what is the optimal number of co-founders when you build a business? 

Ankur Nagpal: It's tough, right? 'Cause I think if you have a co-founder, that is incredible, they're more than worth the equity. But you know what I was able, what I did this time around is, instead of having one equal co-founder, I took the same amount of equity and I distributed it to a founding team. And as a result, every single member of the founding team has substantially more equity than they would anywhere else, yet it's just like what one co-founder would've been. If I'd had a great co-founder, I would've not made that trade. But again, it gave me a lot of equity to be very generous with because of that. 

Alex: Yeah. It's also an interesting tool to just diversify expertise if you don't think all of that expertise can be pent up in a single individual. 

Ankur Nagpal: Yep. So yeah, so I think there's many, many approaches. I think Silicon Valley's finally lost its stigma a little bit against solo founders. For a long time, YC and stuff were like, you have to have co-founders. And I definitely think good co-founders are a game changer and massively help. But co-founder disputes are also the number one reason companies fail.

Alex: Love it. Ankur, thank you so much for the time. So much wisdom as always. 

Ankur Nagpal: Thanks for having me. 

Alex: I hope you enjoyed this episode of Founder’s Journal. If you like this format where I curate world-class entrepreneurs and investors to answer the most important questions or challenges for early stage entrepreneurs, shoot me an email to alex@morningbrew.com to suggest a future question or challenge that you want answered, or a specific expert who's like on your wall of fame that you would love to see come on the podcast. As always, thank you for listening and I'll catch you next episode.