Use capital wisely!

The importance of careful capital management in a startup, highlighting long-term benefits and avoiding common mistakes.

As an experienced startup investor, I want to share a common mistake I frequently see among founders: using company stock as if it were cash to pay for services. Unlike cash, stock isn't interchangeable, and its value can increase significantly in a short period of time. This potential increase makes stock a powerful tool for motivating long-term commitments, but it's not suitable for immediate payments or services already rendered.

Capital is a valuable asset. Shares in a high-growth startup represent the company's most valuable resource. Shareholders not only influence the company's direction but also share in the financial benefits of its success. Using stock to pay for services directly and equivalently to the value of the service (dollar for dollar) can overvalue these services in the long run, create "dead capital," and make it difficult to attract new talent and investors.

In the early stage, a startup's initial valuation typically has no market value. For example, if a startup issues 10 million shares of common stock at an initial price of $0.00001 per share, its total initial valuation is only $100. Founders and early employees can acquire shares with a minimal investment, incentivizing their commitment to the company's growth.

The problem with using equity as cash. Suppose a software development company offers to build an MVP for $10,000, and the founder pays with equity. If the equity is initially worth very little, the development company could receive a disproportionate percentage of the company, which doesn't reflect its true long-term contribution. This can disincentivize key future team members and complicate future funding rounds.

A startup's capital should be used to motivate key team members and attract investors, not to compensate for short-term, inefficient services. By managing capital strategically, growth potential is maximized and the company's value is protected for everyone involved.

Content extracted from the URUCAP blog written by Marcelo Martello