Startups · Incentives

Startup paying dividends. Is there such a thing?

Dimitry Rotstein Founder at Miranor

August 5th, 2016

Has anyone here been in a startup (or seen one, or heard of one) that starts to pay dividends from profits while still being a small private company with few shareholders (founders, seed investors, and first employees)?
If so, what is the minimal revenue/profit that would justify this?

Some context:
Our CEO has suggested that we could start paying dividends as soon as we become profitable in order to give more incentive to employees and investors, but I'm not sure it's a good idea - I believe that it's more important to re-invest profit into growth. What do you think? What other advantages and disadvantages are there for paying dividends in such an early stage?
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Dimitry Rotstein Founder at Miranor

August 8th, 2016

Thanks, everyone, for your input.
To summarize it, it seems there is a near consensus that for a "lifestyle" business (or a large, stable company) giving out dividends is generally welcomed, as long as the company can afford it, while for a startup that tries to grow and raise its valuation as quickly as possible, dividends are probably not a good idea, even though that's not unheard of.
Did I get this right?

Irwin Stein Very experienced (40 years) corporate,securities and real estate attorney.

August 5th, 2016

A lot of small companies pay dividends to shareholders. I advise companies that are crowdfunding for investors to issue dividend paying preferred shares to attract investors.  Many of the commentators on this board could use  a basic course in corporate  finance. Every business needs to be well financed, well staffed and operate profitably. I am not suggesting that you deplete the corporate treasury to pay dividends but a reasonable grasp of your own business, its cash flow and profitability should answer this question for you.   

Thomas Kaled Business Development Consultant @ thomas.kaled@gmail.com

August 6th, 2016

I will direct my comments to US Corporations as it is those I am most familiar with. 

I have rewritten my response several times in order to qualify my answer however each time I do so I get 'off into the weeds' so let me answer you quite simply (or as simply as I am able). Yes-differing classes of stock can be treated differently assuming the Investors of each Class were aware of that distinction when they Invested. Stock options however are not stock and if the vesting period is complete they must be exercised in order to become dividend eligible. Even if the stock is not marginable (restricted, legend, 'buy-sell' etc.) the difference between the exercise and the 'Fair Market Value' (FMV) is a taxable event. FMV given your question, would be the difference in the employee exercise price and the 'Outside Investor' price + dividends.  Dimitry Rotstein

David Pariseau

August 5th, 2016

Also, typically you want to use any profits to accelerate growth typically toward some exit event.  More investment typically = more growth (assuming well managed of course).   Is there an employee retention issue, or lack of buy-in from folks as the the company's trajectory?  If so, perhaps that's the issue that needs to be addressed?

Michael Barnathan

August 5th, 2016

You're private, right? So there are two classes of people holding your equity: investors and employees/founders. Since you're funded, the latter are getting paid. A dividend on their stock is basically a small quarterly bonus. So the real question is: do the investors care? I don't think they'd strongly object to free money (well, it's their own back...), but I echo the sentiment that they'd rather see those huge capital gains which were the reason they invested in you in the first place.

Judith Szepesi Founding Partner and Patent Strategist at HIPLegal LLP

August 5th, 2016

No, I have never heard of such a thing.  And I think you may have some legal issues around it.  It could easily slip into a Ponzi scheme where you take money from new investors to pay old investors.

If you mean that you have moved into being a profitable company, and are no longer taking investors, and have shifted into a lifestyle company (where you intend to neither go public nor be acquired) your obligation should be to pay back your investors.  Dividends are not considered "paying back" your investors their investment.  

So if you are in that scenario, I would recommend talking to a competent attorney and drawing up agreements with your investors about how you will pay them back their investment in the company.

Thomas Kaled Business Development Consultant @ thomas.kaled@gmail.com

August 5th, 2016

@Dimitry Rotstein I have more questions than answers. What is the Corporate Structure that allows investors, founders and employees to hold the same Class of Stock? Are you suggesting that your employees (especially key) have already obtained their performance bonuses or have they an equivalent equity position to investors that dividends will act as an incentive? 

@Ivan Kaye and David Pariseau I agree with, with the exception that the CEO has an equivalent responsibility to the preservation of the Company and dividends (capital) are the lifeblood of a venture hence @Dave Lemly gives you the long term strategy. 

In any case you have an interesting and pleasant challenge. Thank you for posing this business case.

Anonymous

August 5th, 2016

Hi Dimitry,
First, thank you for spelling your name the RIGHT way :).
As to your question, there are, unfortunately, two plausible, yet mutually exclusive schools of thought.  On one side, many successful portfolio managers and individual investors solely invest into companies that pay dividends.  They claim that paying dividends is, as you mentioned in your question, a way to "take care of their investors," and it also signifies corporate strength/stability.  On the flip side, dividends cost money in administrative expenditures and may often incur greater tax liability to those same investors.  There may be legal concerns, too, as mentioned in another reply.  On a more strategic level, paying dividends is a loud-and-clear message to the investment community, saying that you no longer have any great opportunities within your company/product(s) to invest into, and you have a high enough reserve of liquidity in the bank...so you'd rather return the "excess" cash you have from your revenues to your investors, who could (ostensibly) make better use of it by investing elsewhere.  The other argument against paying dividends is that any individual investor who wants to make some money off your stock can simply sell some of your company's shares from their portfolio.  Theoretically, by not paying a dividend, the capitalization of your company should be higher (since the value of the dividend payout stays in your treasury).  Of course, theory does not always match reality, but it certainly is something to consider.  You can probably guess which strategy I'm leaning toward (especially in the high growth startup environment), but each company is unique, and yours may have circumstances that point to a dividend payout as the more effective use of your "excess" liquidity.  I hope this helps!

Ivan Kaye Chairman BSI and BBG

August 5th, 2016

Best thing ever... This shows your commitment to look after and align with your investors... They should be remunerated in proportion to founders 

Lisa CFA founder Perspicua Strategic Partners

August 5th, 2016

In general, investors look for dividends because they believe they will get a better return on investing the after tax value of that capital outside of the company than they will get in an equity return if the company retains that capital to fund future growth. Companies that generate more cash than they need to fund growth activities often pay dividends with their extra cash or have share buyback programs which offer better tax treatment for most investors. Unless a company is generating enough profit to fully self-fund future growth, paying a dividend decreases the time to a future funding round and hastens the dilution of your current investors. Investors who need a cash return in addition to their equity return will likely demand preferred shares with a guaranteed interest rate rather than want a profit based dividend. From an investor point of view, the willingness of a startup entrepreneur to part with cash can be viewed as a bad sign for the future potential of the company. Think of it this way: They allocated capital to the startup investment because they thought it offered a reasonable likelihood of a high return. By paying a dividend you're telling them you think they'll end up with more money investing 60% - 80% of the dividend elsewhere than they will by letting the company invest 100% of the dividend amount to fund operations & growth. If your CEO is mostly thinking about employees, incorporating a profit sharing component into the compensation package (with shareholder approval) is a good way to get cash to employees without bearing the risk of permanently raising salaries.