The Blade

You might think asking startups to pay dividends is odd. But hey, I’m a realist. Let me explain.

There’s this misconception that only mature companies should pay dividends to its shareholders. The theory is that if you’re growing fast (more than 20%, for example) internally generated earnings are the cheapest source of capital to finance future growth. If you’re business is expanding you should invest those earnings into high-ROI, profitable activities. For example, if your company is expanding 30% per year, the best return on your investment would be to invest into that business- not a bank account that pays 0.2%. Why slow that machine down by displacing earnings elsewhere – such as paying out a dividend? Amazon, Google, and even Warren Buffett’s Berkshire Hathaway don’t pay dividends – mostly due to the reasons I just explained. Ok, I get all that.

But keep in mind, as an investor I need to realize a return on my investment in some way. The most popular way to do that is to sell companies, and get a big return all at once. Here are six reasons why I strive for receiving paid dividends instead.

1. Your company isn’t going to be sold anyways: Let me give you an example. A 30% growth, $1.5 million business isn’t quite attractive to strategic buyers. I tend to invest in niche ideas which aren’t explosive growth candidates. Let’s face it, strategic mergers are few and far between. I’m a limited partner in a VC, and its portfolio is chock-full of innovative companies selling into big markets. Many of them have $5-10 million in revenue with 30-50% growth rates and are trying to get purchased—yet most of them aren’t getting purchased or going public. There are only so many Ubers, Amazons, Netflixs, and Snapchats in the world. Therefore, I’m not counting on an exit to get my money back.

2. Dividends provide a pretty sweet ROI: Let’s say I invest $75,000 in order to own 15% of a pre-revenue startup. Five years later the business has $1.5 million in revenue, 30% growth and earns 15% free cash flow. It pays out 75% of that profit as a dividend, or $168,750. I get $25,312 of that…every year. And the amount grows 30%…every year. I’ll take that and walk away quietly.

3. A business can still grow fast while paying dividends: this is something to consider. If you have a $1.5 million company with 15% profit margins (75% of which will be paid in dividends and 25% for savings), you’re still spending $1,275,000 per year. If you’re also growing revenue 30% per year, that means the next year you’ll bring in $1,950,000 and have $1,657,000 available for expenses—an increase of $382,000 from the previous year for new hires, new marketing programs, raises for staff, and product upgrades. A smart business model should be able to pull that off.

4. Small company cultures rock: Being involved with a group of 15-20 people, all working together in a manner or culture they prefer is unbeatable. When you sell out to the bigger companies you are selling into the not so appetizing corporate cultures.

5. Market-size, market-size, market-size: A majority of startups I know sell into niches so their markets simply aren’t big enough to justify a profitable sale. In order to grow, they’d have to come up with new, bigger ideas or sell related products to the same market. Maybe it’s more fun to just pay dividends?

6. Selling out is overrated: Check out my blog Twelve Reasons Selling Your Company is a Bad Idea.

Don’t sell your soul to the devil. The defense rests.