Cashing In at a Startup: What You Need to Know About Dividends

Startups rarely pay dividends on their stock because they favor reinvesting their profits into growing the business. Only 53% of global small-cap stocks pay dividends anyways, and startups are not in this position because they aren’t floated on the stock market. 

Early-stage startups are all about growth. They must focus any additional money on acquiring new customers or improving your offering. Dividends are usually offered later once a business has scaled and started to mature. 

Most people who invest in startups aren’t looking for a safe dividend yield each year. The people who invest risk capital in the hopes that the startup becomes the next Google or Amazon. Investors tend to make their money when the company is either bought by a bigger business or floats on the stock market. The early investors of Instagram didn’t expect the startup to pay dividends. Instead, they cashed in $100+ million each once it was sold to Facebook for $1 billion.

Let’s first look at what a dividend is and then explore why startups don’t usually pay dividends and also what this means for employees

What is a dividend?

A dividend is the distribution of a business’s earnings to its shareholders. The number of shares you own dictates the amount of money you earn when a dividend is released. Dividends are paid on a per-share basis and the average dividend yield on the S&P 500 is between 2% and 5%. It means you receive 2% of the share price for each share you own.

The ability to pay dividends is a sign of good company health and this is reflected by the fact only mature businesses pay dividends. They are usually paid on a quarterly or yearly basis and around 80% of S&P 500 companies pay dividends. 

It is generally assumed large publicly owned companies that float on the stock will eventually pay dividends to investors. However, it is usually a surprise when privately-owned companies or startups pay dividends. It shows the company is self-sustaining and confident about its long-term prospects.

Do startups pay dividends to investors?

Startups do not usually pay dividends to investors. Investors get their money once the startup is either bought by a bigger competitor or when they go public through an initial public offering (IPO).

When a startup lists on the stock exchange an enormous amount of money is raised by selling shares in the company to the public. The business is valued first.  Then, investors sell a portion of their shares during this process and it is at this point they see their return on investment (ROI). 

If the company is sold before growing big enough to list on the stock exchange, the investors and founders take the amount from the sale and divide it among themselves. 

Paying dividends is a sign of business maturity and long-term confidence in the business. Startups don’t have the luxury of paying their investors when they are still trying to grow the company.  If a business is paying dividends they probably aren’t to be classified as a startup anymore. 

High Returns

Private equity companies and angel investors don’t supply money to start in the hope of modest returns. Instead, their goal is to find the next Google, Amazon, or Netflix and see monumental returns on their investment. 

While very few startups pay dividends this doesn’t come as a surprise to investors and is part of the playing the game. However, a company may begin issuing dividends after 5 or 10 years but depending on growth and business maturity.

Company policy

No businesses are required by law to make dividend payments to investors. Profits can continually be put back into the business to find growth. Owners of a company determine the dividend payment each year by holding a vote.

For startups, the company policy is usually to avoid paying dividends to investors and just focus on growing the business.

Growth plans

If a startup is beginning to mature it may curtail its growth plans. With plans to grow on the back burner the opportunity to pay investors some money back via dividends becomes more of an option. Conversely, plans for high-growth all but rule out dividends. 

Do startups pay dividends to employees?

Startups do not typically pay dividends to their employees. If employees have been given equity as part of the business, money is usually given when the business is sold or put on the stock market. 

A company is under no contractual obligation to pay dividends to employees, especially if they own no shares in the business. The most common way for employees to be rewarded is either with higher salaries or additional bonuses. Big tech companies usually pay incredible bonuses on top of their share scheme which is why meeting their criteria is so important in nabbing a job.

Usually paid with equity 

The 13 Instagram employees each got a piece of the $100 million set aside for employee equity when the company was sold. So startup employees are rarely given actual dividends like you would if you owned shares in a floated company.

Instead, many are offered equity and 10-20% of shares are usually set aside for this purpose.

Not in the short term

Startups usually invest any extra profits into growing the business. To grow rapidly startups require extra funding which usually comes from outside sources. These investors want to see large-scale growth and usually aren’t on board with paying dividends in the early days. 

People who invest large sums of money into a business don’t want a 6-8% dividend yield. They want big results which lead to extraordinary returns later down the road. 

It means that if employees do have any shares in the business, they will have to either wait for the business to be sold, to be listed, or to grow mature enough to offer dividends. All of which takes years.