Startup equity can be one of the most problematic things to come across in your startup. Figuring out how to split can be daunting, not to mention the awkward conversations with the co-founders and the team regarding who gets which slice of the pie.
In layman’s terms, equity refers to how much ownership stakeholders have of a business. Ownership is defined by the number of shares issued to founders, investors, and employees.
Before we dive deep into what startup equity is and how to go about splitting it, it is important that you familiarize yourself with a few common startup equity terms first.
See: Startup Funding Explained
Startup Equity Terms
Equity: “the value of the shares issued by a company.” “one’s degree of ownership in any asset after all debts associated with that asset are paid off.”
Exercise shares: to choose to buy or sell your shares in a company.
Fair market value: the current value of the share.
Stock grant: “A stock grant occurs when an employer pays a part or all of the compensation of an employee in the form of corporate stock.”
Stock options: “a benefit in the form of an option given by a company to an employee to buy stock in the company at a discount or at a stated fixed price.”
Shares: “a part or portion of a larger amount that is divided among a number of people, or to which a number of people contribute.”
Shares outstanding: “Shares outstanding is the total amount of shares that are held by all its shareholders.”
Valuation: “an estimation of something’s worth, especially one carried out by a professional appraiser.”
Vesting: “Employees might be given equity in a firm but they must stay with the firm for a number of years before they are entitled to the full equity. This is a vesting provision.”
Source: Startup Equity 101
Who gets equity?
Equity is generally given to 4 main players. These are,
- founders and co-founders,
- team,
- investors,
- outside advisors.
We’ll be looking at how to split equity between them one by one.
Founders/Co-Founders
Splitting equity in a startup with only one founder is a no-brainer. However, the problem arises when you have a co-founder or co-founders. 65% of the startups fail due to co-founders’ conflict. Arguments and disputes revolving around equity are common, and in no time founders find themselves in court. Perhaps the most famous example of this would be the dispute between co-founders of Facebook; Mark Zuckerberg and Eduardo Saverin.
Read: Eduardo Saverin: The other half of Facebook
If you want your startup to be successful, it is important that you have the equity split conversation early on. Deciding how much share each founder gets boils down to 3 factors.
Read: Common Startup Mistakes
1) Risk
You need to assess the degree of risk each co-founder is bearing. If one of the co-founders is at a greater risk than the rest then he definitely deserves a bigger share. The risk could mean investing your own savings or leaving your job to focus solely on the venture.
2) Innovation
You may have come up with the idea for the startup on your own, or maybe it was a team effort. If it was the former, ownership of ideas would mean a bigger share for sure. However, if it was a joint effort then an equal split would be the fairest option.
3) Degree of Involvement
This reflects the level of commitment of each co-founder. Are all of them investing time equally? Is everyone putting in long hours and expecting nothing in return? If not, and if one of the co-founders shows greater commitment, then he deserves more equity.
The most common equity split is 50/50 or 33/33/33. You can also use an equity calculator to help you out.
Team
As you’re building your startup, you need to start hiring people who can help grow the company. Keeping in mind that you would still be an early-stage startup, you won’t be able to offer much to these new employees in terms of salary. What you can do instead, is offer them equity as compensation. Employees like having equity, as it reflects a financial gain in the future if the company hits big. However, there are a few important factors to consider while giving away equity to employees.
How much to give?
You will need to decide how much you are willing to give away to your employees. You should make an option pool earlier to help you with this. An equity option pool is the designated total amount of equity that you can bear giving away to the employees. Then you’ll have to consider how many people you plan to hire, their experience, and project future capital flow.
Vesting Period
You need to set a timeline to when employees can access their shares of the company. If you don’t set a vesting schedule, there’s the risk of employees leaving the company whenever they want and the shares of the company with them. The most common timeline is a four-year vesting period with a one year cliff. This means that the employees will have to spend a minimum of one year at the company, before they can access their shares.
Giving equity to employees will motivate them, and they would want to stay with the business and help it grow.
Investors
It is unlikely that you can scale and grow your startup without having an investor on board. An investor offers his network, connections, expertise, and most importantly capital to the business. With that being said, it’s understandable that investors take a significant amount of equity. Their share is much more than the employees and advisors.
How much equity the investor gets depends on the valuation of the startup and how much money they invest. The investors and the co-founders have to mutually agree on a realistic company valuation. This helps the investors get an idea when they would be able to reap the benefits of their investments.
Read: How to Build a Startup Team
Advisors
Your advisory board comprises of experienced individuals who are experts in their respective fields. They offer their invaluable advice through experience and help set the direction of the company. In return, they ask for equity. Although there is no fixed percentage, companies generally offer 0.2% to 1% to advisors.
Equity Dilution
One last thing to remember in giving up startup equity is dilution. Equity dilution occurs with the issuance of new equity. The ownership percentage of all the shareholders is reduced. Investors at times may ask for anti-diluted shares. This means that future investments won’t dilute their shares. It is important to make sure that you place anti-dilution caps smartly. After all, you would want to keep the majority of the business to yourself.
Also see: Startup Funding Explained
