Equity represents a startup’s ownership, typically expressed as a percentage of shares of stock. During the early stages of a startup’s formation, founders like you may need to give up a big chunk of equity to match the risk that investors take by funding your startup; however, as your startup grows and displays more success, your (the founder’s) startup equity increases in value. Thus, investors are typically willing to pay more or access less equity in exchange for funding.
In general, four main actors can get startup equity – co-founders, investors, advisors or mentors, and employees. Of course, different startups have different combinations of equity share of the four categories mentioned above. However, what remains constant is the looming challenge that every startup founder faces when deciding to split equity! In such a situation, a startup equity calculator might help.
Types Of Equity Splits
Simply put, there are two ways of splitting equity: evenly and dynamically or unequally. Before embarking on the daunting mission of equity division, you should understand which trajectory suits your startup.
- Equal Splits – Such a division formula is ideal at the very formative stage of your startup when all the work lies ahead. Roping in a co-founder or co-founders lets you divide the labor involved in getting the business off the ground. However, the key is to ensure that all the technical co-founders are equally committed to and invested in the startup’s success. If you are doubtful about offering an equal share of the equity to your business partner, you must rethink partnering with them in the first place.
- Dynamic Splits – The other and more common equity split is unequal or dynamic. You and the other co-founders have to decide how much each of you deserves based on your contribution to the startup. Dynamic split is also applicable when dividing equity among employees, investors, and the board of directors and advisors.
Factors To Consider For A Fair Equity Split
After a brief introduction to the two main types of equity splits, let us quickly examine the factors on which a dynamic split must be based.
- Ideation – The person who ideated the primary value proposition of the company undoubtedly, deserves the most significant portion of equity ownership. For instance, one of the two co-founders of Instagram ended up with a 40 percent equity stake, owing to the fact that he was the one whose technological innovation made Instagram a reality. The other co-founder, who joined later in the process, received a 10 percent equity stake in the company. The balance is distributed to investors and employees.
- Startup Stage – Typically, co-founders or people who join a company in the most formative phases of the establishment (prior to the seed round and funding) deserver a large pie of the equity share as a reward for their time and assumption of risk.
- Salary Replacement – At times, technical co-founders and employees will accept a much lower salary based on their understanding of what their ownership stake in the company will be worth later. For instance, the designer of Nike’s logo, who was paid USD 35 plus a piece of equity, is now worth over USD 640000.
- Seed Capital – At times, you may adjust a 50/50 split of equity among co-founders to 60/40 or any other figure in favor of the founder who had put more seed capital into the business.
- Other Considerations – Some other elements that can help make the equity splitting process an easy success include –
- Gauging the time spent by each person presenting the business model to potential investors
- Each person’s contribution to the company’s intellectual property
- Time to be spent on business development
- Ability to resolve future problems based on professional connection and individual experience
- Value of opportunities lost to the individual due to their commitment to the start.
- Having a startup equity calculator and other such tools becomes crucial during such a situation.
The Basics Of Startup Equity Split
Dividing startup equity split by roles or responsibilities is beleaguered with hurdles, especially for laypersons. However, a simple startup equity guide will help you navigate the process.
- Splitting Startup Equity among Technical Co-founders – To begin with, equity division among co-founders is reasonably straightforward as long as you abide by some pivotal rules. Firstly, it is vital to make the equity split equal and fair. Avoid roping in multiple co-founders, as it can create confusion and distribution problems down the line.
- Splitting Startup Equity among Investors – The most challenging aspect of equity division is among your investors, but a simple formula might come in handy. For instance, if you plan to raise USD 3 million, and the investors feel that the company’s worth is USD 10 million, you will have to provide them with 30 percent of your organization in exchange for the money. The investors do not have any new responsibilities or liabilities. In most cases, investors will always have full ownership of any shares they’ve bought (known as “vested”) in the company. Having an app development for equity can be of tremendous relief during such sticky situations.
- Splitting Equity Among Board of Directors and Advisors – In most situations, the equity offered to the board of directors ranges from around 05 percent to 2 percent. On the other hand, the equity distribution for advisors is approximately at around 1/10 o 0.5 percent.
- Splitting Equity for Employees – One of the primary goals of splitting startup equity is to provide early employees an incentive in exchange for the faith, blood, and sweat they have placed in an embryonic organization. Such a strategy will motivate them to improve and grow your company in the long haul. An efficient and wise tactic you can follow as a startup’s technical co-founder is to keep 10 to 15 percent of your company’s equity for indispensable and irreplaceable employees. However, the thumb rule is to keep aside equity points from 1 to 10 percent for your early hires.
So, there we have it, a comprehensive overview of how to split equity among various stakeholders of a startup.