Splitting Startup Equity – Complete Guide
Let us begin this startup equity guide and discuss the fundamentals.
Large corporations attract potential employees by offering them lucrative packages that include high salaries, numerous paid leave, and other company benefits. On the other hand, startups and smaller companies utilize different tricks to attract and retain talent. When it comes to workers, startups offer them the chance to gain profits with the help of sharing company ownership and splitting startup equity.
Setting up the startup equity structure can sometimes feel like you’re going through a maze, with many possible paths leading there, but only a few ways to reach success. If you are completely new to startup equity, it would help to understand what equity actually is and who can obtain equity in startups.
What is Equity?
Equity is arguably the most essential tool in a startup’s arsenal. Why? Because it highlights you as the owner of your company, along with giving you something credible to provide your investors for obtaining financial support. You can compare equity to slicing a pie – you will need to cut smaller pieces if the number of people you have to distribute to is high.
What’s more, every time you slice the pie, more people will get a share and the size of the remaining pieces will become smaller. When it comes to dividing equity, keeping everyone happy is essential. However, you also need to retain your company’s ownership. Fortunately, there is a straightforward way to do this. Just make sure you plan each step very carefully from the first day, ensuring everything is covered by binding legal agreements.
It would also help to create a business plan which consists of rounds of equity investments you plan to utilize for raising funds in the future. Consider adding the total number of equity you plan to offer investors during each stage, making sure you don’t give it all away. Keep some for yourself and other founders in your startup.
You may also want to think about other ways to utilize equity in your organization. Offering it to high performing and talented people would be a great idea, as it will help secure them as long term employees from the beginning. Taking advantage of equity tax breaks would also be a great option, as it will make the idea of investing in your organization incredibly attractive to stakeholders.
Who Can Own Equity in a Startup?
At the beginning of a newly formed startup, the founders possess 100% equity in the business. In simple words, sole founders own everything in the startup. However, as people begin to invest time and money into your venture, you might need to start dividing the equity properly, making sure you offer it to the right people, especially those who supported you.
Here are a few examples that highlight how this could happen:
- Multiple co-founders
- Financial support provided by family and friends
- When third parties provide early investments
In this case, we are especially thinking about equity for startups, but it is important to keep in mind that there will be stages later on where you will have to offer someone or multiple people a stake in your company.
For those who don’t know, the funding rounds (Series A, B and C), mostly consist of an equity transfer to investors. Once you start moving through your business’s life stages, remember the amount of equity you possess, and what you can give away easily in the future.
Actors, singers, and other types of celebrities often work for the profit shares in their movies, music videos, or album makes, instead of taking fixed fees. No matter which business you are in, the way equity stake works is more or less the same.
Startup Equity Split
Offering startup equity by role can be a bit confusing, especially for those who are new. However, there is no need to worry as this startup equity guide will help you understand how splitting startup equity works with co-founders, investors, board of directors, and employees.
Splitting Equity among Co-Founders
Splitting equity among co-founders is relatively simple, as long as you abide by some important rules.
First off, it is important to make your split equal and fair. Avoid taking over two or three co-founders, as it could cause confusion and distribution problems down the line. It would also help if you utilized besting when splitting equity among your startup’s co-founders.
Another efficient tactic is to keep 10-15% of your company for important employees. In addition, don’t look for funding soon after forming your startup. Instead, take some time to settle down.
Splitting Equity among Investors
The main formula for dividing equity among your investors is fairly simple. If you plan to raise $3 million dollars, and the investors think the company’s worth is around $10 million dollars, you’ll need to provide them with 30% of the organization in exchange for their money. Gaining a worthwhile company valuation for any startup requires you to have an excellent idea paired with a convincing elevator pitch.
Remember, an investor’s ownership doesn’t imply added liabilities or obligations. Once someone invests or purchases an equity stake, they own it. This also makes the investors reside over the organization’s board of directors, depending on their equity stake.
Splitting Equity for Board of Directors and other Advisors
When trying to determine the right way to distribute equity among the board of directors and other important advisors of your newly formed startup, it’s important to keep everyone’s particular role. In most cases, the equity offered to the board of directors ranges around 1/2 or 2%. However, the equities split for advisors ranges from one 1/10 to ½ percent.
Equity for Employees
As mentioned earlier, one of the main goals of splitting startup equity is to offer early employees with an incentive to have an emotional investment and ownership with your product and idea. Doing so will motivate them to improve and grow your company in the long run.
So, when offering equity to your first few hires (could be 3-5 employees) you may not be able to utilize a formula. Unlike other equity processes, this one is not an exact science and requires you to analyze the situation to make a decision. Despite that, a rule of thumb concerning the first important hires is to keep in mind that they want some equity points, which could be anywhere between 1 to 10 %.
Once again, it is worth noting that the people we are discussing about aren’t founders. Instead they are talented, high performing employees. After assembling a team to operate your business, consider taking a scientific approach for offering employee equity. It is of utmost importance that you move away from equity points and focus more on equity dollar value. This is because dividing equity for employees can be incredibly expensive in terms of points.
Use Vesting Schedule
Utilizing a vesting schedule is critical no matter which way you plan to distribute equity to your board of directors, co-founders, employees, advisors, and others. The reason why using a vesting schedule could be of great help is because it specifies how and when your co-founders can use the stock options received in the split agreement.
A traditional vesting schedule also comes in handy because it offers the option of incremental vesting (up to a 4 to 5 year period). What’s more, a sizeable part of the options will vest once the first year ends (also known as the “Cliff”). Vesting schedules offer up and coming companies with an incredible amount of protection by preventing co-founders from abandoning the organization and taking a massive piece of its value with them.
Example of a Fair Equity Split in a Startup
There is no denying that there are plenty of fair equity splits available, but this simple example is easy to follow and clear any ambiguities you may have in your mind.
- Option pool – 20% (dividable among the company’s employees)
- Venture capital providers – around 30-40%
- Angel investors – 20-30%
- Founders – 20-30% (distributed among the company’s co-founders) it is rarely an exact 50-50
Manage Startup Equity on Eqvista
Here is how the Cap Table would look on the Eqvista App:
You can easily view the total shareholding of each founder and employee, and plan how you want to split your startup equity in the future.
Now that you have a fair idea of a typical startup equity structure, you will face fewer obstacles when splitting startup equity. Once again, as long as you provide everyone with a fair split while keeping your organization’s future in mind, every party involved will be happy, and will contribute towards your business’s growth.
Eqvista is one of the market leaders in equity management software. Our advanced equity management tool enables companies to issue shares, set up and apply vesting schedules, exercise options and warrants, create convertible notes, store company documents, and process financial modeling, all from one place.