Thinking to issue shares to the founders in your company but not sure if it is important for you to do it now? Well, there are a lot of reasons to issue shares to the founders, with the main reason being a founder is the one who works hard to make the company grow. Keep reading to understand more.
What is Founder’s Stock?
To be more precise, the founder’s stock is an equity interest issued to the founders when the company is formed. Usually, founder stock is issued in exchange for what the founder is adding into the company, including cash, property, ideas, or anything that would help the business gain value.
Some founders tend to add a vesting schedule to the founder’s stock. This works as a security blanket in case one of the founders decides to back off and leave the company mid-way through. In this case, the departing founder would not get any shares from the company as they would have left before the shares became fully vested.
All the rights of the founder’s stock are based on the agreement entered between the founder and the company when the stock is issued. The rights can include:
- Super-voting rights
- Lock-up agreement
- Co-sale provision
- Right of first refusal
- Vesting provisions
- Accelerated vesting upon the sale of the company
As startups are highly dynamic, where people and roles keep changing, it is better to consider all the provisions at the initial stage of the company. To understand more about founder’s stock, check out the knowledge-based article here!
Issuing Shares to founder – How should I allocate them?
The way you issue shares to the founders would depend greatly on the kind of business you are running. For instance, if a few founders are waiting for the business to accomplish a milestone and then join, you will have to keep stock of these founders on the side until they become a part of the company. In fact, when the core founders do not join the startup at the same time, deciding how to divide the stock would become more complicated.
Due to such reasons, allocating founder’s stock is difficult during the initial stages. It is hard to figure out how valuable the company would become in the future and which founder would contribute the most to the company. In short, you do not want to give out too much of the company stock without knowing what you will get in return.
So if you are trying to decide on how to issue stocks to founders, you will need to begin by looking into their long-term and short-term roles. A few founders like the CEO and CTO would be the ones making important decisions for the company, while others would be less involved. Based on this, you will have to make a decision. All the founders would have to meet and discuss the roles, and how the stock would be divided as soon as the company s created.
As you discuss how the equity would be split amongst yourselves, remember to consider the following:
- The expectations of each founder.
- If the split is likely to require a reallocation later on.
- If the equity split will continue to work after securing initial funding.
Typical Startup Stock Allocation
Initially, when a startup is created, it usually authorizes about 10 million shares of common stock. And the first allocation using these authorized shares would be broken down into 3 different groups, as below:
- 8 million shares would be allocated to the founders, distributed based on their ownership percentage in the company.
- The option plan of the company will have 1 million shares.
- The remaining 1 million shares would be left unissued for future use.
If you plan to recruit co-founders later on, you would have to decrease the number of shares issued initially and increase the number of unissued shares. The reason to leave some shares unissued in your company is to avoid seeking corporate approval. By leaving unissued shares, you can delay having to amend the formation documents of your company to authorize more shares as your company grows.
Once the company is formed, use a simple capitalization structure, with one that does not have any options, warrants, or securities that can be converted into stock. So, as long as the startup keeps a simple capitalization structure, the number of unissued shares would not impact the ownership of the company.
Let us take an example to understand this better. If your startup has two founders and you both take 4 million shares each from the 10 million authorized shares, both of you would own 50% of the company. However, this ownership would not remain the same when additional shares are issued for the company. So, before you issue further equity, you should keep in mind that it would affect the percentage of your ownership of shares.
Considering vesting schedule for founder stock
As mentioned before, typically founder stock comes with a vesting schedule. This schedule lets us know the right time that the shareholders are permitted to exercise their stock options. For example, if a person shares are vested over a period of 5 years, it means that the person will have to stay and work for the company for 5 years and then would be able to exercise their options.
A vesting schedule is important as it secures the future of the founders in case one founder decides to leave the company early. Although it is unusual for people to leave half-way, it’s a good practice to have a vesting schedule for the founder’s stock.
In the end, it is important for you to issue shares to the founders in your company, as they are the ones taking the risk of being a part of the company and helping it grow. You can easily add a vesting schedule for the founders stock to be secure as you add in other founders in the company. To learn more about vesting schedules for the founder’s stock, check out the next knowledge-based article here!