Startup Equity: The Founder’s Playbook

When starting a company, you must decide who will own part of it and to what extent. This is called startup equity distribution. If you’re the only founder, you own the whole company. But if you have partners, you must decide how to split the ownership. Maybe you’ll split it equally or in a different way, like 80/20 or 60/40. This depends on each cofounder’s role, investment, and contribution to the company.

As your startup grows and you need to hire more people, you might not have enough money to pay the high salaries that attract the best talent. Instead, you can offer them a small piece of the company. This ownership means your employees might get big financial gains if your company grows. Offering startup equity is also a great way to get support from advisors and board members.  

Like most startups, you might need money to grow your business. Investors can provide this funding, and in return, they also get a share of your company. In this deal, investors are basically taking a chance on your company doing well. They hope that their future share in your startup will be worth more than what they first put in as an investment. 

When you and your cofounders exchange startup equity for stakeholder support, you’re making a significant trade-off. You need to ensure everyone feels like they’re getting a fair deal while keeping enough of the company for yourselves.

Startup equity jargon made simple

Startup equity means having a share in the ownership of a startup company. Essentially, it’s a piece of the company’s future potential and success. But grasping the concept of startup equity is just the beginning. There are many other terms you’ll encounter on this journey, such as:

• Capitalization tables are detailed charts that show who owns your company’s securities, including stock, options, and warrants.
• Dilution is when your ownership percentage decreases as you create more shares for employees and investors.
• Dividends are payments to shareholders as a portion of company profits.
• Employee equity pool is a set number of shares put aside specifically to give new hires equity or reward current employees.
• Equity compensation is when you pay your team not just with money but also with shares in your company.
• Equity grants are shares or stock options given to people like investors, employees, and advisors to pay or motivate them.
• Fair market value is the price at which shares of your startup would sell in the open market.
• Liquidation rights determine who gets paid first when a company is sold.
• Pre- and post-money valuation is your company’s value before and after receiving new investments.
• Shares are the individual units of ownership in your company.
• Strike price is the fixed price at which holders of stock options can buy the shares.
• Vesting schedules are the timelines that show when employees can officially claim their stock options or shares.
• Voting rights allow shareholders to vote on company matters, such as electing the board of directors.

How much equity should go to founders, employees, and backers

As you launch and grow your startup, many influential people can help it succeed. These are your co-founders, employees, investors, board members, and advisors. They all get a share of the company when you use startup equity. But the amount they get depends on various factors. Here’s how it works.

Founders

Founders are the ones who develop the startup idea and turn it into a reality, taking on all the risks involved. This makes it reasonable for you to hold the majority of the company’s shares. To do that, you’ll need to carefully think about how much of the company you share with others in order to maintain ownership.

If you’re the company’s sole founder, you own all of it. But if you have co-founders, you must decide how to split the shares between you.

Equity splits among co-founders in private companies often vary, depending on factors like:

• The total number of co-founders
• Their job roles and responsibilities within the startup
• The value each founder brings to the company
• Any agreements made when starting the business

For 2 founders, a 50/50 split is typical but can change if 1 founder contributes more capital, time, or expertise. With 3 founders, splits like 40/30/30 are common instead of equal shares. For 4 or more founders, the equity division gets more complicated, possibly looking like a 30/30/20/20 split.

Early-stage employees

Early-stage employees are often key to excellent startup growth and success. They join when your business is new and not yet stable, bringing their skills, dedication, and belief in your vision. To reward and motivate these employees, you can allocate shares from the employee equity pool.

In a typical venture-backed startup, the employee pool ranges from 10% to 20%. Early employees usually get a piece of the pool based on their role, expertise, and contributions.

Depending on your startup equity structure, percentages given to your employees might look like:

• C-Suite Executives: 5%
• Vice President: 3%
• Senior Engineer or Product Developer: 2.5%
• Experienced Business Development Employee: 0.35%
• Sales and Administrative staff: 0.20%

The equity percentages given to new employees usually get smaller as your company grows. This happens because joining a more stable company isn’t as risky as joining a brand-new one. Also, the company is worth more now. Over time, getting shares as part of salaries might stop or be reduced to a smaller percentage.

New investors  

Investors give you the money needed to grow your business in exchange for a portion of equity. The amount of equity you give to new investors depends on a few factors:

• How much they invest: The equity given to investors usually correlates with the amount of funding they provide. A larger investment often means a bigger share of equity.
• Startup stage: Early in your startup, when it’s riskier, you might give more equity to investors. As your startup matures, the amount of equity needed to attract investors generally decreases.   
• Your startup’s value: The higher its value, the less equity you need to give away to attract investors.
• Type of investor: Angel investors invest at an early stage and in small amounts, so they’re more likely to accept a smaller equity stake than venture capitalists.

There’s no fixed rule for how much equity to give your new investors. Startups often give up to 25% in the initial seed funding round and around 15% in later rounds. These later rounds include Series A for entering the market early on, Series B for growing and meeting market needs, and Series C for major expansion after success.

Founders should aim to retain 40% to 60% ownership across all funding rounds. This ensures all founders and early employees maintain a substantial share in the company.

Board members

Board members are essential in guiding your startup. They’re usually experts or seasonal entrepreneurs who offer professional business advice but aren’t involved in the daily operations.

In the beginning, you can compensate your board members with shares instead of cash. Consider giving them anywhere from 0.5% to 3%, depending on how much funding your startup has. You’ll want to go with the higher percentage if your startup has limited funding. Otherwise, you can offer a lower equity rate.

You might begin offering cash compensation as your startup grows, but it’ll be less than what larger companies can offer. This could include payment for each meeting or a fixed annual sum. Alongside this, the equity part of their compensation will decrease, typically on a yearly basis.  

Advisors

Advisors also offer guidance that helps your startup grow and thrive. They typically bring specialized knowledge in areas like marketing tools for startups. Unlike board members, advisors focus on giving specific advice and usually don’t get involved in big company decisions.

For compensation, you’ll likely offer them a smaller amount of equity than board members, often ranging from 0.25% to 1%. This amount is based on their role and how much they help your startup. While you might consider offering cash payments later, it’s more common to continue compensating advisors with equity.  

Equity grant types for early-stage startups

For early-stage startups, equity grants come in various forms, each with its unique features:

• Common stock: This is the standard share type given to founders and early employees. It usually includes voting rights and the potential for dividends. But if the company closes down, common stockholders don’t get their money back before others.
• Preferred stock: Preferred by investors, this type of share doesn’t come with voting rights. However, it does allow owners to receive fixed or preferred dividends before other stockholders. Plus, if the company ever closes, they’re the first to get their investment money back.  
• Stock options: These provide the right to buy either common or preferred stock at a fixed price later. This is popular with employees because they can buy shares for less than they’re worth as your company’s value increases.
• Restricted stock units (RSUs): RSUs promise equity shares after meeting specific criteria, like staying with the company for a set time. This encourages people to stay with your startup for the long term.

Each equity type offers different rights and incentives. Choosing the right one depends on the needs and goals of the people involved, as well as the stage and health of your startup. For example, in an early-stage startup, you might choose stock options to motivate your team without immediately reducing your ownership.

Best practices for managing your company’s equity  

Managing equity in your growing startup is no easy feat. As you add new hires and bring on investors, doling out shares in your company can quickly become complex. You can simplify the process by following these best practices.   

Create an equity allocation and vesting schedule plan

While negotiations might occur later, it’s important to proactively establish an equity plan early on. It sets the foundation for fairness, performance incentives, and future growth.

Allocate equity thoughtfully among co-founders based on their contributions. Consider using a 4-year vesting schedule with a 1-year cliff, meaning no equity is given in the first year. After the 1-year cliff, 25% of the total equity vests, and then the remaining equity vests monthly over the next 3 years.

Afterward, choose the types and amounts of equity grants for investors, employees, and other stakeholders. The vesting timelines for these individuals may differ.

For investors, you might consider a 3-year vesting schedule with no cliff, giving them 33% of their stake each year. It’s often better to offer a 2-year schedule with a 6-month cliff for advisors, reducing the risk if their services don’t meet expectations. 

Confirm equity practices comply with laws and regulations

Ensuring your startup’s equity practices follow the law is crucial to avoid legal problems and maintain a good reputation. Noncompliance can lead to fines and lawsuits, potentially harming your business’s growth.

To stay compliant, seek legal advice from experts in startup equity and corporate law. They can review your equity plan to make sure it meets local, state, and federal regulations. They’ll also check if your plan follows securities rules, especially when offering equity to external investors. 

Update your company’s valuation after significant milestones

Regularly check your company’s value to increase your chances of getting investments or partnerships. These milestones might include expanding into a new market, landing a big customer, or hitting monthly revenue goals. Keeping your valuations current as your business grows will help you make the most of future growth opportunities.  

Maintain an up-to-date capitalization table  

Keep a current capitalization table (cap table) by updating it with changes, like new investments or employees that have used their options. This ensures transparency for your existing shareholders and potential investors who want to understand the current ownership structure. To streamline this process, consider using cap table management software that comes with automation and real-time updates.

Minimize dead equity to preserve company growth and morale

When early investors and employees leave your startup, their leftover equity can become dead equity that no longer contributes to growth. To prevent too much dead equity, use buy-back agreements or repurchase policies that allow the company to buy back shares when stakeholders leave. This ensures that ownership stays with stakeholders who actively work to grow the company.

Discuss how each exit event scenario might impact equity

When attracting investors and potential buyers, discuss how different funding rounds, acquisition deals, or IPO plans could affect their ownership. Explain how they can cash out and how it aligns with their goals.

As expectations rise, this approach becomes even more powerful. Unicorn startups, in particular, benefit from openly discussing exit scenarios due to their unique growth path and potential for substantial gains.

Educate your employees about the startup equity offer  

Instead of just giving equity, teach employees about equity grant types, vesting terms, and the potential for your company’s stock value growth. Then, explain your vision for the company’s growth and how their hard work can help achieve it. When your team understands this, they’ll be more motivated to push your company to the next level.

Don’t underestimate the power of equity in propelling your startup toward success. Distributing equity wisely is the key to building a solid foundation for your startup’s future. It’s what attracts top talent, secures funding, and keeps your team motivated. Put your startup in a favorable position by creating and following a strategic plan for granting equity ownership today.