Founding a startup is incredibly exciting. It’s almost like a new baby: lots of promise, years of hard work, and knowing that you’ll succeed in bringing something into the world that will make a positive impact. However, like parenting, startups are often clouded by cofounders and initial employees who bicker over who does what and how much of the responsibility they are shouldering. In the beginning stages, everyone will want part of the ownership of the company. Deciding how to divide is essential to avoiding potential pitfalls down the road.
A company is usually formed based on the idea of one person. In some cases, two or more individuals will collaborate to create the foundation for the business. At its earliest concept, it’s likely to be a series of conceptional thoughts tossed around across a dinner table or discussed over drinks. As the business grows from an idea to an actual enterprise, talks over equity will need to occur.
At this time, potential revenues and obstacles to overcome are virtually unknown. However, as the business begins to take on its first customers and deliver goods and services, the earnings of the founders, their expected contributions, and life circumstances will need to be thoroughly discussed.
It’s not uncommon for startup founders to put maximum effort into their business. They may work 80 hours a week to put the foundations in place for success. In other cases, cofounders may have families that need support and less time available to grow the business. This is where talks concerning expected salary and equity ownership should occur.
To decide upon the appropriate earnings and salary mix, it’s essential to weigh everyone’s contributions and what they bring to the table and gain a realistic insight into how much effort they can put into the business. Most cofounders assume that 50 / 50 equity, or 33 / 33 / 33 in cases where there are three prominent company leaders, is appropriate.
However, if one cofounder will rely more on a salary for their income and can’t wait for probable returns in future years, an even split may not make sense. Other individuals may be dividing their time between another job and the startup and might be unable to put substantial effort into the new venture. In other cases, one individual may have the time now but hope to start a family within the next few years. Whatever the reasons, mixed equity splits may be more realistic than even splits.
For example, suppose one person plans to be the main driver of the business and can sustain waiting for a return on their efforts. In that case, a higher percentage of equity and a lower salary may be more favorable. Someone who has a family and can only work on the venture part-time may receive a minor equity percentage and a lower wage. Determining the best split will look different for every company. Having a frank talk about a realistic division can eliminate future arguments if someone isn’t putting forth the effort that others are.
Startups commonly offer stock options to their employees, especially when they don’t have a lot of funding to provide large salaries. Deciding on the appropriate amount of equity to offer is key to attracting top talent. However, a balance must be struck, as stock options are diluted every time a new round of funding is achieved.
Business owners should also be careful not to give too much of their company away to employees, as it can reduce their earnings. It also reduces the amount available to future workers as the business scales. When deciding on the appropriate amount of equity to provide your new employees, consider the following.
Employees crucial to product development and engineering can often provide the most benefits to a growing company. Their work drives the products created for the company and helps to define an active consumer market. This results in revenues, which are imperative to the organization’s success.
Individuals in these roles — especially those expected to oversee product development or engineering — commonly receive the highest equity. However, before awarding them a percentage, get a feel for how much they hope to contribute to the company.
Like cofounders in similar situations, they may be more reliant on their regular salary than equity. In such cases, it makes more sense to offer them a lower equity benefit but top out on their pay. Top-level engineers and product developers are often awarded 1.5 to 3% in equity, while mid-level producers may receive 0.5 to 1%.
The CEO title often comes with big stock option perks. However, a startup may not be able to afford a top-tier CEO. One of the cofounders may take the helm until the company reaches the level when it can afford a full-time CEO with extensive experience in leading a smaller company into significant growth.
When a CEO is hired, they’ll often command between 3 and 5% of the company’s equity, plus a high salary. More experienced CEOs with a demonstrated history of leading companies in the industry should be adequately rewarded.
Newer companies can often grant higher equity levels because the cofounders have control. As the company attracts investors, the influence of cofounders will dwindle every time funds are acquired. The tenured people in the company often can obtain higher levels of stock options, while the newer employees receive less.
From an operational perspective, this makes sense, as the first individuals to hop on board at a startup take on the most risk. Their future colleagues will benefit from the work that they put in from the beginning.
Deciding on the appropriate amount of equity amongst cofounders should involve a thorough discussion on how much effort each plans to put into the company and their personal circumstances. Some people may be more reliant on their salaries, while others may prefer to wait for their payback after a company has proven its success.
Similarly, when deciding on employees’ stock options, the contributions they are expected to bring should be carefully weighed before deciding on an appropriate percentage. In some cases, employees may prefer a larger salary than the potential payback that stock options may bring.
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