You have an amazing staff of highly skilled workers and advisors and would like to offer them equity in the business. You know that startup equity is a valuable commodity but distributing it can be complicated. You only have so many shares of the business to divide and share with others, so it’s important to ensure proper distribution.
In this article, we will discuss who should receive equity in your business as well as a few important dos and don’ts.
Equity distribution naturally starts at the founder/co-founder level. It’s important to have open and honest conversation about startup equity with all starting players right from the beginning. Regular equity conversations from the beginning will help your startup succeed in the long run.
After founders, you typically have early-stage employees. You might not be able to offer high salaries right at the beginning of your business, but you can offer equity as part of the compensation package to entice talented workers to your team.
Another important equity distribution category is investors. Startup investors are taking a risk in your business with the anticipation of seeing a financial return in the future. The amount of equity an investor receives depends on a number of factors including the valuation of a company as well as the size of a company.
The final equity distribution category is advisors. As a startup, it can be incredibly valuable to have an advisory board of experts and experienced founders. These advisors can provide industry knowledge and strategic insight to your young company. It’s common for advisory boards to perform their role in exchange for equity in your startup. In most cases, startups will offer advisors anywhere from 0.1 to 1 percent in equity.
Equity is typically distributed during different funding stages. As the company’s financial status shifts, equity is distributed in different ways. For example, in the early stages of a business, the founder is the majority shareholder of the business but by the time you get to stage B funding, the investor stakes have surpassed the founder shares. Determining how much everyone receives isn’t easy, but here are a few important distribution dos and don’ts to keep in mind.
Do talk about equity distribution and be transparent about what you’re offering. Discussing equity can make some founders nervous, especially if they’re talking about it with their co-founders. Determining how equity will be split and having regular conversations about it, however, will make the process easier and keep everyone on the same page.
Do consider using equity as leverage for an important hire. Anu Shukla, the founder of RewardsPay offered her VP of engineering a 3 percent stake in the company. The average at the time for an executive position like this was 1.5 or 2 percent. However, Shukla wanted to keep her VP of engineering motivated and recognized how vital the role was to the overall success of her new business. In this instance, using equity to invest in crucial staffing decisions was a strategic move.
Don’t do a 50/50 co-founder split because it’s the easiest option. Sometimes equal equity splits among co-founders is the right decision, but this isn’t true all of the time. For some teams, one leader will play a more central role in the overall growth of the company. In this case, something like a 60/40 split may make more sense. A perfect example can be seen among the co-founders of Microsoft. Bill Gates and Paul Allen split the company 64 percent to 36 percent respectively.
Don’t fall for high advisory fees. Before signing a contract with any advisors or consultant, double-check the standard stock options for these types of partners. Too often early-stage founders will sign term sheets listing an advisory fee of 5 percent of common stocks. In most cases, a reasonable advisory fee for an early-stage startup would be closer to 1 percent, if that. Remember, your company’s equity is one of your most valuable commodities, so don’t give it away unless you expect a serious return on your investment.
Overall, equity distribution needs to be carefully considered on a case-by-case situation. Review industry equity distribution standards, but then consider the unique needs and growth trends of your business. If it makes sense to offer your VP of sales more equity than the industry average, then carefully evaluate the strategic advantages and make the offer.
Equity distribution ultimately depends on the overall growth and success of your business. However you decide to share ownership of your business, be sure to make the decisions with thoughtful care and intention.
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