Put My Money Where? How to Distribute Startup Equity the Right Way
Photo by Frederick Warren
Will your startup be the next unicorn?
It’s easy to feel invincible, as you hear the stories of startup successes sweeping the nation. However, while it’s great to have something to aspire to, the reality is that your startup’s much more likely to fail than succeed.
Money problems cause 97% of consumer software companies to fail, and 70% of all tech startup ventures. While these numbers are scary, they don’t have to be your story. Don’t let your precious startup die before it ever gets a chance to live.
Read on to learn the right way to spend your startup equity.
What Is Startup Equity?
Startup equity is a type of investing. Startup investing works when a few people get together and create a solution to a shared problem. They test out their solution, whether it’s a service or product, to make sure it provides value.
When these creative minds find something that works, and they find a market for it, a start-up investment opportunity is born. The innovative thinkers can then turn their idea into a lucrative company.
However, to start making money off of their new business idea, they’ll first need financial support from people who have money. Particularly, entrepreneurs who have experience building successful companies.
Ownership of the Company
When you own shares of a particular company you immediately become a shareholder. As a shareholder, you’ll have all of the same rights as every other shareholder within that company.
Options, on the other hand, work differently. When you have options, you only have the right to buy shares at a predetermined price.
The predetermined price, or strike price, will be set for a future date. When you have options, you don’t have the same rights as a shareholder, until you convert your options.
Shares vs Options
Big-name companies such as Google and Amazon once relied on venture capital. Venture capital is a great way to finance your startup company if you expect to spend a lot of time in the red as your company becomes profitable.
When it comes to investing in early-stage startups there 2 main options. First investors can choose to purchase shares in the start-up at a fixed price. When this happens it’s called investing in the appraised equity round.
The second method is for the investment amount to convert into equity or investing in convertible securities.
When you issue and allocate shares from your company, the holder will have to buy them at a price. In most cases the price will be set at a normal value, requiring a minimum deposit of cash.
Options, once again work differently, because they don’t require the investor to pay any price at the time of receipt. Instead, the price that you can convert the option to at a future date, is set by the strike price.
Splitting up Your Equity
One thing you have to be careful of is that you don’t give away too much of your business. While your equity is a type of business funding, if you give away too much control, eventually your idea won’t feel like your own anymore.
Make sure you’re limiting the number of individuals that you’re splitting your equity with. Here’s a shortlist of investors that typically will receive equity throughout the journey of your startup
- Directors and advisors
The equity you’ll be splitting up among these investors will be the options and the shares of your company. To understand the differences between shares and options, you have to understand how ownership of your company works.
Your Equity Is Gold
It’s easy for early-stage startup founders to become overly generous about giving away their equity. However, remember equity is the ownership of your company.
Make sure that your treating your equity like gold, and being picky about who you’ll share it with the outside of the cofounder group. Instead of instantly offering equity to every employee, make sure you only give it to the right ones.
Equity and Employees
It’s a common mistake for cofounders to believe that every employee wants a piece of the pie. In some cases, employees aren’t interested in anything to do with equity. Everyone operates at their risk tolerance, all motivated by their unique situations.
For example, some employees would rather get paid more, than have a large portion of the equity in the company. Perhaps these employees have high rent payments to make, or kids to feed.
On the other hand, certain employees will be more motivated by equity, than they will a weekly paycheck. These employees enjoy considering the limitless possibilities that their equity can provide.
Being Fair to Founders
Choosing how to split up your startup’s equity funds boils down to finding balance. Your goal will be to equally and fairly split up the equity among each cofounder. Remember to include yourself in the equation.
It can be difficult to assign value to anyone’s founders’ role. While one person may have come up with the original idea, it’s impossible to tell how the other founders will play a part in the company’s success in the years to come.
For this reason, we highly suggest that you go ahead and divide your startup equity up equally.
Work With People You Trust
If you’re not willing to divide your startup’s equity equally with your cofounders, are you truly dealing with the right people? Here are a few questions to make sure you’re entering into the right business relationship
- Are you ready to spend more time with the other cofounders?
- Will you and the other cofounders be able to survive difficult times?
- Are you comfortable handling disagreements with the other cofounders?
If any of the questions above make you feel anxious, then you might want to consider changing your cofounding team.
Take Each Equity Decision Seriously
We hope that our article will inspire you to make wise, well thought out decisions about your startup equity. After all, every decision you make to give away a piece of your company will determine the way your business grows.
If you’re looking for more ways to grow your business, we would love to help! Go ahead and check out the other articles we have on the site.