Building a successful startup is not a sole endeavour. It relies on the contribution of several individuals, collectively shaping the organisation’s vision and path to growth. Two crucial elements of this journey are equity split agreements and recruitment of the right team members.
Co-founder equity and splits
Co-founders sit at the heart of a startup. They provide not only the initial investment but also contribute to a startup’s vision, strategy, and growth. Equity splits among co-founders is a subject that commands lots of attention in the journey of a startup.
Equity splits can vary depending on the nature of the situation and the contributions made by each co-founder. There is a common belief that splitting equity equally among co-founders is usually the best solution. However, this might not always be the case, particularly if one co-founder has significantly contributed more towards the development of the startup.
There are also scenarios where a founder builds a Minimum Viable Product (MVP) for their startup and then brings in a co-founder with a strong commercial background to help build the venture. In this scenario, the founder might own a larger share of the business, perhaps 60%, leaving the co-founder with 40%.
It’s also important to note that equity is representative of the work you will do in the future and not just what you’ve done in the past, meaning co-founders earn their equity shares over time. A vesting agreement is a common way to ensure this. This means the co-founders only fully own their shares after a certain period (usually over three years or more) has passed since the company’s inception.
Giving equity to employees
Bringing in the right team members can not only fill a skills gap but can significantly impact the startup’s culture and future trajectory.
Generally, when hiring an employee, there are certain factors that need to be taken into consideration when it comes to equity offers. For one, employees rarely receive a double-digit equity figure in a startup. A C-suite level person in an early-stage startup, for instance, might receive up to around 3% to 4% of equity. However, as the business matures and the risk level for a new hire decreases, the equity offered would usually decrease.
When dealing with equity offers, understanding equity as a finite currency is vital. Giving away equity implies a permanent loss of that share in your business, making it crucial for startups to be cautious with their equity distributions.
The idea of advisors receiving shares has often been debated. They come into the picture when you need help with specific areas of your business and can bring specialised knowledge that the existing team may lack. In specific scenarios, it indeed makes sense to offer shares to advisors and keep them interested in the startup’s welfare. But they should be viewed as an exception rather than a norm.
The funding matrix
The founding team can always benefit from creating a spreadsheet with columns which correspond to each funding round from seed to series A, B and C to divide business equity between every shareholder. This matrix allows all founders to visualise how much equity should be allocated at each stage as new employees or investors come on board. It is very important to adjust the equity distribution as the business grows and more people join.
The matrix approach helps founders understand that an ESOP (Employee Stock Ownership Plan) of 10% may not be sufficient to cover future hires and investments beyond series A. It becomes apparent that increasing the ESOP or revising individual equity percentages may be necessary. It is crucial too for founders to have open conversations about rebalancing shares based on the value each person brings to the company. This ensures fairness and acknowledges varying contributions over time, which can lead to stronger partnerships between co-founders and employees alike.
Overall, using a matrix for funding splits provides clarity in determining appropriate equity allocations at different stages of growth while considering individual contributions and maintaining fairness within a startup’s ownership structure.
Difference between a co-founder and an employee
It’s also essential to understand and distinguish between a co-founder and an employee. A co-founder shares leadership, vision, and strategic decision-making responsibility while an employee usually takes directives and has well-defined supportive roles.
With co-founders, founders share the responsibility of guiding the business and building it from the ground up. This dynamic demands cohesion and openness between the founders, making it possible to reevaluate and adjust the equity splits along the way. Hence while bringing in a co-founder or an employee, it’s indeed important to weigh their roles, the value they add, and how their association would benefit the startup in the long run.
We’d like to thank Adib Bamieh for sharing his thoughts on equity management. Hear more of Adib in our Atom Podcast episode: https://atomcto.com/2023/10/09/adib-bamieh-the-rule-of-three-and-ten-in-business-growth/