Choosing the appropriate stock split between founders and workers is a difficult challenge. Here’s a checklist of things to think about and resources to utilise.
Startups have a significant edge when it comes to acquiring talent. While large corporations might provide large incomes and excellent perks, startups can provide workers with the opportunity to become very wealthy by sharing company ownership. Here’s an overview of the strategies used by corporations to determine how to distribute ownership evenly among founders and workers in early-stage enterprises.
There are as many different ways to organise a stock split for a business as there are companies. Before signing any equity split agreement, it is usually a good idea to obtain the opinion of experienced specialists.
What Exactly Is an Equity Split?
Non-cash remuneration that reflects a portion of a company’s ownership is referred to as equity. The stock is often shared or split among the startup’s early founders, financial backers, and, in certain cases, workers who join the company in its early phases. Founders often agree to offer skilled workers a tiny stake in the firm in exchange for the large salary they might make elsewhere, as well as pay for accepting all of the risks that come with working at a startup. Instagram is one of the most well-known instances, with the 13 initial workers splitting a 10% ownership share in the firm, which amounted to $100 million once the company was sold to Facebook.
Considerations for a Fair Equity Split
Choosing an appropriate and equitable stock split among founders, investors, and workers may be difficult. The following is a list of critical criteria to consider when determining the best stock split for your new firm.
Ideation – The individual who came up with the company’s key value proposition frequently earns the most stock ownership. However, this is not always the case. Actual, tangible donations of cash and sweat equity, for example, may be more important to your firm than a single great concept.
A reasonable ownership split among two or more co-founders should typically be based on a realistic appraisal of each’s proportional amount of early development effort. In the case of Instagram, for example, one of its two co-founders ended up with a 40% ownership interest since he was the founder whose technical breakthrough resulted in the formation of a firm that was absorbed by Instagram. The second co-founder came on board later in the process and earned a 10% stock investment in the firm, with the remainder dispersed to early investors and company personnel.
Startup Stage – Typically, co-founders or employees who join a firm in its early phases of development (before the seed round, before series A financing, etc.) are entitled to a bigger share of ownership to compensate them for their time commitment and risk assumption.
Wage Replacement – Co-founders and workers may be ready to accept a significantly lower salary if they feel their ownership part in the firm will be worth more in the future. A notable example is the creator of Nike’s emblem, who was paid just $35 plus a stake in the company that is today worth more than $640,000.
Seed Capital – The amount of investment as a proportion of the startup’s value should be considered when distributing equity. A 50/50 share for otherwise equal co-founders, for example, might be reasonably changed to 60/40 in favour of the founder who put in the most initial cash.
Other concerns are divided into past and future contributions. Past contribution considerations to consider include, but are not limited to:
Each person’s time spent presenting the company strategy to prospective investors
Individual contributions to the intellectual property of the firm.
Future contribution considerations to consider include, but are not limited to:
It is now time to focus on company growth.
Capability to handle future challenges based on professional ties and expertise.
The value of chances forgone by the person as a result of his or her dedication to the company.
Schedules of Vesting
It is strongly suggested that a vesting schedule be adopted regardless of how you decide to share stock among co-founders. A vesting schedule specifies when and how co-founders might exercise stock options issued under the equity split agreement. The adoption of a vesting plan helps to minimise difficulties that, in the absence of a vesting schedule, may sink a fledgling firm if a co-founder chooses to quit and take a significant amount of the company’s worth with her.
A typical vesting plan is for gradual vesting over four or five years, with the majority of options vesting at the end of the first year.
An Example of a Stock Split
Advent International, a global equity company, presents the following example of a stock split after the first round of funding:
Founders: 20-30% shared among co-founders. The corporate contribution is seldom precisely 50/50, and the stock split should be determined by a number of variables, including those mentioned above.
Angel investors: 20% to 30%.
Venture capitalists account about 30 to 40% of the total.
Option pool: 20%, which may be distributed among workers.
This example demonstrates how a company’s share split may be structured. Keep in mind that your company’s ownership percentages should reflect its particular character, requirements, and business plan.
It is also important to remember that the specific elements that comprise an individual’s equity share (such as the number of shares, share price, percent of outstanding option pool, equity relative to other employees, and strike price of options) are less important than the actual equity percentage of the company received.
What Tools Can Assist in Navigating an Equity Split?
Without a good organisation tool to handle all of their ownership data, many company entrepreneurs might get mired down in details. Consider adopting a cap-table management tool, such as this one from eShares.
Equity calculators, such as those provided by Founder Solutions and Foundrs.com, might be valuable as well. In computing equity splits, equity calculators take into account a range of elements (ideation, time spent away from other projects, per-hour salary estimate, and so on). Foundrs.com also provides a useful venture capital calculation.
Is equity synonymous with stock?
No. Stock is a kind of firm equity, although equity is made up of more than just stock. Stock options, bonds, warrants, paid-in capital, retained profits, and other kinds of corporate equity are also available. Stock options, on the other hand, are not considered equity until they are exercised.
What Kinds of Stock Options Are Typically Offered to Employees in an Equity Split Agreement?
Employees are often given two kinds of stock options: non-qualified stock options (NQOs) and incentive stock options (ISOs) (ISOs). Consultants, directors, and others, as well as workers, may be awarded NQOs. NQOs do not provide their receivers with any unique tax benefit. ISOs, on the other hand, are solely accessible to workers and provide more advantageous tax treatment to their holders, especially when options are exercised. Before granting a stock option, you should consult with your company’s financial and tax professionals about the specifics of each kind.
Other Quick Tips to Think About
Anyone with less than a 10% ownership stake should not be regarded a co-founder, but rather a first employee whose remuneration should be augmented with a wage.
More co-founders aren’t always a good thing. A team of one or two co-founders is optimal. However, no more than four co-founders are recommended. More than that, and a reevaluation of particular business functions should be contemplated.
Don’t allow your emotions define how you distribute your equity. Make an impartial appraisal of the worth of each equity holder’s contribution in real time and effort. This is especially true when there are family members involved.
Be practical, but not frugal. Remember that a higher stock stake typically equals a greater motivation to contribute to the company’s success.
Please be patient. It might take some time to determine the relative worth of each employee’s contribution to the organisation. A basic, equal stock split among co-founders, for example, may be seen as an indication of management inexperience by prospective investors, and may also result in personal hostility as the firm grows.
Consider withholding certain shares from allocation at the start. As the firm grows, it is conceivable that certain founders or early employees would be entitled to higher remuneration than was initially planned owing to larger than anticipated contributions to the company. Shares held back can be used to compensate for such inequities.