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Here's how the question is typically posed to me: "I'm in the process of starting a new business. I've developed some new technology -- with patents pending. But I have no experience commercializing new business ideas. So I was able to find a veteran CEO who wants to be a part of the venture. How much equity should I grant?"
There's no easy answer. And there is no rule book. You may be tempted to hand out a lot of your equity to hire the talent you need. But what if your start-up turns into the next Google (NASDAQ: GOOG), eBay (NASDAQ: EBAY), or the latest hot IPO, like VMware (NYSE: VMW)? Might you risk giving away the store?
Over the years, I've talked about equity splits with many pros. For example, last week I discussed the topic with Todd Dagres, a founder and general partner of Spark Capital.
Here's the easy part: In the beginning, go for an equal split among the original founders. After all, in the early stages of a business, there is really not much value anyway.
Although, if a founder contributes hard cash, customers, partners, or technology, he or she deserves additional equity. But somehow there needs to be a way to value the contribution, which can be complex (except for cash) and may result in some heated exchanges.
It can also be complicated to decide who will be considered a founder. Include only those that will be critical for the success of the company in the first couple years. For all others, it's probably a better idea to hire them or bring them on as consultants.
How then to treat early hires? It's typical to set aside 5% to 10% of the company's equity for employees. But it's a good idea to have vesting. For example, you could set it up so an employee may vest 20% of the equity for each year with the company (for a term of five years). This can be helpful in attracting strong employees -- and keeping them on board. Another benefit -- if an employee leaves, there will be more equity available to give to new employees.
Now, let's say you contribute technology, cash, or some other asset to the new venture. When you're determining your equity stake, it's also smart to provide a way to take back the asset in the event of a liquidation, dispute, or other problem. In the start-up world, the probability of survival is not good. So, make sure you don't lose something that may still have value.
Finally, I highly recommend that you hire your own counsel. Many founders will hire an attorney to represent them as well as the company. While it may save some legal dollars, it could be expensive for your long-term financial interests.
Tom Taulli is the author of various books, including the Complete M&A Handbook and the EDGAR-Online Guide to Decoding Financial Statements. He also operates DealProfiles.com.
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Reader Comments (Page 1 of 1)
8-20-2007 @ 11:45AM
LBO said...
Founders equity can be quite complicated. There is a delicate balance between retaining the lion's share of the equity and attracting a qualified team that will make you much wealthier than you will be capable of doing yourself. The best approach depends on the individual situation of the entrepreneur. You must be very candid with yourself about your strengths and weaknesses and your personal ability to get the idea executed and successful. Many individuals who are very capable of coming up with the idea lack the financial competence or operation skills to successfully execute the business. Hire around your skills and get others who see the vision and have the complementary skills to make it happen. We often tend to like people who are like us, but that will not provide the broad skills necessary for success. If you are a sales person capable of managing others, that should be the last person you consider hiring. Get the operations person in place and someone who can effectively manage the financial aspects of the business. Once you have identified the core team to help execute the idea, be generous with the equity so you get real partners working with you on the deal. There are many challenging days ahead, and knowing that you can share the real issues with a core group (not individuals who will be looking for the door as soon as a hard problem arises) will make you all better at what you are trying to accomplish. Put the equity on an earn out basis, meaning the inidivuidal has to be with the company for a long period of time to get all of the equity, for example, 10% should be paid out as 2% per year for 5 years.
Hire people who are smarter than you and then let them do their jobs. Never stop monitoring their activities and you must have certain checks and balances in place to make sure their loyalty to your company is in tact, but let them do what you hired them to do.
Last thought is to have an abundance mentality. Your business is often limited by your view of it, but that is often not a real limitation. Let the business grow as it can, and you can be wealthier through your venture than you can currently imagine, and hopefully, the other key people in your organization will become quite wealthy as well. Always remember that you are much more shareholder than employee...which means that if someone comes along who can do your job better than you can, give it to them to do!
8-20-2007 @ 4:35PM
Roger Waugh said...
If you learn from liars then one lives a lie ,nothing gain is nothing lost,If you witness a crime and do nothing about it then you are a criminal! Have a nice life!