by • August 30, 2011 • Founders, Pitching & selling, UncategorizedComments (1)111

Asking for equity

You are about to found (or join) a new company. A handful of people are involved to varying degrees, and you need to offer or ask for an equity chunk.

(Disclaimer: These are Opinion numbers, not Truth numbers)

Founders are going to get 75-90% of the company. Employees and advisors are going to have 10-25%.

What qualifies you as a founder is being involved full-time before you have a salary. Significant equity exists to offset founder-sized risk, not to reward whoever comes up with the idea.

When thinking about what equity allocation, I like to use the perspective of being a consultant or director of the board, who wants the company to run as smoothly as possible rather than wanting to maximize a particular stakeholder’s share.

Begin by drafting a few possible cap tables. You are just writing out possibilities for what everyone might own, in table form.

Let’s assume there are 3 founders and 4 other team members.

Founders: 75%

  • Joe: 30%
  • James: 25%
  • Jeff: 20%

Current employees: 15%

  • Mark: 8%
  • Matt: 4%
  • Mike: 2%
  • Mason: 1%

Future employees & advisors: 10%

  • 5x advisors: 5%
  • Future employees: 5%

(Note: If the company has closed angel or a series A, just reduce all the above ratios by about a third for a good-enough approximation, e.g. founders 50%, employees 10%, pool 7%, investors 33%. If they’ve closed a series B+, they’ll have standardised a compensation scheme already.)

Draft a couple more versions by asking yourself “what-ifs”. What if the founders had 90% instead of 75%? What if Mark was considered a founder rather than an early key employee? What if we decided to screw all future employees by giving them no equity? What if all the engineers had exactly equal shares?

You’ll notice that there’s only so much wiggle room inside the employee bracket. If you feel significantly under-valued, you need to either leave or somehow get the founders to view you as a late founder instead of an early employee. If you haven’t been full-time without a salary, there’s not really a case for that (but it’s possible if you’re actually irreplaceable).

I mentioned using a 3rd party perspective. When you consider these draft cap tables, you are asking yourself the question, “How do I set it up so it properly incentivises everyone to work well together?”

Splitting everything down the middle sounds like an easy answer to this question, but then you severely dis-incentivise your best people — the ones who are simply able to deliver more value and know it.

2% feels like a tiny amount when you consider it in a vacuum. But once you slice off the bits for the founders and advisors and an options pool and think about team growth, it may end up being correct. Equally, as a sole founder you may think you need to hold onto 80%, but on making the mocks you can see that the team will run more effectively if you knock yourself down to 60 or treat some of the team as late founders.

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One Response to Asking for equity

  1. sean says:

    We need a simple model to help us properly slice the pie. It needs to be flexible and fair. By fair I mean it needs to give each founder what they deserve. And by flexible I mean it needs to adapt over time to re-allocate the startup equity so that the distribution stays fair until the fledgling company takes flight. check out Mike Moyer’s book slicing pie it talks about 50/50 share and how to divide it through his grunt calculator.