Wednesday, September 10, 2014

Tech Startup Equity Distribution

English: Defunct Belgian shares in a Russian T...
English: Defunct Belgian shares in a Russian Tram company for the city of Saratov. With the Russian revolution these shares became worthless. Nederlands: Oude Belgische aandelen in een Russische trammaatschappij in Saratov. Na de Russische revolutie zijn deze waardeloos geworden. (Photo credit: Wikipedia)
100% is like the speed of light. The total has to add up to 100%.


33 to the Cofounders, 33 to the investors in all rounds all the way to IPO, 34 to the team.

When you start a company, you probably have two Cofounders, or three. One is often the Senior Cofounder, the possible Founder CEO. It could be 10-10-13, with 13 going to the Founder CEO. Or it could be 5-10-18. Or they could agree to cap themselves at 30% and give another 3% to the team. And so, 5-7-18.

But the investors have not come yet. The team has not been built yet. The Founder, or the Cofounders could keep the rest of the equity in a caretaker capacity. So, 5-7-18 could become (5+15)-(7+25)-(18+40), with the caveat, should a Cofounder leave the company, the equity held in caretaker capacity reverts back to the company. Even the 5-7-18 should have a vesting period of, say, five years. So if the Cofounder at 5+15 leaves after one year. The 15% goes back to the company. And he/she walks away only with 1%. Because the other 4 has not vested yet.


I am for an anti-dilution clause. Say you raise 50K in your first round to give away 5% of your company at a million dollar valuation. The anti-dilution clause makes sure that 5% stays 5% in all future rounds. Otherwise, without the anti-dilution clause, a round 1 investor could put in money, feel like he/she owns 25% of the company, but by the time there is an exit, that person ends up seeing that the 50K they invested is still 50K when they walk away from a successful startup's exit. I think that is a shame. And it happens all too often.

Say, it is 30-35-35. Then 5% is gone. And 30% to go.

Round 2 you raise 500K at a 10 million dollar valuation. That is 10% gone with 25% to go. Round 3 you raise 2.5 million at a 50 million dollar valuation. That is 15% gone. There has been an anti-dilution clause at each stage. That makes each round of fundraising independent of each other.

You go IPO at a 100 million valuation. You raise another $5 million at that valuation. That is 20% gone. Hopefully your company keeps doing well, and you raise another 50 million dollars at a billion dollar valuation.

The Team

This is of utmost importance. You have 35% to give away. And you have to assume some of your best people might come years later. The formula is, the higher up you are, the earlier you come, the longer you stay, the more you get. And here you want to move to number of shares as soon as possible. Because 0.1% feels like little, but 100,000 shares feels like a lot.

Your team could be five deep, or 10 deep. The Board is layer 1. The CEO is layer 2. The executive committee (COO, CTO, CFO) is layer 3. All three are not equal. The CTO might get more. The CFO might get less than the COO. Depends. Assume there are five other layers all the way to the receptionist.

I think tech startups should pay below market rate salaries as a rule. You only want people who really see the value of your equity. And the equity you give out should vest over five years.

The Board we took care of. The Founder CEO we took care of. Assume the executive team is not any of the Cofounders. Say the CTO gets 2.5%, the COO gets 2%, the CFO gets 1.5%. To vest over five years. That is 6% gone. But a COO coming in in year 3 would get less, something like 1.5%, or even 1%. Also to vest over five years. Unless you get a star CFO in year 2 who is good enough to take the company IPO, then you can be a little more generous. How about 1.5% to that CFO in year 2?

A superstar CTO might be worth 3%. I don't know.

The thing about the lower layers is there are more people in those layers. That further reduces the size of their cake.

Layer 4 might get 3% total. Or you might say, 3% for each layer with a cap of a certain percentage points for each layer.

Layer 4 gets 3% total, but an individual may not get more than 0.5%, something like that. But if there are 10 people in layer 4, they get 0.3% each on average. Some might get 0.2%.

Layer 10 people might get 0.05%.

Number Of Shares

At a 100 million dollar valuation, the company has 100 million shares to give at a dollar each in value. So at a two million dollar valuation, the company shares are worth two cents each.

So 0.05% in equity is actually 50,000 shares, which is a lot. The junior most members of the team will probably be looking at something like that, again, to vest over five years. You don't have to buy them. You just have to stick around, work hard, and your shares keep vesting.

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