As you probably know, your company’s equity is the ownership of your startup. You use a captable, the table outlining the distribution of a startup’s shares — but it can’t be done just any old way! If it’s not handled correctly, it can be a problem for your startup’s future. Making mistakes when you distribute equity can really screw up your startup in the long term.
For an inexperienced founder, it might seem like the shares of a newly created company have almost no value. Even if that’s the case, it does not mean your shares will always be without value.
Your shares do have value, even if there is no concrete numerical figure attached yet. If you give away too much equity while your shares have no concrete value, it might cause issues in the future when they do have value! That action is irreversible or at least very hard to reverse.
Moreover, it doesn’t help founders when people around them also consider their equity of low value. Like my wise colleague Nino Subotic said:
“People think that just because they were present at the idea stage of your startup, they have earned themselves a large chunk of the equity of your company.”
When it’s not worth much, they expect a large portion of it.
This unfortunately, leads to founders giving away lots of shares to people who don’t actually help long term. On top of this, a crowded captable makes the startup unattractive to investors. And in most cases, it’s the investors who are going to help take you to the next level.
The fact is that your equity is a currency, so use it as such! It has real value — shares should always be exchanged for something. Not given to someone just because “They want to be on my captable”.
I would like a bag of diamonds. That doesn’t mean I’ve earned it!
When people work for or help your company, shares are not always the right way to pay. Sometimes equity is a fair payment, sometimes money is more appropriate. And most importantly, that is your decision to make.
So who gets equity? There are four different types of people you can have on your captable and each person has their place.
Co-founders should have almost all equity early on, but as the company raises capital and hires employees, their share will decrease. As an example, the Spotify founders started at 100% and were down at 30% ownership at the time of the IPO.
In exchange for having such a large share, founders are expected to be 110% committed and work full-time with the startup. Here, it’s important that founders sign a Founders’ Agreement or Shareholders Agreement so that the shares are contingent that you stay in the startup.
Advisors may be essential for the type of startup you want to build, but you might not have enough capital to pay them out-of-pocket. In that case, you can instead offer them a few percent of equity. It’s also important that the shares they receive are contingent upon their actual participation. “I have some advice for your startup” does not an advisor make!
You want to attract top talent to your startup, but you might not have access to the capital required to compete efficiently on the talent market. Using an option pool to pay employees partly with shares on top of salary can be effective.
And of course, the one you’ve all been waiting for — investors! Investors are people who might want to join the ride, but they don’t want to help with their time. Instead, they prefer to chip in some capital. Investors are the ones who set the valuation of your company and determine what your shares are worth. But investors also need to think long term. If they invest at too low a valuation, they will take too big a part of your equity, which will make your startup unattractive for future investors.
So you can see, managing your equity early is vital to the health and success of your startup. Treat it like real money. If you start passing it out willy-nilly, you’ll find your pockets empty when you need it most. Just because your shares do not yet have a concrete valuation does not mean they are without value.
It’s about looking forward — the future value someone will bring and the importance of the future of your startup.
People with shares should be people who are passionate and that really care. You’re on this journey together, and it’s about equity after all!