When It Comes to Equity Stakes, There's No Need for Contention
Get the working capital your business needs from Entrepreneur Lending, powered by CAN Capital. Learn More »
As a VC guy, I'm often asked by novice investors if there is a magic range of equity that founders should keep in their startup. It's a fair question, as investors are always looking for the secret sauce that makes startups succeed without hiccups--or at least not many.
There's no perfect formula, though. Founder and investor equity negotiations are highly situational and constantly changing, so dialing in a perfect equity number is really a function of keeping everyone motivated and working together. Let's take a look at the issue from both sides of the table.
The Investors' POV
The biggest mistake many investors make is overvaluing equity (they want too much of it) and undervaluing execution (the team behind the startup). A million-dollar idea in the heads of brilliant people is great, but it's hardly liquid. If an investor is bullish in an opening negotiation, a founding team may hold him and his money hostage. The fix--replacing the founders--is generally not an option in the early stages of a company's life, so the founders tend to hold a lot of the cards. For the investor, it's often better to take a slightly smaller stake at the beginning in order to motivate the founding team to shoot for the moon.
The Founders' POV
Like investors, startup founders often overvalue equity (they don't want to give it up) and undervalue cash. But let's face it: A majority stake in a startup with no money is worth exactly that--nothing--so put your ego in check. What's more, things inevitably go wrong, and when they do, you'll need those early investors to be your best friends. If your investors feel they don't have much to gain during the rough periods, their answer will be to write the investment off or renegotiate their equity stakes in a punitive way that you will not enjoy.
The key isn't to zero in on a perfect number that will stick, but rather to understand that the founders' equity number should start high and naturally evolve as the company grows into a sustainable business and brings on more investors. Managing this process so that everyone--founders and investors--stays excited in the company is a true art, one that overshadows the first VC investment conversations outlined above. It's the responsibility of both parties to do it right.
In the end, keep in mind that great investors and founders didn't make their millions by constantly beating up on each other. They worked together to make everyone wealthy. And if you're still thinking there's no way you'll ever give up a majority stake in your business, consider this: Bill Gates became the richest man in the world despite ending up with just a single-digit ownership stake in Microsoft.