Dividing Equity Between Founders and Investors How to figure out who gets what percentage of the business when investors come on board
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Q: Ifounded a company with two partners, and we're currentlylooking for a venture capital firm to invest in us. How will theequity be divided among us and the VCs?
A: Oneof the most common questions I get is about how equity should bedistributed. I'll warn you in advance: There are no hard andfast rules. Equity is negotiated on a case-by-case basis, whichmakes it hard to give any generalizations. I'll try to givesome thoughts on what to consider when you give out equity.
Dividing Equity AmongFounders
Founders receive equity for what they bring to the table. How muchof the company they own as a result of their contribution is purelyup to the group to decide. There are several factors that need tobe considered, however.
- Timing, size and duration of contribution: The earlier,bigger or longer the contribution to the company, the more equity afounder should receive.
- Power: Equity conveys voting power and control over thebusiness. Generally, founders who intend to stay with the businesslong-term should retain the most control. I have heard itrecommended that one individual own at least a 51 percent of thecompany, to provide consistent decision-making when resolution isneeded. Equal partners, while great in theory, can destroy acompany when the partners don't agree and have no way toresolve fundamental disagreements.
- Money: Early money is a contribution for equity. Moneyhas the side effect of valuing the company. If you give 10 percentof the company for someone contributing $50,000, it implies acompany value of $500,000. If you try to raise money immediatelythereafter, that valuation could hurt your negotiating ability. Butif substantial infrastructure has been built in the meantime--ifcustomers have been acquired or if more of a team has beenbuilt--then a higher angel/VC valuation is justified.
- Kind of contribution: A founder may contribute in manyways. Some bring patents or product ideas. Some bring businessexpertise and ongoing work to build the business. Some bringcapital. Some bring connections. Some may bring big names orreputations which convey credibility with VCs and/or clients. Onebig name that provides instant credibility may, in fact, be worthmore to the company than a founder who actually puts in the work tobuild the business. Make sure to understand what each founder'scontribution is and value it appropriately.
We Have Five Founders--What DoWe Do?
Negotiate, big-time. Too many founders can be a big problem. As thecompany reaches for outside funding, you make many decisions aboutequity, contribution and dilution. The more equity-holders, themore negotiation has to enter into each of these decisions.
Having several founders makes it hard to keep everyoneadequately compensated. By the time of harvest (IPO oracquisition), the founding group can expect to own about 20 to 30percent of the company. With one founder, that can mean riches.With several founders, that may mean splitting the pie into so manypieces that no one is happy with the value of his or her piece.
In short, fewer major equity holders are better. If you'vealready got several, make sure to tie each founder's vesting tothe contribution you're expecting from him or her.
How Much Will Investors Expectto Own?
The basic formula is simple: If you need to raise $5 million, andan investor believes the company is worth $15 million, you willhave to give them 33 percent of the company for his money.
Different investors value companies in different ways. Some lookat the quality of the idea, assets, market size and managementteam. Some rely on financial projections. Some simply look for"big ideas" and determine their percentage ownershippurely through negotiation.
I asked a couple VCs, some entrepreneurs who recently receivedfunding and an angel investor how much of a company is typicallygiven up in the first round. While one VC had seen investments aslow as 5 percent, the majority thought that first-round investorsusually take between 25 and 45 percent of the equity.
One entrepreneur remarked: "The better thing to ask is, howmuch should management and founders try to hold onto before theIPO? Answer: as much as possible, but no less than 25percent."
The entrepreneur has an important point. If it comes down to themoney (as it often seems to, these days), what matters ispercentage ownership at harvest multiplied by the valuation atharvest. Owning 1 percent of a company with a billion-dollarvaluation is still more interesting than owning 10 percent of acompany with a $50 million-dollar valuation.
What Equity Should Part-TimeContributors Expect?
Not very much. The reality of the situation is that start-upsusually require 150 percent commitment by everyone involved.Venture capitalists insist equity be given in return for ongoingcommitment. Even founders who stay with the company have amultiyear vesting schedule. Many VCs will not allow equity to begiven to part-time employees or contractors.
There is a one-time contribution for stock that is routinelymade: giving capital itself. A cash investment for stock lets theinvestor own the stock free and clear, with no further contributionrequired. Having part-time contributors purchase stock outright maybe the best way to include them in the deal.
What Does Ownership Look LikeAfter the First Round?
According to Ann Bilyew of Advent International, a typical firstround is:
- Founders: 20 to 30 percent
- Angel investors: 20 to 30 percent
- Option pool: 20 percent
- Venture capitalists: 30 to 40 percent
Stever Robbins is the founder and President ofLeadershipDecisionworks Inc., a national training and consultingfirm that helps companies develop the leadership and organizationalstrategies to sustain growth and productivity over time. His website is http://LeadershipDecisionworks.com.
