Slicing the pie

“It is like having the startup and eat it too”.

Startup equity is one those things that every startup founder and co-founder may struggle at the beginning. If you don’t have an MBA or experience in this matter you may encounter some dilemmas trying to split your company as fair as possible to all members involved.

Starting a project is no small feat: think about tech complexity, business model and you still have to strategise scaling up. Besides that, along the road you will encounter some other hard-thinking subjects such as equity, shares, options, fair market value, vesting, etc.

Equity is an important step and may define the future of your company, so today we are going to talk about it and give some guidance on how to split up the startup equity distribution fairly among you and your team members.

The first thing to know is that usually the share size to split is divided by categories. Each member involved belong to a category and therefore should receive a different share.

So, who gets startup equity? Generally we have the following:

Co-founders
Advisors: general advisory / business and VC contacts;
Investors: family members, angels and venture capitalists
Employees

Basically you also have to keep in mind the risk each one of you is taking and how much value is being contributed. This will be detrimental when discussing an offer.

Each startup will have to figure out its structure and portion out equity to the founders of the company, so let’s start there: the founder team.

Co-founders

A co-founder is a person who, in conjunction with you and other members was instrumental in starting the business and developing it. Like you, they are willing to take risks, grow the business and contribute to the success of the company.

This is a tough task to handle because each member contributes differently, making difficult to measure and come with a fair share. This step will require a lot of patience, discussion and transparency from all sides.

How much should one get? The general advice here is to always begin with and even split. If you all believe there’s a balance in responsibility and knowledge among you and the co-founders, it is better to avoid disputes that may hinder the success of the company.

The concept of “fairness” will vary for each person, so try to listen to everybody before proceeding. The more advice you take, the better the chances to get a solid plan that will make everybody happy.

Also You may try to split based on how much value they are contributing right now to the business instead of focusing on an unknowable future. This is because human beings are terrible at predicting the future [1], so look to the present and what you have now.

There are useful tools that may help you understand what’s at stake, which questions to focus on and each numbers to expect as a “fair share”:

Startup Equity Calculator - To Get Started: I loved this one because it is simple, easy to use and comes with an useful questionnaire to help you see the big picture;
Slicing Pie: This application creates a model to help you create a fair equity split. It requires a subscription but may be worth it if you are struggling too much.
500 Startups KISS Convertible Debt & Equity Documents: This one is a complete Equity Financing Documents Generator that may create a good template to improve on.

Advisors

Advisors are amazing. They are the people who contribute their time and expertise to startups which can be absolutely invaluable as you and your fellow partners learn on the go.

The simplest method here is to talk with other founders or people from your area. Build your network is essential and will help you get insights and guidance without having to slice the pie once or twice. Whenever you meet with someone, bring to the table your experience and knowledge to make this a win-win situation. Helping them as much as they are helping you make the discussion pleasant, build confidence and relationships that will make the difference down the road.

While you are learning how to swim, may be desirable to seek a professional. There are no strict guideline here on how to compensate them, but you may expect something up to 2 percent depending on the work, vested over one to two years.

Kris Kelso writes to startups.com website [2]:

“0.5 percent and 1 percent is a good range to consider, vested over one to two years. For that amount, he suggests you can expect about two to five hours per month of involvement from your advisor.”
— Kris Kelso, entrepreneur and executive advisor.

According to corporate lawyer Yoash Dvir [3], startup advisors can be divided in general advisory / business development and VC contacts:

“[…] from what I’ve seen, advisors usually take 1 to 2 percent. However, for the VC contacts (and make sure they are not ‘brokers’ if they are not licensed as such), you can offer a percentage (usually between five and 10 percent) from the investment, or a percentage from the issued shares in such investment (again five to 10 percent) or both.”
— Yoash Dvir, Business and legal expert.

An equity offer is a powerful tool to get invaluable guidance from a professional. Being unexperienced or a veteran, build strong relationships and get helpful and wise advice along the way is always welcome.

Investors

An investor is a person or organisation that puts money into your company with the expectation of achieving a profit. Generally this character varies from family members, angel investors and VC firms / funds, and each one of these may request a different size of the pie.

The amount you’d give an investor depends on some factors:

How much you value the company at the time of the investment?
How much they are willing to invest in your company?

These points may define the expected compensation during negotiations with the investors and in order to get the most you have to come prepared and have at least a solid idea about the valuation of your company.

But how do we value our company? Well, that is a very good point and we should reserve a whole post just for this, but bear in mind that family members, seed-stage VC firms and professional angel investors may perceive the value of your company in different ways, so one way to estimate what they might expect is to take a look at their portfolios, i.e companies they’ve invested in recently and compare with what you have.

💡Pro-tip: Check social media and websites like Startup Valuation Data | AngelList to get insights about other companies located nearby or with similar business models. This may help you to evaluate your own project.

Try to talk to as many founders as you can while trying to share your own experiences with them, transforming the meeting in a win-win situation. Talking to founders that operate similar business helps to get a sense of what “normal” is and what to expect from investor’s propositions. As you can see, knowing your surroundings and networking are the heart of the business.

Once you have answered the questions above about valuation, what you can bring to the table and what expect from others, you will be much more confident and prepared to talk with investors. Most likely they will present you a different idea at the beginning of the negotiation, but the objective here is to reach an agreement that works well to both sides.

Employees

When a startup is at an early stage and not generating revenue yet we often have to be frugal in our expenses to be sure that the resources will last long enough to see some results coming. Because of this limitation it becomes hard to offer a salary at a fair market rate, therefore one strategy to retain great employees is to offer them a stake in your company.

Offering startup equity to early-stage employees is a way to show trust and can be a good motivation factor for them because they will have a part of the company. Also this partnership has an additional benefit to retain them should you choose to vest their stock over a four year period, which is a common practice.

So the question is how much should you offer? Well, you have to think equity as a compensation for the risk your employees are taking. If your employee is getting a full market salary and all expenses paid, he is not taking any risk at all and should no get equity. However if your engineer is getting paid in pizza and coffee, he totally deserves a share based on the risk and uncertainty he is taking.

When creating your package, try to think equity in terms of monetary value instead of share of your company — which will be diluted as you scale. This means that if you have 2.000 shares and investors paid $20,00 per share, your equity is worth roughly R$ 40.000,00. This allows you to evaluate your package and make a more solid offer.

Also, as mentioned above, it is a good idea to vest employee stock over a few years, with many companies choosing a total of four year period.

Michael O. Church presents a thorough answer [4] on offering equity to employees:

“The distribution of that employee pool seems to be around 1/(15+E)^1.5 (as a fraction of that available 20%) where E is one’s employee number (including founders), times 4^k where k is the managerial level of the employee (0 for engineers, 1 for managers, 2 for managers of managers, etc.)
[…]
So, for each employee count, your typical engineer equity slices are: First employee (E = 4): 0.24%; at 10 people: 0.16%; at 20 people: 0.10%
[…]“.

The formula mentioned may be a good start while figuring an offer. Depending on the talent you are looking for and the positions you are offering, the values may vary. As a retention strategy, these equities may be vested over 2 to 4 years.

Conclusion

Now you have a sweet introduction on how to split fairly and distribute equity among your co-founders, advisors, investors and employees.

The next step is talk to your team and start the slicing! Remember to liste and be patient. Every journey of a thousand miles begins with one step.

Trust me, it gets easier once you start 👌.

Startup equity and who gets a piece of the pie

Co-founders

Advisors

Investors

Employees

Conclusion

References

Sources

Citations