Using ownership, or equity, in your startup as a way to raise capital and bring on the right talent has many benefits. It means you don’t have to use cash and aligns incentives on the success of the company. Here are some do’s and don’ts around giving away a piece of your company.
When raising an unpriced seed round, understand exactly how convertible notes or SAFEs will impact your cap table when you do raise equity in a priced round. Convertible notes and SAFEs are not equity, but normally come with price discounts or valuation caps which allow the investors more favourable terms than new investors when you do raise equity.
For a variety of different valuation amounts in your next round, do scenario analysis around what the note and SAFE holders would do and how this would impact the equity left for founders, employees and new investors. Dilution for a founder diminishes not only the cash you get if and when the company is sold, but also the control you have over key decisions on the direction of the company.
If there are co-founders, don’t default to splitting equity equally. Instead split equity based on contribution you’ll be making to the company, for example if one of you is contributing more by way of hours or impact of work, then split accordingly.
Don’t have the equity, which means rights to all future profits plus decision-making power, available immediately. Do include vesting, which means shares are earnt over time, such as 4 years. That way if your co-founders are incentivized not to walk away prematurely and if they do, you won’t be left having to explain to investors why a large chunk of equity in your cap table being owned by someone who is not contributing to the company.
When it comes to advisors, don’t give equity outright.
Do give stock options, which vest based on specific deliverables and milestones. As you don’t have the same day to day oversight over advisors like with employees, there is a huge benefit to being clear what impact is expected from their involvement.
For employees, don’t give too much in stock options to one single employee or advisor. Do make sure you really understand their value and impact to revenue growth beforehand. The right amount of equity to give varies a lot and in general the earliest employees would get the most for the risk they are taking and impact they’re making.