Startups Stack Exchange Archive

Can you give me some hints while dividing equity with my teammates?

Our startup has reached a point where it is critical to set well defined roles for each member and of course define equities or other type of “profit”.

However my background is IT, not management, and this is my first startup, so I lack some fundamental knowledge on this.

1) About the equity itself, how much is it worth? What power does a person holding a certain equity of my startup has? What operations can one perform with equity?

2) I am also worried about equity dilution over time. Something tells me that at least someone should always have the biggest equity slice, even if it is by just 1%… But I dunno why exactly. Moreover, I bet someone holding equity can gather even more equity by buying it from other person also holding equity. How wrong am I?

3) How can I guarantee that all people holding equity in my company keep doing their work properly? I.e. how to avoid someone of holding equity and bringing no value to the company (becoming dead weight)? Can a strategy be defined in order to avoid this (in the contracts or so)? What happens if someone just leaves out of the blue and takes equity? How can I avoid that from happening, even if it requires taking all that equity back from the person to the company (if I have such power, it may be undesirable for the other members)? Also, what happens if a person holding equity dies?

4) We are 5 people so far, and I am considering doing the following equity division:

Does this look good? Or am I making some big obvious mistake here?

5) Imagine that for some reason we cannot divide equity that much (for 5 people). What can I negotiate with someone who will not have equity (or will have lower equity than he deserves) in order to keep things fair for everyone? (Maybe higher salary in long term?) What is a good replacement of equity for a co-founder? How flexible are these contracts, what can be agreed on them?

This is the hard part of being a CEO (specially, a very inexperienced one), where you have to make these hard decisions and even consider worst case scenarios (a co-founder leaving or dying). One needs to be cold hearted in moments like these. I hope things keep going as cool as they have been so far.

Thanks!

Answer 11876

  1. I would suggest the use of “shares” and/or options vs. equity. This would also require you setting up your company as a C-Corp or S-Corp. You can protect your company shares/equity by implementing vesting. Typical vesting periods are 4 years with a 1yr cliff. So that means they would not receive any shares until they have been with the company for 12 months, and then receive the balance of the shares by month over the remaining 36 months. You can also enable vesting by milestones - so once a milestone is met then the shares/options would vest.

If your company is an LLC, then these people would become members immediately and you have no protection through vesting.

  1. Dilution will likely occur when you bring in investors. An investor is going to want a stake in your business (shares / equity) based on the company’s valuation / market value. The reason you as the owner want to have the majority of shares/equity is because that allows you to continue to make the decisions.

  2. As noted above, vesting is your best course of action. This can be done over a timeline (like 4yrs) or using milestones (like bringing in $100,000 in revenues for a salesperson). So if someone leaves before 12 months or doesn’t hit the milestone, they get no shares/options. But if they leave after 3 years, then they would have 3/4 of their shares. You can also use “options” as opposed to shares. That way when someone leaves before fully vested, they would have to write the company a check to exercise their options (and turn them into shares).

  3. This looks ok in general - but it could be on the high side if you are going to pay salaries at some point. I would separate the two - one amount of shares/options for pre-funding and a second amount after they get a salary.

  4. This depends on you and how much equity you want to give up personally in order to attract the right team. There is no right answer - as long as you are comfortable with what the person is providing to the company for shares then run with it. It also matters when you think you will be able to pay them real money.

Good luck!

Answer 11871

1) The power with equity is when an individual or group has over 50% (the majority). Then they can make the main decisions (e.g. dividend pay out etc). Power should be delegated to officers (e.g. employees) of the company. Generally, you can put a framework in place. Search for “delegated authority”.

2) Equity can be bought and sold. On the dilution front - you need a lawyer to write words on this part. On the 1% more, it is about the majority having power. If you want a majority shareholder(s) then they need to have over 50%.

3) It is easier to do this with a profit sharing agreement then with equity. The purpose of people having equity is so that their focus and interest is tied to the fortune of the company. If they want to walk with equity they can, if they are a Director with profit sharing it is easier to remove them.

4) Don’t know your business so cannot advise on specific amounts. However, I would try and get as much equity for yourself as possible, but offer just enough equity (or profit shares) to the others to keep them engaged and passionate. If you have not told everyone that you will share equity then keep the idea in your back pocket…

5) Why does everyone need profit or equity? You can just employ people normally… It is not a great idea to water now equity or profits just for the sake of it. There are different definitions of “fairness” and also if the company is successful, some will just be happy with a job. They would only have equity/profit sharing expectations if you tell them about it.

In terms of what can go in a contract… anything, it just needs to be legal.

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