How is equity calculated for a startup? originally appeared on Quora - the place to gain and share knowledge, empowering people to learn from others and better understand the world.
Answer by Alexandra Isenegger, CEO @Linkilaw | Entrepreneur | Advisor & Strategist, on Quora:
There are important things for a set of co-founders to discuss before the equity question. It is essential to set all obligations from the start. Before getting lawyers involved it will be beneficial just to discuss your expectations between the two of you. Ask your co-founder what is really important to them?
- Is the title of co-founder important?
- Is being a share owner important?
- Is simply working in a startup important to him/her?
- Is having a particular role most important?
- Is the most important to create a great business?
You should also answer these questions. These sort of questions will help you both get the best deal, but also understand one another and what you are most looking to get out of the venture.
How much equity should you give away?
There is not absolute rule on this. Factors that will influence a co-founder's value in a startup generally are:
- Co-Founder skillset (and whether it is complimentary to yours)
- Co-Founder's experience
- Co-Founder's education (looks good on paper, to a much smaller extent)
- What co-founder is giving up to be art of your startup
- Whether co-founder is bringing any money to the table
- What the role and responsibilities of the co-founder will be
- Whether the co-founder has exited or built any successful startups previously
- Whether co-founder has access to investors
- Whether co-founder has contacts in the industry
- Whether co-founder is interested in the particular sector/has experience in it
If your partner is to become a shareholder, you should definitely consider having a Shareholders' Agreement drafted.
Once you've discussed this, you can bring a bullet-point arrangement to your lawyer that will be a great base for drafting the actual contract. A good shareholders' agreement generally covers the following:
- Shareholder names
- Shareholder respective equity holdings
- Class of shares
- Share vesting (if any)
- Rights and obligations of the shareholders
- Voting rights
- Drag along and tag along
- Dividends
Even though you can easily find shareholder templates on the internet, those will not be bespoke to your business and I strongly suggest you get a specialist lawyer to draft this contract for you.
GOING INTO BUSINESS WITH SOMEONE IS A LITTLE LIKE GETTING MARRIED
So don't go in blindly. Make sure the co-founder is someone you really see yourself working with in the long term. Make sure you are on the same page on what you can and cannot expect from one another.
Also, make sure you do actually work together for some time before you actually give away equity. I strongly suggest vesting.
Make sure that your co-founder shares your vision. Passion before profit. Richard Branson said it best: "The brands that will thrive in the coming years are the ones that have a purpose beyond profit."
VESTING SHARES
If you do decide to give away equity, learn that you cannot get it back. Make sure you give away equity under a vesting schedule, with a cliff period.
A vesting clause is basically a clause that enable you to give away a certain amount of shares over time, rather than all at once. If your partner leaves or is fired during that period, the remaining shares will come back to you and so this is a good safeguard to ensure that you are happy with whomever you are working with.
A cliff period means that during that period, no shares are owned by the person. For example, under a 4 year vest with a 1 year cliff - if the co-founder leaves or you fire them within the first year, they wouldn't get any equity.
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