Founders are, in most cases, the brain and heart of a startup. They conceive the idea, set up the framework for the company's success, and raise investments internally and externally.
Thus, it follows that the benefits accruing to the founders should be as much as the effort they put in. One way founders maintain motivation and get rewarded in a startup is through equity stake. That naturally leads to the question, "how much equity should a founder keep?"
This article will discuss the answer to this crucial question and touch on equity distribution between founders when there is more than one founder in a startup.
How Much Equity Should a Founder Keep?
The short answer to "how much equity should a founder keep" is founders should keep at least 50% equity in a startup for as long as possible, while investors get between 20 and 30%. There should also be a 10 to 20% portion set aside for employee stock options and, in some cases, about 5% left in a reserve pool.
Of course, there are no hard and fast rules regarding this distribution, and founders will likely get below 50% in the latter fundraising rounds. Every startup has different factors affecting the equity distribution between founders, investors, and employee stock options. However, founders should have a majority stake in the company for as long as possible.
To determine who gets what slice of the pie during equity distribution, you should first determine the people involved. This would include the founder or founders, investors, independent advisors, and the first employees.
Similarly, you should follow the hierarchy in distributing or sharing equity amongst these parties. This may mean the founders first, then investors and the independent advisors before the first employees.
While many startups may not have a typical "hierarchy" as you might find in a corporate, a set order is essential regarding shares in the business.
Equity Distribution for Co-Founders
Most startups will have two or three co-founders. In most cases, while a person might conceive an idea for a business, they usually recruit a few people to support them and join them on a mission to deliver a product or service. These people are known as co-founders and should receive equity in return for their commitment to the company.
Why Should You Consider Co-Founders in Equity Distribution?
There are many reasons to consider giving someone a "co-founder" status, but the first and most important is, rewarding and solidifying their loyalty. People who joined you when the business was only an idea and had put in time, effort, and resources to ensure the idea turned into a product deserve to be rewarded. Founders contribute a lot to a business.
And what other way is there to best reward them other than giving them the most valuable thing a company possesses - equity and co-ownership of the company they have helped build?
It's tempting to shower words of encouragement on your co-founders. You want them to know how much you appreciate their work, so you'll praise them accordingly. Of course, it is not wrong to verbally thank them, but the best way to show your appreciation is by ensuring that they participate in the company ownership.
By granting co-founders equity, they have skin in the game and know they benefit directly if the business succeeds, which gives them the incentives to put in more effort to ensure the company's success.
Co-Founder vs First Employees: What's the Difference?
Sometimes, founders mix up the role of the co-founders and early employees. This confusion usually stems from the fact that most first employees joined the startup when it was only an idea and helped build out its product or platform.
Therefore, you need to understand who your co-founders are and who your first employees are. Apart from the need to enable easy equity distribution, understanding the difference also helps establish a working hierarchy within the company at the early stages, affecting the work culture and interpersonal relationship between team members.
As a rule of thumb, whoever joins a startup after it receives its initial funding and has more than five people is an employee. As simple as this rule is, other necessities could affect its application, so there is another means of appropriately discerning between employees and co-founders.
An employee joins a startup using an employment contract. This contract clearly states the working hours and the salary to be paid to this employee. Anybody with such a contract is not a co-founder.
A co-founder will unlikely receive a salary in the early days, nor will they have an employment contract. The contract a co-founder signs upon joining the startup apportions them some equity - typically called a founder agreement.
A co-founder takes an active part in the startup's decision-making process and works with more commitment than the employees. Co-founders typically have no set working hours, as their role is to ensure the success of the business - something which will likely take more than the standard 9-5! Essentially, they work and think long-term because they are committed to the idea upon which the startup was built.
So while an employee may decide to leave the startup at any time, this seldom happens with a co-founder. Also, while a co-founder shares the risks of a failed startup, the employees bear no risk except having their employment terminated.
Now that there is a clear difference between employee and founder titles, let us examine how to share equity among co-founders.
Sharing Equity Among Co-Founders
Like almost everything in the startup space, there is no hard and fast rule to sharing equity between co-founders. There are certain factors that you need to consider, and these factors include;
- Money invested
- Experience and expertise
- Responsibilities and risks
- Time and commitment
- Preparation of business plans
Using these metrics, you can determine which startup founders deserve more of the equity shared and what percentages each of them get.
This is a difficult thing to work out. Determining equity split can make people feel like they're worth less to a business than someone else, so be sure to approach this conversation thoughtfully.
Equal equity splits can increase the chances of success, as all co-founders will feel like they're in it together, with no equity baggage hanging over their heads.
By determining how much equity a founder should get, startups clearly understand their structure and how it affects the company's operation. It also influences the perception of investors during financing rounds for the business.
Regarding financing rounds, BaseTemplates offers high-quality fundraising templates for entrepreneurs that help save time and money starting a business. We understand the importance of a pitch deck to you.