Startup equity management can make or break new businesses. It's an entrepreneur’s prime currency when it comes to attracting talent and investors. However, equity is finite, and giving away too much could dilute ownership and create problems further down the road.
For founders, giving away enough equity to secure the necessary funding while also protecting their interests can be a balancing act. Read on for more on how to structure startup equity from day one and position your business for growth.
When you start a business, the number of decisions you have to make can feel overwhelming. When you're rushing to design your product or service, attract customers, build a social media presence, and chase up countless other necessary tasks, you may be tempted to take shortcuts with startup equity management decisions.
Unfortunately, that could come back to bite you further down the road. For example, you may opt for an equal split with founders that later generates resentment and damages your working relationships. You might agree to venture capital conditions that later hamper your growth, or give equity to people whose values don't align with yours.
These are all understandable moves in the cut and thrust of getting your startup off the ground. However, you can avoid future problems by taking the time to structure your equity now. Getting it right could give your business a better chance of success and ensure you profit from your hard work if it does. For founders planning to grow through private capital, understanding how early equity choices impact access to private investors is a key part of building a long-term strategy.
When it comes to equity management, planning is critical. Early fundraising — pre-seed and seed funding — is usually the most expensive because investors take on a lot of risk. Try to avoid raising too much at this stage as it can dilute your holdings. Calculate how much you'll need to get to the next funding round and explore other options that won't eat into your equity, such as grants and business loans.
Here are some other equity management principles to follow:
The most common way to approach a founder equity split is to divide it equally. So, if there are three founders, you'd each get a third. That may make sense in some scenarios, but it won't be the right choice for every set of entrepreneurs.
For example, if people contribute different amounts, an unequal split may be a better route. One person might put in more time or bring significant expertise to the table. Perhaps the plan is for one founder to take the CEO role, while another will continue their day job.
Take time to talk to your co-founders about their expectations and planned contributions so you can jointly decide what the fairest split is. It's difficult to value each person's efforts, but it is important to have frank discussions about expectations and get an agreement on paper. This can prevent resentment and disputes later on.
Also known as a capitalization table, a cap table is the cornerstone of startup equity management. It's how you keep track of each stakeholder's ownership in the company, including the percentage and types of equity they hold.
As the company grows and you issue more equity through funding rounds, employee ownership plans, or other stock options, an up-to-date cap table will help you keep track. Potential investors will want to see your cap table to know more about the company's structure and how much equity they will receive.
Income tax and capital gains tax may sometimes be due on startup equity. Understanding how they work can help you maximize any exemptions you're entitled to and avoid nasty surprises. This, in turn, may influence how you structure the company.
For example, to be eligible for the qualified small business stock (QSBS) tax exemption, the company must be a C-corporation that meets specific asset and other requirements when the stock is issued. Learning about the requirements now could save you millions of dollars in capital gains tax in the future. It’s also helpful to understand how the timeline of value creation plays out — this guide to the J-curve in pre-IPO investing explains why timing and structure matter for maximizing returns.
Employee stock option plans (ESOPs) help you attract key personnel, even if you don't have the budget to pay huge salaries. Think about how much equity you want to allocate to your ESOP, how you'll structure it, and what criteria you'll use to allocate shares. Vesting is a common practice as it releases share options over time rather than in one lump sum.
There's no hard and fast rule about how much equity to offer employees, but it usually depends on the work that person will do, the experience they bring, and what stage the company is at. For example, suppose you're trying to attract a skilled CFO early in the company's lifecycle. In that case, you'll likely need to offer a higher stake than you'd give a recently graduated account manager.
Even the best-structured equity plan will struggle if stakeholders can't cash out when they want to. As businesses stay private longer, private stock marketplaces like the one operated by Augment Capital* are an increasingly popular way for early investors to generate liquidity.
Augment is a FINRA-registered secondary marketplace where investors can buy stock in top pre-IPO companies. It is designed for every player in the private market, including buyers, sellers, and startups. If you're looking for a compliant way to handle your company's secondary sales, check out Augment's purpose-built solution. Learn why timing your entry matters when it comes to maximizing liquidity for founders and early employees.
Secondary markets offer a way for stakeholders to cash out without waiting for an IPO. Whether that's a private equity fund that wants to see returns on its investment or an employee who needs cash for life goals, Augment can help.
Proactivity is essential for a startup looking to manage secondary transactions. Augment can help you manage your cap table and maintain control of the process. That way, your stakeholders benefit from a pre-IPO investment platform, and you keep control of your company's equity.
*Securities transactions are executed on Augment Capital, LLC's ATS and offered through Augment Capital, LLC (member FINRA/SIPC).
Important Disclosures: Investing in private securities involves substantial risk, including the potential loss of principal. Private securities are typically illiquid, have limited pricing transparency, and often require longer holding periods. These investments are available exclusively to qualified accredited investors and offer no guarantee of returns. Additionally, past performance of private securities does not indicate or predict future results.