A common question that I receive from first-time entrepreneurs is the amount of equity to issue to co-founders, advisors, employees, and broker-dealers. How much is too much, and how little is too little? Here, we’ll cover factors to consider in determining the percentage of equity that makes the most sense to give away.
Co-Founders
The relationship between co-founders is akin to a marriage. In fact, they will probably spend more time together than with their spouses. From the onset, they should make clear their financial goals, personal goals, and career goals, a rough outline of the roles that they would be expected to take on in the startup, and the average weekly or monthly time and financial commitment that they would be able to contribute to the startup.
The percentage of equity initially allocated to each co-founder should be based on the overall amount of contribution that they would be expected to make. Be very wary of splitting equity up equally, as inevitably, some co-founders will end up putting in more work than others. If there are any feelings of unfairness, then the entire relationship between co-founders could break down, leading to disastrous results for the startup.
Advisors
Similar considerations should be made for advisors. From my experience, percentages can be as low as 0.25% and as high as 10%. Founders should be careful of advisors asking for too much without being able to contribute meaningfully to the growth of their startups. It isn’t uncommon for experienced advisors to try to get large stakes in startups run by inexperienced entrepreneurs. Most of the time, if advisors are available to meet between once a week and once a month and can provide certain other resources, such as an investor network or industry expertise, then anywhere between 1% and 3% would be reasonable.
Employees
As startups begin to bring on employees, they may issue stock options or restricted stock as part of compensation packages. Generally, founders should allocate between 15% and 20% of the equity of their startups to employee pools. How this pool is divided between employees is dependent on other factors, such as the proportional contributions of the employees to the growth of the startup, but collective ownership by employees should not exceed 20% of the total amount of equity of the startup. This means that founders should determine vesting schedules early on so that the pool isn’t used up too fast. It also means that founders should be conservative with issuing stock options or restricted stock to their earliest employees, unless these employees are so involved with the startup that they are essentially founders themselves.
Broker-Dealers
At some point, founders may want to use the services of broker-dealers to raise additional capital for their startups. Broker-dealers usually charge a commission on the total amount fundraised, but in lieu of this, they may ask for a fixed fee or a cut of the equity pie of the startup. Generally, both commissions paid and percentages of equity issued to broker-dealers fall between 3% and 5%, and it is rare to see a number that exceeds this range. If ever given the choice, however, founders should always opt to pay a commission instead of equity, because 3% of equity can end up being a big price to pay as their startups scale.
Allocate Equity Without Losing Control
At the end of the day, founders should be careful about giving away too much equity too early on, as they may lose their voting and management rights as their shares become increasingly diluted. Founders should keep in mind the voting and management rights granted to them in the bylaws, certificate of incorporation, operating agreement, and other formation documents of their startups when allocating equity pools. The sweet spot: when they retain control over their startups while being able to pay a fair compensation to co-founders, advisors, employees, and broker-dealers.
Nonetheless, founders should go with their gut feelings in what feels right when issuing equity. This article just aims to provide guidelines on what is commonly seen; only founders understand the nuances of their relationships the best.
