One of the most common ways for startups to attract talented employees and investors is to offer partial ownership in the company itself through an equity split. By giving a small share in the company, startup founders are able to compensate themselves and early-stage employees for smaller salaries and the risk of working at a startup.
It can be a challenge to create an equity split that treats investors, employees and founders fairly; here are four factors to consider:
Replacing salary. Sometimes co-founders and employees will accept an ownership stake in a startup in lieu of a competitive salary if they believe the value of the company will appreciate greatly in the future. For example, in 1971, Nike co-founder Phil Knight paid Portland State University graphic design student Carolyn Davidson just $35 for the Nike logo, which is now estimated to be worth $13 billion. Davidson also received 500 shares of company stock, now worth in excess of $650,000.
Ideation. It makes sense that the person whose idea or invention is the reason for the company’s existence be compensated more when it comes to an equity split, but it’s not always that simple. Sometimes capital contributions might mean more to a company in its startup phase than the idea itself. A careful analysis of the early development contributions of each co-founder will typically help determine a fair equity split.
Stage. Typically co-founders and early employees who work in the company from its inception, before any funding activities are undertaken, receive larger equity shares to recognize their assumption of risk and time invested in a new venture.
Contributions. Co-founders who provide more seed capital than other founders will often be rewarded with a larger percentage of the equity split. Other contributions such as playing a larger role in the development of intellectual property may also be recognized with more equity.
Once equity splits have been assigned, there must be a vesting schedule established that details how and when co-founders can exercise their stock options. Vesting schedules help protect a startup by preventing a co-founder from leaving and taking a substantial portion of the company’s value with him or her by allowing for incremental vesting over a 4-5 year period.
Williams Commercial Law Group, L.L.P., provides strong legal advocacy for companies at all stages involved in general business lawsuits. We are known for using our skills, experience, and cutting-edge technology to get great results, whether after trial or through a favorable settlement. Call us today at (602) 256-9400 and schedule an appointment to meet with us about your case.