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Startup equity is one of those things that every non-MBA startup founder struggles with. Unfortunately, most entrepreneurs do not have to contemplate much about equity unless it is absolutely necessary. Equity calculation can be the most cumbersome task in operating and managing a startup, but a little knowledge of the topic can make quite a difference.
In simple words, equity illustrates the ownership of your startup. It is typically expressed as a percentage of shares of stocks. During the early days of inception, startup founders like you may need to give away a significant chunk of equity to match the risk taken by the investors funding the startup. However, with the startup's growth and continuous success, the startup equity increases in value. Therefore, investors are willing to pay more or access less equity in exchange for funding.
As equity calculation is such a pertinent need in the success of a startup, a high-tech and reliable equity calculator comes in handy.
IMPORTANT TERMS RELATED TO STARTUP EQUITY
Before venturing into the maze of start equity calculation, it is vital to be acquainted with specific important terms. There is a high chance that the minute you try to figure out the startup equity compensation, you will be bombarded with terminologies whose meanings will have profound implications in the calculation process.
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Equity – It is the value of the share that a startup issues. In other words, equity is the degree of ownership of an individual in any asset after all associated debts are paid off.
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Exercise Shares – The choice to buy or sell shares of a startup
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Stock Grant – It refers to a situation wherein the technical co-founder of a startup pays a part or the whole of the total compensation of an employee in the form of corporate stock.
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Fair Market Value – The current value of the shares of a startup
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Stock Options – A benefit given to an employee in the form of an option to buy company stocks at a discounted or a stated fixed price
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Shares – The portion of a larger amount divided among several people or to which several people contribute.
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Shares Outstanding – It refers to the total amount of shares held by all company shareholders.
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Valuation – The professional estimation of an asset's (here, a startup's) worth
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Vesting – It is a 'position' wherein employees might be given equity in a firm, but they have to stay within the firm for a stipulated before they attain entitlement to the entire equity.
ENTITLED GROUPS AND NEGOTIATION FACTORS IN STARTUP EQUITY CALCULATION
The most rudimentary aspect of calculating startup equity is knowing who is entitled to the same. Well, four groups of people typically get a portion of the startup pie –
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Co-founders
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Investors
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Advisors
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Employees
Every startup offers equity in some permutation and combinations of the four categories mentioned above. However, there is no one-size-fits-all, as not every startup will offer equity to employees, or not every venture is going to provide equity to advisors, and so forth. In such a context of confusion, an equity calculator comes to the rescue.
To gauge who deserves what portion of the 'startup equity pie,' it is essential that you analyze some of the pressing pillars –
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Risk – The most indispensable marker of startup equity distribution is to gauge who has the most risk in the investment. If everyone is facing a similar risk, then the answer is easy. However, if one co-founder is investing more startup capital or if someone is resigning from an erstwhile full-time position to take the helm, then the potential risks vary.
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Commitment – The second step is to understand your startup's equity distribution by gauging the level of commitment of an individual to the startup. Most startup founders receive almost no pay. However, if a technical co-founder shows a higher level of commitment through their role, then it can be deciding factor in equity division.
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Innovation – Lastly, to analyze the equity distribution of your startup, you have to examine who wears the 'thinking caps' in the company. A startup is premised on an original idea. At times, there is a disjunct between the persons ideating for the startup and those executing tangible tasks. However, both two groups perform tasks for profitability, and the distribution share of equity is primarily the same. However, those who innovate may be entitled to more shares.
TOP FIVE PREMISES OF STARTUP EQUITY CALCULATION
The calculation of startup equity impinges upon the following bases –
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Last Preferred Price – It is the price that investors pay for each share during the fundraising process of the startup. Higher preferred prices imply that your startup has a higher potential for success.
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Post-money Valuation – Your startup may go through multiple rounds of funding. Thus, post-money valuation refers to the valuation of your startup after the first round of funding.
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Strike Price – It is the price per share you will receive when you exercise your options
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Hypothetical Exit Value – It is the ideal value of the startup upon sale.
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Number of Options in our Grant – It refers to the number of grant options available for employees.
Thus, an equity calculator factors the above points to arrive at an optimal equity distribution.
STARTUP EQUITY DISTRIBUTION – A CRISP SUMMARY
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Co-founders – There is no definitive way to determine the equity split between you, the founder, and the startup resources. We often see that the default is a 50/50 split or another equal division to avoid heated conversations. More than 60 percent of startup founders who end up in court do so because of equity distribution issues. Thus, a structured division must be communicated between the founders and co-founders.
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Advisors – Experts opine that there is no black-and-white rhetoric while assigning equity compensation to advisors. However, 0.5 percent and 1 percent is an excellent way to start, vested over one or two years. For that amount, you can expect about two to five hours per month of involvement from the advisor.
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Employee – Early employees do not receive salaries per the market value due to a strict cash crunch within the organization. Thus, employee equity compensation is a great way to rope talented people in. It is deferred compensation based on the hope that they will someday own a valued piece of your startup.
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Investors - In exchange for the risk of pouring money into your idea, investors usually expect a larger share of equity as a reward.
If you keep the confusion of equity calculation at bay, then a startup equity calculator will be your best bet.