I’m now in the process of launching a startup in the retail sector. I have startup expertise, and I’ll be contributing 100% of the required funds and possibly 30–50% of the required time myself.
The company’s goal is to promote lesser-known musicians. I’m not familiar with the artistic aspects of finding artists for merchandise or the viewpoint of an obscure artist.
I have a potential partner with this background who developed the idea but is unfamiliar with companies that are seeking only pure equity and will manage this area of the business.
Another partner wants to assist me operate the business when I’m pressed for time, but they’re only asking for pure equity. However, he isn’t much experienced, so I will have to show him the ropes.
How much should I give each of them? To put things in perspective, I am also attempting to form an LLC. I need to be certain that I have enough money set up for investors as well.
They are not requesting any compensation, to be clear. just equity
Let’s say that you must set aside 10% from the start for your Series-A investors and 10% for the stock option pool. (That could change; it’s up to you. The remaining 80% will go to the three cofounders.
You may have an advantage because you both seem to be familiar with starting techniques and bells and whistles. You will also be contributing the seed money, thus you should undoubtedly own the most shares.
Your first partner appears to be important because s/he understands the artistic side and is the idea’s owner. If you hadn’t invested any money, you and your initial partner would own almost equal shares (your experience would put you slightly ahead). However, money alters it:
Since your second partner will spend a lot of time organizing things, you also need them to be hard workers. However, given their inexperience and need for training, I believe that 10% should be sufficient for this partner.
I finally arrived at something like 41 - 26 - 13 equity by using some black magic calculus. However, you will make the decision and I know very little about the situation.
Whatever choice you select, make sure to clearly and individually explain it to each of these individuals. Stress your commitment, your knowledge, and the fact that you’ll put in at least a third of the required effort. Your startup will be severely harmed if they have second thoughts about being undervalued, and your investment will also be lost. Therefore, be sure to set aside enough equity so that each of them is fully motivated and committed. These are the individuals that ought to work tirelessly on this project with you from beginning to conclusion. If they are not satisfied, you will suffer now or in the future.
@TinaGreist, Wow. I appreciate your efforts very greatly. These figures appear to be reasonable and are quite near to what I had in mind. You are the best.
This isn’t actually how things operate, and I don’t mean to offend @AlanaMartin, who began this topic, but I wouldn’t use this as a benchmark to assess equity.
There is no requirement to “set aside” equity for option pools or investors. When necessary for the firm, more shares are issued.
In fact, I wouldn’t fret about the option pool or the investors at the moment. Your primary concern should be assessing whether you have discovered a real problem and whether there is a market for your solution because you are SO far away from this.
There will ALWAYS be dilution if you choose the financial method because of the way the math works. Instead, concentrate on what each of you needs in terms of ownership % right now; future funding rounds or dilution will take care of themselves.
You’re right; at this time, market research is crucial. I don’t plan to undervalue that. And from there, we’ll be able to tell who is genuinely devoted.
Your response has led me to believe that I do have a query. Don’t you want to consider dilution while choosing equity? That was the reason I even mentioned investors in the original post; I had never allocated equity in this manner previously and wanted to take dilution into consideration.
Don’t worry about dilution. Right now, it’s not a problem, and if you try to engineer for it, you’ll end up with a system that is overly limited. You don’t yet have a venture worth investing in, you don’t have investors, and you have no idea how the market will behave. Right now, a lot is outside your control.
There will be investors and dilution, that much is certain. Beyond that, there isn’t much engineering is currently worth doing. Just concentrate on your clients and create products that help them with their concerns.
Once you have that aspect figured out, come back and we can assist with dilution and investment strategy planning.
@BobbyDuncan, Fair enough. I appreciate your input.
I am with a smile reading your positive feedback. I wish you a successful journey.
I haven’t yet given anyone anything. Find out first if there is a business in this area.
I’ve tried this a few times before, and what has worked effectively is to just try and get the business going when you have a motley crew interested in starting something for equity and when they lack experience. You are not yet required to incorporate.
Just begin construction and assign everyone a task. Check to see who actually makes a contribution and how well you all cooperate.
Especially if you’ve never worked with any of them before, the likelihood that at least one of them won’t work out is rather high.
The worst case scenario is when you go through the entire corporate process and discover you’ve made a mistake or that someone hasn’t been able to hack it. It’s a terrible waste of time, effort, and resources. There is nothing worse than finding out that your 30% partner on paper is only worth 3% equity.
Simply get to work on growing your customer base. Find paying customers. Define the roles and obligations. When it becomes obvious that you get along well, memorialize your partnership. You can choose the equity if you are providing all of the capital. By that time, you’ll know the players better and be able to determine what you think is just and what they’ll accept. Make it a discussion or negotiation after that. Choose the situation with which you feel most at ease.
In other words, it’s actually quite simple for you to have the conversation in the future if you could potentially picture yourself as 33/33/33 partners. But before really assigning stock, I wouldn’t provide any hint to either partner of what you’re willing to do. It will set expectations, and at this point you need people to be more concerned with building a firm than with how much of it they will own. 33% of a $0 business is still $0 today.
It’s funny you should bring that up! That’s quite similar to the current strategy I wished to test. I wanted to try my hand at the market and not distribute any equity because of my previous terrible experiences. Then, I would base my choices on how each person had contributed. It’s good to know that perspective has some real merit. Thanks
That’s fantastic! Although there are a few “gotcha” moments to watch out for, overall I’ve found it to be a fairly effective tactic for getting things going and determining everyone’s level of commitment.
I think you should write out your plan very roughly on paper if you decide to go this path, which isn’t the worst idea. Right now, the choice is simple and quick, but if it is contested when you are much, much bigger, the choice becomes more difficult and expensive.
Mismatched equity expectations have proven to be the main problem I’ve encountered. However, the OP has influence over this situation.
The 33/33/33 split (probable) where they are equal partners with everyone is the most extreme variation.
You can then try to bargain into any other scenario if the OP is okay with that one.
However, if the OP is anticipating anything along the lines of 98/1/1, there will undoubtedly be problems in the future, so obtaining something challenging early would make sense. People should be informed that they would never receive more than 1% equity in any situation before investing time or effort.
However, the OP has the freedom to choose their strategy.
If you bring up the subject too soon, it causes people to become more interested in equity than in creating a firm, which can cause things to fail before they even start. Tossing the can down the road until there is actually something worth fighting over, as opposed to fighting now when there is nothing, however, if everyone knows they are earning their equity and establishing their worth now.
Simply stating that equity would be resolved at a later precise date would suffice as “putting it down on paper.”
The worst-case situation is that someone works, but no equity is discussed since they don’t fit in, so they leave and then return after the business succeeds and claim ownership.
If these individuals are actually cofounders and not workers, I would contend that there is also a possibility that equity being withheld by one founder over the heads of the other cofounders can result in issues. Vesting seems to be the most logical solution to align incentives without causing conflict; additionally, it allows the company to fire the cofounder who is a poor fit without having to pay any unpaid equity.
@ChristieDook, The difficulty is that you’re not sure how much to budget for what other individuals bring to the table.
I’ve seen situations where you give equity to someone who was intended to be a full partner but they turn out to be a dud. Vesting does help to keep it from sticking, but it also undervalues other individuals.
It’s a good idea to note that the actual allocation will happen at a later time, even if it’s simply in an email, so there will be a paper trail.
If you’re referring to equity, such as shares, you must incorporate (as a C or S corp) to become known as “Company, Inc.” But it requires a lot of setup.
With an LLC, you can distribute ownership according to membership levels without distributing shares.
In most states, it’s simple and quick to set up an LLC for a sole proprietorship, but you need engage legal counsel to help you design the agreement if you want to execute proper membership splits.
To be able to trade shares, you essentially need to incorporate if you intend to raise money in the future from investors like angel investors or venture capitalists.
@HannahBorges right, so according to what I understand, the tax issues of LLCs prevent them from being profitable for investors. I therefore intended to operate as a LLC for the time being and switch to a corp as necessary. Will that ultimately come back to haunt me? Should I just start out as a corporation?
One thing to keep in mind is that equity differences amongst founders are very likely to cause conflict and animosity, which has a significant impact on how successfully your firm operates. Additionally, your chances of success are severely stacked against you simply by virtue of being in an early-stage startup.
Personally, even if the upside of success for me personally is slightly reduced (after all, 100% of $0 is still less than 50% of millions or even billions of dollars), I would exert every effort to increase the startup’s chances of success.
My personal (and perhaps unconventional) opinion is that I would identify my cofounders and determine who is only an employee before allocating shares equally to each. If someone is investing money in the firm or receiving less money, record it as a liability that will be paid back later at par or with a reasonable interest rate; nevertheless, do not factor it into your calculations of equity.
Use the “slicing pie” technique along with a co-founder trial period (lasting 3-6 months) and vesting with a 1-year cliff. If your trial period has gone well and you feel like you can all work together, the slicing pie will inform you how much equity goes to whom. You log contributions for all of you, both monetary and non-monetary.
The partner who came up with the idea and has the experience needed here is your co-founder: 30-70% seems fair?