Equity: Three Mistakes Founders Make

Shareholders' Equity

The Equity Mistake They Make With Each Other:

If you’re founding a company with other people. All founders should vest in their stock over time. Typically, you should use a one-year cliff and 4 year vesting period. The one year cliff solves the problem where one founder drops out because of changing life conditions or lost interest. If you don’t vest into your own company, you often end up with a big chunk of equity you can’t sell or redistribute to other parties who are going to add value to the company. Secondly, they tend to split up the company equally, instead of based on people’s abilities to contribute and relative scarcity of the skill sets they provide. Fairness is setting percentage ownership based on the amount of lift each Founder provides to the company’s valuation, not splitting it equally per capita. If you’re too afraid to discuss how much value different activities, backgrounds, and networks, add to the company – you should reconsider your co-founder relationship; the conversations are only going to get harder from here.

The Equity Mistake They Make With Outsiders:

You’re not going to know everything about your business, your market, or your team. That’s OK, but you should seek out Mentors, not Advisors. Mentors give of their time and their talent freely, knowing that they will learn from their mentees. Advisors require an equity stake in the company. I’ve seen some insane term sheets offered to early-stage founders with advisory fees between 5-10% of common stock. That’s predatory, unless that’s contingent upon a huge investment, international brand recognition through celebrity influencers, or some other exception to the rule – I would run for the hills if I saw something like that. A reasonable advisory fee for an advisor/firm who is working unpaid for you in an early stage startup is somewhere between 0-1%. Founder’s Institute Founder / Advisor Standard Template lays out a great table to align close to market value.

The Ownership Mistake They Make With Insiders:

We all hear about how hard it is to be an early-stage founder. But what about the first few hires on the founding-team? They tend to get significantly less equity than founders and even later stage C-level hires, but they’re taking the risk with you because they believe in the company. You should treat your first employees like Angel Investors. They accept the biggest risks early on, so it’s only fair to provide them a multiplier on their ownership stake. They help to set and reinforce the culture of your organization and deal with all the chaos you create while thrashing around trying to find product/market fit and funding. Your first employees end up being friends and family, so treat them well.

What other distribution mistakes do you see repeatedly?

Let’s chat about it in the comments!

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