Raising the Stakes: Who Should Get Equity In Your Startup And How Much?
The numbers speak for themselves. With over 4,200 startups, India is the world’s third largest startup ecosystem. According to a Nasscom report, Indian startups have risen to the next level with 100% growth in the number of private equity, angel investors and venture capitalists. Moreover, a 125% growth in funding was also recorded over the last year.
While this is a welcome news for startups, it also brings with it the responsibility of sharing equity with the stakeholders and determining how much equity you should allocate to the co-founders, investors, employees, and advisors.
Usually, in the case of co-founders, the rule ‘lesser number is the better’ applies to the division of the equity. That is, co-founders should retain the minimum pie of equity as compared to other stakeholders. The following factors need to be considered as well during the equity split between co-founders:
- Timing and duration: The co-founders with the longest stint in the company may get the highest equity from the total share of all co-founders.
- Investment: The higher the personal investment of co-founders, they may want the percentage.
- Expertise: Apart from the monetary investment, other contributions also matter. Some co-founders may bring investors while some may bring the product expertise or technology on board.
Bhavish Aggarwal and Ankit Bhati, co-founders of Ola, own 12% and 5% stake respectively as a mutual agreement. Deepinder Goyal, the co-founder of Zomato believes that 45:55 is an ideal distribution so that the veto power lies with just one person.
An alternate approach is to assume that all co-founders have put in the same level of efforts and risk, and started from the scratch. In such a case, they can agree to an equal split among all the co-founders. Ashish Goel and Ravi Rajiv Srivatsa of Urban Ladder hold 48.5% stake each in the company.
In order to arrive at the equity percentage among co-founders, there should be ranking / tier system based on a clear demarcation of their roles and responsibilities. Check this Co-founder Equity Calculator to know how to undertake this exercise.
Whatever approach you take, ensure that all the co-founders agree to the standard four-year equity vesting schedule (along with a one year cliff). This will prevent a co-founder from quitting early and your company won’t be red-flagged to the investors.
Investors want the stake in return for their investment made at the current valuation of your startup. In February’15, Paytm was valued at $800 million. In September’15, Paytm received $680 million funding from Alibaba and Ant Financial based on its last valuation. After this deal, there was a major change in Paytm’s stakeholding. Alibaba acquired a direct stake of 20%, while Ant Financial’s holding fell down to 20% from 25%. SAIF Partners’ stake came down to 30% from 37%, while Paytm’s founder Vijay Shekhar Sharma now owns about 21%, a fall from 27%. The remaining equity is now held by SAP Ventures, Silicon Valley Bank, Reliance Capital and others, including the company’s management team.
If a startup is not valued yet, investors prefer to invest on the basis of the business idea, its product-market fit, its growth potential and the management / team. Usually, they prefer between 10% to 25% for the seed round. However, to arrive at the valuation for a seed round, the first question you should ask is ‘how much would I sell my startup for?” Let’s say, you want to sell your startup for $20 million. This is the value you see for your startup. Now, if you want to raise $5 million from an investor, investors may want to share 20% of the equity in lieu of their money.
Every investor or funding agency has its own norms regarding equity stake. For example, Utthishta, a firm that provides seed funding for software, the web, mobile, and cloud computing based Indian startups invests between $0.02 mn and $0.03 mn in return of equity stake between 10% and 15 %.
Related Article: Startups Opt Out On Equity Dilution Until Market Favors Them
By combining equity stake with the cash compensation, you can lure top talent to join your startup. It also improves your startup’s employee retention. Looking from the employees’ perspective, your early employees gamble on your company by accepting stock in exchange for working at low salaries. They also support you at the risk of your startup being folded down. So, they are your real partners in success and deserve a share of the ‘hard-earned equity’.
Rewarding employees with an attractive equity is not that easy. You need to consider employees’ skill sets, their tenure with the company and the value they add to your business. For example, a CTO (who is not a co-founder) would expect more stake as compared to a software programmer. As an easy rule, you can also plan some equity refreshers for the employees who stay longer in accordance with their level. You can come up with two-year, four-year, six-year completion plans and so on. The longer someone stays, the higher stake, they will get. Also, combine these equity plans with the business risks like liquidity event or the odds of company survival.
Flipkart, smartly hired and retained the top talent using ESOPs scheme which makes as much as 70% of the compensation package of top-level executives at Flipkart. In August 2014, when Flipkart was valued at $7B, about 400 Flipkart employees who had stock options become millionaires. Currently, Flipkart is valued at $11B, which means, these employees have more reasons to rejoice!
Advisors guide through fundraising, product launches, crisis management, market analysis, and much more. In return for their commitment, you should value their time by offering a decent percentage of equity. While a few advisors might not be doing it for money, you should be transparent with them while discussing the equity compensation. Usually, equity for advisors ranges between 0.5 – 2%. This also depends on the stage of your startup, whether you are pre-funded or you’ve already raised a decent round.
When Rishab Malik joined Frrole, a social intelligence company, as an advisor on business development and go-to-market strategies, he received 2.5% equity stake. After the seed round, investors took a stake of 23%, of which 10% went to the options pool and remaining equity was divided into equal proportion among the founders and Rishab.
The division of equity is a tricky task. There are no hard and fast rules, but it calls for conducting diligence before taking the leap.
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