How to Divide Equity in a Startup

You decide to take the leap and launch your startup, but you have questions, including how to divide equity in a startup. People in different roles might deserve different portions of the equity. Even within categories, like investors, there can be variance based on the amount of contribution.

It might help you to sort out these sticky issues if you contact a Maryland business attorney for guidance. Getting a legal expert on board early in the process could be invaluable for your business both at launch and as the company grows.

Categories of Parties in a Startup

Every startup is different, and things can change rapidly. You might have one or two founders working in their own “silo” initially, and then have employees, investors, advisors, and directors six months or a year later. Each of these parties will likely want a piece of the action.

You might be brilliant at the subject matter of your company, but not have experience in running a business. What is the industry standard? How can you attract and keep valuable talent without giving away the store?

Common Mistakes of Equity Distribution

Many people assume that they are merely one good idea away from getting rich overnight. They think that if they could come up with that great idea, they will sell the idea for millions of dollars and never have to lift a finger again. The product will fly off of the shelves magically without any more work required for research and development, production, marketing, fulfillment, or any of the other essential tasks needed to turn an idea into reality.

When the person who came up with the “great idea” gets 80 or 90 percent of the equity in the company, there is not enough equity to compensate the people who do the hard work of developing the idea and getting it to market. The great idea will likely die on the vine. What will make or break your startup is how the idea gets executed. If the founder will be involved in the grinding hard work of execution, they could command a larger share of the equity than if they merely pass the idea off to others, like a quarterback handing the football to a running back.

Also, not all co-founders are created equal. Startups require many skill sets, each with its own value. You should not assume that every co-founder will bring equal value to the table in terms of roles or responsibilities.

The co-founders need to speak candidly about the value of their contribution to the startup in terms of skill sets. For example, based on relative values of their skill sets, in a startup with four co-founders, it might be appropriate to divide the equity as 40 percent, 30 percent, 15 percent, and 15 percent, rather than 25 percent to each co-founder.

Equity Distribution Among Non-Founders

The co-founders should also contemplate how they will divide equity among other key parties, like investors and others. Employees, advisors, and directors could be candidates for the “others” category. Do you want to offer some employees stock options later? If so, where will that equity come from if you have already split up 100 percent of the equity among the co-founders?

Also, investors will expect to get a piece of the company in exchange for their capital infusion into the business. The total equity among the co-founders, investors, and others must total 100 percent. To reserve 10 or 20 percent for options and 20 to 30 percent of the equity for investors, the co-founders need to limit their total equity to around 50 to 70 percent of the total equity of the company.

Anyone who has watched the television show Shark Tank knows what investors expect to get in exchange for their money. Let’s say that your company has a value of $5 million. You want to raise $500,000 to develop and market a product. The investors will get a 10 percent ownership interest in exchange for their investment.

People who serve on your Board of Directors usually expect to receive a small percentage of the equity, typically less than one percent up to one or two percent. An advisor might get a fraction of a percent of the total equity.

Talk to an Experienced Maryland Startup Lawyer

There are many additional issues you will need to address, like vesting schedules and multiple rounds of investments. Your legal counsel will help you tailor the approach to the specific needs and goals of your company. A Maryland business attorney can provide the legal advice you need for these and many more subjects.