Splitting startup equity is just like the ceremonial cutting of a cake. You want to split the cake in a way that makes sense for yourself and every one in your party, ensuring that every one enjoys a delicious slice and gets a fair amount.
And just like cake cutting, dividing equity can be tricky at times! It requires thoughtful planning, some maths, and a bit of practice and skill development. Startup equity distribution is just one of the many challenges startup founders have to overcome while baking a cake, er, growing a business.
We can go on and on with this cake metaphor (if you haven't picked it up at this point, we are all about Cake-sharing around here!), but let's go back to distributing startup equity.
To build a great work ecosystem and a successful business in these modern times, a startup founder must understand how to split equity and the many considerations (legal and ethical) that go with it.
Splitting startup equity
In this guide, we talk about the fundamentals of startup equity distribution:
- What is startup equity
- Who gets equity in a startup
- Factors to consider when splitting startup equity
- Typical startup equity distribution
- Automating equity distribution
What is startup equity?
The term startup equity refers to the ownership of a startup, usually demonstrated as a percentage of ownership (or shares) given to individuals that contribute to the growth of a business. These could be your co-founders, investors, employees, and even experienced advisors.
Back to the cake illustration, the whole cake is yours to eat if you're a solo entrepreneur, 100%! But eating an entire cake is not.. fun, nor realistic, particularly if your goal is to scale your business. In fact, keeping complete ownership can sometimes be the biggest hurdle in exponentially growing your startup.
You need to enlist the help of experts, specialists, and a team of dedicated employees who will grow with you. Aside from hiring skilled labor, you need to raise funds to cover the costs. It does not make sense, if not completely impossible, to bake that cake and eat it alone!
Successful businesses are those who are able to scale, and split the equity in a way that benefits more people.
Fun fact: Did you know that Jeff Bezos, the 4th richest person alive and the CEO of Amazon, owns less than 10 percent equity in Amazon, a company he founded? 😉
Who gets equity in a startup?
When your startup is in the initial stages, the founder or the co-founders usually own it entirely, typically in a 50/50 split, or 60/40, depending on various conditions.
As you grow, equity is distributed among those who contributed to fund your startup, give you advise, or develop your product/service offerings.
- Co-founders that invested into the vision or business idea
- Friends or family members who contributed seed money
- Employees who invested their time and skills
- Advisors who gave expert advise or network
- Investors who provided capital
- Other service providers
The timeline, level of contribution, degree of commitment, and the company's valuation at the time of equity distribution all influence that percentage.
Factors to consider when splitting startup equity
Every startup is unique, and the equity split varies depending various factors:
1. Contribution. One of the most common factors to consider when splitting equity is the relative contribution of each founder, advisor, or employee. This can include things like the time and effort that each one puts into the company, the expertise they bring to the table, and any intellectual property they contribute.
2. Roles and responsibilities. Founders should consider the roles and responsibilities of each team member when determining equity splits. For example, a founder who is taking on a key leadership role or an employee who has a more specialized skill set may be entitled to a larger share of the equity.
3. Future plans. Founders should also think about long-term goals and how equity splits may impact those plans. For example, if one founder plans to take on a full-time role with the company while the other intends to remain a passive investor, this may affect equity split.
4. Market conditions. The state of the market and the industry in which the company operates may also influence equity distribution. Say, if a company is in a highly competitive market or seeking future funding from external investors, the founders need to give a larger share of equity in order to secure necessary capital.
5. Legal and tax considerations. There may also be legal and tax implications to consider when splitting startup equity. For example, founders may want to consult with a lawyer or accountant to understand the tax implications of different scenarios to ensure that the company is structured in the most tax-efficient manner possible.
Ultimately, the right equity split will depend on the specific circumstances of the startup and its founders. It is important to carefully consider these factors and communicate openly and honestly with each other to determine an equity split that is fair and aligns with the long-term goals of the company.
Typical startup equity distribution
Here's a simple model on equity distribution per funding round, and a sample of how equity gets diluted as a company grows.
Essentially, dilution is all about your slice becoming smaller as the cake becomes bigger. You get more from a smaller slice of a big cake than a bigger slice of a small cake.
Let's dive deeper. How much equity should each stakeholder get?
Startup equity split between co-founders
If your startup has co-founders, it is preferable to have a transparent discussion on equity distribution as early as possible.
David Kenney, an angel investor and Partner at Hall Chadwick, believes this is one of the first things to get right among co-founders at the very beginning.
“One of the things that’s important to get right at the very beginning, is the conversation with your co-founders about founder vesting. One of the very big errors on a cap table is often the dead weight where a co-founder has got capital and has gone. If you don't think that can happen to you, it happens to lots of people. [..] You should be monitoring your capital allocation and who owns and controls your company."
Startup equity split among co-founders can be a defining step for your business and is essential to creating long-term relationships. When splitting equity, some of the factors to take into account include the risk involved from each side and the initial capital contributed by the co-founders.
Cap table modelling is one way to analyse the ownership structure of a company as it develops, and allows co-founders to visualise the impact of various scenarios (i.e. equity dilution) at important liquidity events. Read more about cap table modelling here.
🍰 Simulate your startup equity dilution with this free calculator
Here at Cake, calculating startup equity comes up a lot in conversations with our customers. This is why we developed this startup equity dilution calculator to simplify the maths and help solve an otherwise complex problem that startup founders often get stuck with.
Using real data and best practices, this startup equity calculator shows how much an early-stage startup founder's equity is diluted when taking on a new capital round. Go try it out!
Startup equity split for employees
We cannot stress enough how important employee equity is in every growth stage, but most specially in the early stages. Many startup founders believe so:
Sondre Rasch, Co-founder and CEO of SafetyWing:
"If there is one thing we need to learn from Silicon Valley, it is that all employees get equity. This is such a powerful thing! It creates this long-term motivation, where you share in the benefits when a company gets successful where everyone is part of building it. It brings alignment from the individual to the company — we're all co-owners of this. It's a remarkable thing."
Michael Houck, CEO of Launch House:
"Employee equity is super important. You want to make sure that employees, especially early employees who are making a huge commitment and taking a huge risk to bet on your startup versus one of the many of the other things they could do with their skills, are compensated for that and have the upside for that in the long run."
Jason Atkins, Co-founder at Cake Equity:
"The best people are attracted by having some skin in the game so you're gonna have a better quality team from the starting point. They're gonna be more engaged. And then there's also the retention element, especially in the first few years when you're finding product market fit and your brand's growing and your product's improving. So much of the IP is within those people's brains and the networks that they build. So you really want to keep them."
How much equity to give employees is an important discussion to make. You want to do right by the people who, just like you, are taking the risk and investing valuable time and resources into your business.
A typical employee stock option pool at pre-seed round is about 12-15%, diluted to 10% at series A.
Houck adds that the employee option pool at Launch House sits at 10%.
"We have an employee option pool as part of our equity structure. It's 10%, which we recommend to be pretty standard. And every time we raise capital, we replish that to bring it back up to 10% available."
There are several ways to go about configuring stock option pools for employees. To know more about this topic, check out this guide: how to distribute employee equity.
Startup equity split among investors
Investors in your startup, whether they are angel investors, venture capitalists, or friends and family, are taking a significant financial risk with expectations of financial gain in return.
Unlike employees and advisors who are rewarded equity in exchange for their professional service, investors gain equity stake from your company in exchange for funding. Percentage of shares given to investors therefore should reflect the amount of money they invested; however, depending on the investor's experience and expertise, investors also sometimes negotiate to increase their equity.
The amount of investment from an investor depends on your valuation and the equity percentage you are willing to give away. The scenarios may be different if you are fundraising. Whenever there's a new round of funding from investors, everyone's percentage is also diluted. It is essential to communicate with your investors and build a trusting relationship with them.
Startup equity split for advisors
Advisors are strategic partners that help startups with business decisions and cover gaps in core areas, including but not limited to recruitment, quality control, industrial digitalization, and geographical expansion.
Typically, advisors can expect to receive anywhere between 0.25% to 1% - but the exact percentage ultimately depends on how much the advisor contributes to the company's growth, their expertise, and how much you're willing to give away.
An advisor sitting in monthly meetings to give advice during pre-funding stages might be given .25% to .5% equity, whereas an advisor with a huge network of contacts might have a bigger slice of the cake. In some cases, an advisor is also one of your investors, which is also a factor in his share.
When the first seed funding takes place, an advisor's stock might be diluted to .5%. At this point the advisor no longer attends monthly meetings anymore and might just be on-call. When another round of financing happens, an advisor's stock could be further diluted to .25%, and so on.
Know more about advisory shares here.
🍰 Automating startup equity distribution with Cake
It goes without saying that startup equity management is a complex undertaking, especially for new startup founders. But that doesn't mean you can't simplify it.
Equity management tools like Cake are built off the back of years and years of experience, lessons learned from mistakes, and best practices developed through time.
We've worked with many startups going through capital raises, and have seen thousands of cap tables in our collective lifetimes. And this is why we've developed Cake—so that you don't have to reinvent the startup equity wheel.
This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.