The most important consideration to make when giving out or selling startup equity is:
Will this person create value and grow the company?
What does this mean?
It means that equity should only be given to those who you foresee as creating value down the road. You need to give equity to those who will grow the company.
The problem is that a lot of founders think of giving/selling equity from a compensation perspective when the emphasis should actually be from an incentive perspective to create value down the road. The emphasis isn’t something nebulous either like “I want to incentivize this guy to do better for the company.” Don’t be vague. Be specific with it. The emphasis needs to be will this incentivize this person to create and grow the company. The small shift in mentality makes a huge difference. The emphasis is the key.
Startups are often using equity simply to solve an immediate issue. In the context of an equity priced round such as a Series A, when equity is sold to an investor in exchange for funds to be used by a startup, go one step further and make sure that investor relationship is a strategic one that can help grow the company (more on this below). Be forward thinking with your equity. Equity and the disbursement of equity is the most powerful tool that your company has. And if it’s not, then it should be. Why? Because it represent the company itself.
Selling equity strategically is all part of the proper growth mindset. This is one of the fundamentals of startup development. This whole site is structured in a way for you to easily understand the fundamentals of startups and startup law. You have to pay attention to fundamentals regarding your startup, and this is a huge fundamental that many founders either don’t realize or don’t take the message home hard enough.
Don’t be stingy with startup equity. Be smart with it.
One thing investors repeatedly tell me is that they are wary of founders who are not willing to share equity. Look. I get it. When it comes to a financing round, investors and founders are on opposite sides of the table (though I would argue that that’s a pessimistic and limited way of looking at it). Both sides want equity. The point is not to give out a ton of equity. Nor is it to be stingy with it. The important thing is to be smart with it and to be reasonable with it.
So realize that you have to share equity and you have to do it intelligently. You could do it alone and own your company alone, but not for very long and your competitors will out compete you. How do you do share equity intelligently? By focusing on sharing equity with those who will help the company grow.
If you adopt the mentality that future equity rounds and stock options are for the purposes of really growing the company two things will happen. First, you will suffer less dilution. The reason is because you’re less likely to be willy-nilly in your equity disbursement. You will become more thoughtful about the process. And second, when you do get diluted, it will be for a good reason. It will be to grow the company.
So here are the main points to have on your mind when you’re giving out equity in the hopes of future growth:
Pay attention to who you’re giving startup equity to
Ask yourself whether this person or this investment will really go to create value for the company. The fact of the matter is that unless you’re getting a great investment deal (and which funds you can use to add value and grow the company) then if the person/investor is not creating value/not making the company grow, then don’t use equity in the deal or simply don’t do the deal.
The shift needs to happen between “awarding or giving equity to this person for compensation” to something more along the lines of, “We are giving this equity because this person will create value in the future.” Make that shift happen and consider who you’re sharing equity with.
Find out what startup investors can do beyond money
I’ve said this before and I’ll say it again. There are lots of investors out there. Always ask, “What can this investor do beyond writing a check?”
Look—investors are not going to do everything for you. In fact, one of the most important things investors tell me that they look for when making an investment in a company is: “Does this founder know the market?” “Does this founder have the contacts?” “Does this founder team know the industry?” But even though the investor expects the founders to know the market well and to have a handle on it, know that there are things that an investor can do besides money.
A lot of individuals and groups can write a check. And if your startup is awesome, there will be a lot of options as far as who can write that check. Writing a check can be pretty powerful, but see if there’s something beyond money that the investor can bring to the table. Are there any distribution channels that the investor can open up? Any strategic partnerships? Product networks? Anything like that? Find out what they can do beyond money. These are the things that will help the company grow.
Understand startup math
This is the most important thing you can do to really understand just how value of the company works in relation to the ownership of the company.
When you understand how startup math works, then you get a better idea of how ownership is being dished out of the company. It gives you a more technical, fundamental understanding of all of this.
Read and understand this article https://www.startuplegalstuff.com/startup-math/
Give stock options appropriately
The fact of the matter is that there will be a number of individuals on your team that are helpful with your company. They’ve worked there. They’ve done things. They’ve smoothed things out.
That’s all well and good. You need people like that on your team. And they should be properly and well compensated for it. But should they be given stock options and equity?
Maybe. Maybe not.
If you don’t need to give options, don’t give it. If you feel like you can properly compensate and incentivize your employees with cash and you have cash, then just use cash. If you feel like that giving out stock options to this person can really make this person add value and grow the company in the future then go for it. The important thing is to be smart about stock options and stock option allocation.
Understand that dilution happens
A lot of founders are extremely paranoid about dilution and tell me they don’t want to be diluted. The problem is that they have this fear because they don’t understand dilution and how it works.
If, as a founder you are raising money, you will be diluted. There is no question about it.
The trick is to control how much you’re being diluted by being smart about how you’re raising the money, about the terms that you’re negotiating, and the type of anti-dilution protection that is on the table.
But one the most important items to consider with equity and dilution is the topic of this article. And that’s that when you DO give equity, yes you will be diluted, but make sure that the equity creates value moving forward. The person who is giving you equity should either directly or indirectly be able to help grow the company.
At the end of the day, you can either have a lot of pie that is worth nothing, or have a small amount of pie that is worth a huge amount. You want the latter.
Key takeaway: you will have to share company equity. Dilution WILL happen. Be smart about it. Make sure those that receive equity will create value for the company and will help grow it.