Determining how much equity to give co-founders or contributors is not easy. On one hand, you want to fairly reward people for taking the risk, believing in you and helping you build your company from scratch. On another, you want to create the right incentives and only offer equity to those who are committed to your company’s success long-term.
Not everybody in your company should get equity
Without access to initial funding, offering equity may seem like an easy way out. However, this is a mistake. The last thing you want is to end up with a crowded cap table full of people who really have no business being a part of your company and for your investors to start questioning you about every single person and requesting to buy him or her out.
As a rule of thumb, there are only four types of people to whom you should offer equity: strategic partners, investors, co-founders, and others who will be involved with your company long-term, for example, employees or advisors.
Here are two methods of determining how much equity you should offer.
Offer equity based on time spent
If there are several co-founders and all of you plan to spend the same amount of time working on your new venture, then the equity should be split equally amongst you. We recommend that you have a vesting schedule so that equity is earned over a certain period of time, similar to a salary. You can negotiate for a small percentage to be vested upfront.
If somebody is not working on your venture full time, then you can approximate the amount of time they will be spending as a percentage of the overall amount of time spent, and use this as a guide to determine how much equity this person should be offered.
Offer equity based on an hourly rate and a company valuation
If you are at a later stage and have a company valuation, we recommend an alternative and more accurate method for determining the equity percentage. You and your contributor can agree on the number of hours a certain project will take as well as on the hourly rate. The rate may be adjusted upwards because it is paid in equity, rather than cash. Then the equity percentage you will offer to this contributor is going to simply be the number of hours times the equity-adjusted rate divided by the company valuation.
For example, if a contributor’s equity adjusted rate is $100/hour and his project will take 100 hours, he is effectively making an in-kind investment of $10,000. If your company valuation is $1,000,000, then he is going to get a 1% ($10K/$1M) equity vested over the time when he performs the work.
To learn more about fundraising strategy and startup financing vehicles, check out Course # 5.
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