By Fernando Berrocal
You, as a potential startup entrepreneur, are aware that your startup is essentially owned through equity in your business. You will use a cap table, which is a table that shows how shares of a startup are distributed, for this. However, if it's not handled properly, it could cause medium- and long-term problems for your startup. Making errors in the equity distribution process with your co-founders (and other stakeholders) can seriously damage your firm in the long run in a variety of ways.
To an inexperienced startup founder, the shares of a newly established business may appear to have virtually no worth at the time an organization is founded. Even if that's the case, it doesn't always follow that your shares will always be worthless. Even while there isn't yet a specific dollar amount associated with your shares' worth, they do have value. If you give away too much equity when your shares have no real market value, it could become problematic later on when they do. That action can have an impact on you and is either impossible or very difficult to undo.
Additionally, it doesn't help entrepreneurs when individuals close to them also think poorly of their startup equity. They demand a significant piece of it–even when it isn't worth much. Sadly, this results in many entrepreneurs handing away a lot of shares to individuals who aren't long-term investors. Additionally, a crowded cap table deters investors from being interested in the business. And as you are aware, investors will be crucial in advancing your entrepreneurial career in different scenarios. Your equity is, in reality, a form of currency, therefore you should treat it as such. Shares should always be traded in exchange for something since they have eventual real worth and a continuous one for that matter. Not granted to anyone simply out of a desire to “be on the cap table.”
Shares are not always the best form of compensation for employees who work for or assist your business in some way. Money is more fitting in some cases, whereas equity is occasionally a reasonable recompense. Most significantly, that will be your final choice. So, the issue to address is: who will receive equity? You can have one of four different categories of persons on your cap table, and each has a specific role. We shall discuss them in the paragraphs that follow.
- Startup Co-founders: Early on, startup co-founders should hold practically all of the equity, but as the business grows and hires staff, their ownership will gradually decline as a result. As an illustration, at the time of the Initial Public Offering (IPO), the Spotify founders owned 30% of the business instead of the original 100%. The founders are expected to put in their all-out effort and work on the business full-time in return for receiving such a sizable portion of the firm. Founders must execute a Founders' Agreement (or Shareholders Agreement) in this situation, so that the shares are conditioned on your continued participation in the organization.
- Startup Advisors: If you are endeavoring to create a kind of startup that requires real expertise to establish, business advisors can be a complete necessity in any scenario. You might not have enough money, though, to pay them directly as of now. In that instance, you may offer them a small portion of your startup's equity instead. It's also crucial that people only get the shares if they participate in its launch; in other words, if they actively contribute to the initial development of the startup. It is not sufficient for an advisor to merely state, "I have some recommendations for your startup.” It is crucial that advisors don’t disappear after a conversation relaying some basic advice.
- Startup Personnel: For your startup, you want to entice the best personnel in the area, but you might not have the financial resources needed to effectively compete here. Bear in mind that the most crucial resource for any kind of organization is human beings. In the majority of cases involving startups, it is even more significant than financial and time resources. In this stage of your business, using an option pool to partially compensate staff with shares on top of salary can be highly beneficial. Finally, you must educate them on how having access to equity can be beneficial for them.
- Startup Investors: Finally, the investor is the most common and important type of shareholder involved. Investors are individuals who might wish to join the adventure but who are unwilling to volunteer their time. They would want to contribute some money instead. Investors ultimately decide how much to value your business and how much your shares are worth. However, investors must also consider the long-term scenario. If they invest at a valuation that is too low, they will take too much of your equity–which will discourage potential investors from your startup.
As you can see, early equity management is crucial to the health and profitability of your startup. That’s why you must consider it to be actual money. If you start dispersing it carelessly, you'll discover that your pockets are empty just when you need them the most. Your shares do not necessarily have no worth just because they do not currently have a precise valuation. It's about thinking ahead, about the value that someone will provide in the future and the significance of your startup's future. Shareholders should be enthusiastic and caring individuals. Since you're all traveling together on this entrepreneurial trip, equity is the ultimate goal.