Equity distribution among co-founders may be a complex procedure while starting any business. How you split founder startup equity can be even harder for a tech startup due to different roles and contributions from the founders. Take the time to iron out the specifics so that you can prevent misunderstandings, compensate employees properly, and run your company in a manner that is pleasant for your staff.
We’ll address the fundamental considerations to consider when distributing stock in a business, including the method of dividing equity among founders and typical traps to avoid, in this post. You can utilize a co founder equity calculator to properly divide equity amongst co-founders.
What is the equity structure of a startup?
Startup equity as a concept is predicated on the notion that a company’s stakeholders are entitled to precisely what their title implies – a stake in the business. This often entails granting a set proportion of ownership to early contributors such as workers and investors.
This proportion is determined by a variety of criteria, including the date of the contribution, the degree of commitment, and the company’s value at the time of stock distribution. Founders often earn the greatest initial ownership, which is predictable.
Additionally, early investors earn more stock than later investors, since their contributions are proportionally higher in relation to the company’s early value. Additionally, workers who assist in the startup process often get a higher percentage of ownership than those who join the firm later.
Equity allocation is also inextricably tied to the stage of financing. As fundraising rounds proceed, your financial circumstances inevitably change, and in almost every instance, your approach to stock distribution changes as well.
The differences between shares and options
Typically, equity pay is in the form of shares or options. The distinctions may be classified into four groups.
Ownership of the business
If you own shares in a corporation, you become a shareholder instantly and have the same rights as other shareholders. However, with options, you only hold the right to purchase shares at a certain price (strike price) at a specified future date. This implies that you are not a shareholder until you exercise the options and pay the strike price on the set date in exchange for the shares.
As a result, you will have no dividend or voting rights until you convert your options to stock. Typically, option holders elect to defer conversion until a departure occurs. At that point, the options are converted just before the sale, and the shares are then sold with the rest of the firm. A primary reason to avoid this method is the impact on your taxes, which is highly dependent on your country’s tax policy.
This is a critical discussion point for both the issuer and the recipient of stock pay. Additionally, it is very localized, so be sure to consult your local tax law or an accountant.
The following are the general tax regulations.
If you distribute shares to someone at a discount (e.g. nominal versus market price), this is seen as quick revenue. As a result, this individual (or business) is very certainly required to pay taxes on this income.
If you distribute options, no tax is due at the time of receipt. However, the difference between the market and strike prices at the moment of conversion is likely taxable income.
To keep things simple, we’re skipping over possible capital gains taxes.
This subject will be discussed in more detail later in this text. For the time being, it is critical to realize that vesting enables you to establish how individuals get their shares over time.
For example, a four-year vesting term normally indicates that the individual will get 25% of the allotted shares in the first year, 25% in the second year, and so on. Furthermore, other criteria may be specified. One of the most prevalent requirements is that the employee continues with the organization. Thus, if the employee departs at the end of the first year, she gets just 25% of the shares.
The main difference between shares and options in terms of vesting is that options vest forward and shares vest backward.
Continuing our example This implies that the employee obtains all shares on the first day, but must return 75% of them after one year.
When it comes to options, the employee gets none on day one and 25% after one year.
Again, this has an effect on voting rights and dividends.
When shares are issued and allotted, the holder must purchase them at a certain price. Usually, this price is fixed at the nominal value of the stock (typically $0.01 per share), requiring the least amount of cash.
There is no price payable upon receipt of an option, but the strike price defines the price at which the option may be converted.
This price might be set at the same nominal value of $0.01 per share, but as this has a severely negative tax consequence in the majority of countries, the option striking price is normally set at “fair market value.”
The fair market value is comparable to what investors paid during the last investment round.
Taken together, this means that the owner of the options will need cash to convert them to shares.
Do not hasten the process of dividing equity. By striking the appropriate balance when you split founder startup equity, you can assist guarantee that your co-founders feel appreciated for their efforts and stay on board for the long haul.