How much is your startup equity worth?
Whether you've seen it before or this is your first foray into the world of startups, you're here: the company is building steam, and you're building an exceptional team who will take things to the next level. For compensation, you want to offer the team comprehensive – yet properly distributed – equity packages.
The process can seem a little daunting, even for an experienced founder. But like the many challenges you've faced along the way, this is just one more hurdle to overcome.
To start the process, you'll need to know what your startup equity is worth. This article will tell you how to value your equity offer, how to account for dilution in your startup's value, and how to distribute it properly to both employees and senior executives.
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How to value your equity offer
Not sure of how to make startup equity calculations? Don't worry. This section lays out a viable startup equity calculator to help you evaluate an offer and negotiate a proper compensation package for your team.
If the company runs on your shoulders, then determining your own equity is a straightforward process. But when you have multiple founders, the equity distribution is a key decision you and your business partners must make. It's important to be open in these conversations and work together to determine the equity split.
How do you negotiate equity in a startup?
When negotiating a split in equity between founders, there are some key questions to answer:
Who has the most risk? – If you're all facing the same risk, then this is easy to answer. But if one of the co-founders is investing more startup capital than the other or someone is resigning from a full-time position to take the helm, then potential risk factors could vary.
What is the level of commitment to the startup? – With a startup, most founders receive almost no pay, if any. But if a co-founder has a higher level of commitment to the job through their role, this can also be a factor when deciding on equity distribution.
Who holds the keys to innovation? – Startups begin based on an original idea. And sometimes there's a divide on who is driving the innovation side and who is performing the tasks to turn that innovation into profitability. The distribution is equal in this scenario if both parties contribute, but the idea side of things can grant others in an ownership position a higher number of shares.
Whether it's 50/50, a 33 percent split three ways, or 60/40, the amount of equity you get as a founder is part of a negotiation process that you'll work out with your business partners.
How do you calculate startup equity?
Any startup equity calculator will hinge on these five factors:
Last preferred price – This is the price that investors paid for each individual share during the previous fundraising round. Higher preferred prices indicate the startup has a high potential for success.
Post-money valuation – Startups may go through multiple rounds of funding, so the post-money valuation provides a reference point for what the value is after the last round. To et this value, add the company's pre-money value to the newly acquired equity.
Strike price – It's the price per share you'll receive when you exercise your options. Many companies offer options with a low strike price, but they're still factored into the equation.
Hypothetical exit value – It's the ideal value your company would exit at upon sale.
Number of options in your grant – This is the number of grant options you have available for employees.
Who distributes this equity to is contingent on the structure of the business. Founders and board members typically get the highest equity stakes, but a smaller percentage will go between employees and other investors and advisors. You can always purchase more.
What is equity stake?
This is your ownership percentage in the company. To build on this, you, as a founder, must purchase more equity shares in the company. Investors can acquire more stake through a contract.
How do I calculate how much equity I have?
For founders, this is predetermined in the initial negotiations on how to split the company.
What is startup dilution?
To have a better understanding of equity, you must factor in dilution. It's a decrease in your equity ownership due to issuing additional shares. It happens when new investors put money into the company during funding rounds, or when you expand the options pool available to current employees.
How does startup equity dilution work?
Equity dilution can come from different scenarios, but these are the three most common ways you'll see it happen:
Funding rounds – When startups need to raise funding, they often give away equity in the
business as a trade-off, thus diluting the ownership percentage of anyone with equity in the company. The dilution occurs in future rounds as well.
Convertible debts – Often when new investors come in or exit, it can create a trigger event for those holding debt within the company. These debt holders can convert into shareholders in this situation.
Stock options – While these aren't the same as existing shares, a startup still must account for them being exercised in the future.
Dilution can work in your favor, as it can help bring in team members that will increase your overall equity value. In this scenario, everyone wins. But in the early stages of the startup process, it's important to know how it works and how it can affect your decision-making abilities within the company.
How is dilution valuation calculated?
Let's look at a scenario where you own 10,000 shares of your company. The company is taking off and you decide to bring in some new investors at 1,000 shares and you also create a new 1,000 share option pool for a future job offer in a senior position. If you had a 100% stake in the company, your ownership just dropped to 83%.
To do the calculation, you take your existing number of shares and divide them by the total outstanding shares plus the total number of new shares. That would be 10,000/12,000 in this example, which brings the dilution valuation to 83% and a drop of 17% in ownership percentage.
How do you calculate startup dilution?
Calculating dilution is entirely contingent on the valuation factors listed above. You can use the same formula, but startup founders must consider whether they'll have more funding rounds in the future. Every time the company creates more shares, the existing ownership percentages will fall for everyone involved, including the founder.
What is pre-money valuation?
The pre-money valuation of a company is its value non-inclusive of its previous round of funding or any other external funding. It encompasses the company's valuation before any investment. It can tell future investors about the value of the business, and it also determines the value of the shares the company will issue.
Post-money equity percentage calculation example
Post-money refers to the company's valuation after receiving funds from investors. Whether pre or post, it's important to understand the difference and know how they can affect your stake in a company.
Let's look at a scenario where a group of investors wants to invest £500,000 into your company. For this scenario, both parties agree that the startup has a current value of £5 million.
Equity ownership will be contingent on the company's valuation pre- or post-money. For the latter, we calculate the value by dividing the amount of the investment by the post-money valuation. That figure is £5.5 million in this case—the pre-money value plus the investment amount. So 500,000/5,500,000 = a 9% equity percentage.
How do startups give equity to employees?
Potential startup employees should recognise that a company's valuation will affect their net worth in the future. Whether the goal is acquisition or IPO, the startup will eventually pay out to those who have invested their time into the business.
But surprisingly, many go into interviews and compensation negotiations with startups without a viable calculation of what equity – like stock options – is worth. Startups grow within different scenarios, and new employees should determine the potential exit values of the equity they'll have.
How much equity should a startup employee get?
Before calculating the value of equity, you obviously need to know how much equity your employees should get in the first place. You must also factor in whether you're going to give stock options, preferred stock, or even common stock?
Startup companies typically operate on a tight budget, so equity can act as an excellent incentive to attract the talent you need to move the company forward. It can make up the difference on a lower base salary within the market.
Here are some factors to consider when determining how much equity your employees should receive:
Ownership percentage – How much do you want to award to your employees? You'll reflect this in your equity pool and be sure to consider the number of employees you plan to hire along with their level of experience.
Vesting schedule – This determines when your employees will be able to access what they've earned. Most companies offer a four-year vesting schedule with a one-year cliff
. So employees can start tapping into their equity after a year of employment. After that year, they'll have one quarter of the total equity grant, and the remaining equity will vest quarterly or monthly.
Types of shares – Many companies offer stock options as an option grant with a low strike price. But you can also offer restricted stock, preferred stock, or common stock.
Regardless, whatever equity you offer should act as an incentive to remain with the business and contribute to its success.
While there could be various scenarios, most startups backed with some venture capital allot around 10-20% of their total outstanding shares as an option pool for employees. This can vary based on the ratio of the stake of the investors to the startup founders or co-founders.
When investors put more money into the company than the founders, there will be less of an employee equity pool. But a new job offer can include anywhere from 1-5%, based on their value.
How much equity should a senior executive get in a startup?
Superb CEOs, COOs, and the like are difficult to find, and there's no number set in stone for what you should offer to senior executives. But there's a general consensus that most CEOs will receive anywhere from 5 to 10 percent, and a COO would receive between 1 and 5 percent as compensation. This is all based on their experience and value to the company.
How do you calculate employee equity?
The most common equity calculator for employees factors in the total outstanding shares – fully diluted shares – within the company and the number of shares available in the option grant. You divide the shares in the grant by the total outstanding shares to get your percentage of ownership in the company.
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