Startup Equity Allocation

I might be building a new team for the new company. While I’m a little reluctant to do so because it’s always a risk, I do miss having people I can count on and who are pulling for the work we’re doing. Teams can be great (and they can break down, as well–a subject for another post).

So a question I get from entrepreneurs is how to allocate stock. There are a lot of other posts about this, so I’m not going to do into great detail here (just Google “startup equity employees” and “Feld startup equity”). But here are a few thoughts.

  • Don’t be greedy.
  • There’s negative dilution and positive dilution. Positive dilution is when you give stock or options and are diluted as a result, but the person creates more value than the cost of the dilution. Negative dilution is when the contributor doesn’t increase the overall value of the company, or worse, hurts it.
  • Create a formula for “deferred” pay. There’s really no such thing as deferred pay. There’s pay not taken, and if it gets made up in the future, it is through bonuses, salary increase, or equity. If an employee takes less money for the same work, I value that more highly than the cash value and will give that employee more for their deferred salary in equity than the dollar value. Early on, 50% discount on equity makes sense.
  • Don’t value your own company. You have no idea how much your company is worth. It’s not a million. It’s definitely not $5 million. You don’t know until someone pays money for stock.
  • So if you don’t know, then don’t allocate shares according to number of shares, allocate based on percentage of ownership.
  • For the first 10 employees, don’t allocate less than 1% per employee, and give key employees more. If you have 3 key employees (not including founders), give them 4% each with typical 4-year vesting. That’s 12%. Of what? You have no idea, nor do they, but you’ve given them great incentive to kick ass. Let’s say the other 7 get 1%–so that’s 19%, and we’ll round up to 20% just for ease. That leaves founders with 80%.
  • Plan on dilution. You’ll get diluted by new employees, but at a slower rate than the first 10. Expect at least 20% dilution in your first round of funding, plus any friends and family money.
  • Don’t sweat the dilution. What matters are two numbers: your exit number, and your percentage of the exit. You’d rather have 10% of $50 million than 50% of $10 million, assuming it takes the same time and effort to get to both exits. But if you can get to $5 million twice as fast, take that route, because your time on Earth matters.
  • Don’t hire VPs or CEOs until you have a model that’s really working–meaning you have customers, revenue, and can sustain yourselves. Too many startups get top-heavy too soon, just to satisfy investors need for feeling safe and confident. Screw that–you know more than anyone what you’re doing (and if you don’t, you’ll find out).
  • Pay consultants equity instead of cash if you can, and give them the same deal you would give friends and family investors. If friends and family get a 30% discount on the Series A round for investing before that round closes, apply the same discount to the consultants deferred pay.
  • Cash is king. So don’t spend a lot on marketing, on lawyers, on deals, on mergers, on anything other than 1) serving customers and 2) serving customers.
  • Your equity is worthless without customers. Start every day asking how you can reach and serve customers that day, and if it’s too early to charge them, set a goal of getting 10, 20, 50 customers who will use your stuff for free. Their feedback and insight will solve a lot of problems for you and can create significant value down the road.

I have to get back to coding. Last year I started a book, and I’ll include a lot more about equity in that and make it available here. Regardless, the overall message here is to have an abundance mentality, and positively incent your employees to find and serve customers extremely well.

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