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Splitting the pie: How to find the right equity balance for your startup

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Category: Insight & Vision
Published: 19/05/2017

Entrepreneurs are the new rock stars. Everyone wants to be their own boss, to create their success story, to be lauded in the business pages of the now online newspapers.

600 startups launched per day in London in the first six months of 2016 alone – and these figures are only growing. More so today, with the culture of startups lauded, setting up your own venture is a particularly enticing proposition.

However, having a great idea and running with it is not enough – leading a successful startup is also about finding the best equity balance for you. Finances matter. We take a closer look at how you find the best way to split that potentially profitable pie.

Splitting equity – but among whom?

Although splitting equity may seem a straightforward idea – giving away parts of your business in exchange for either funds or services – it can be an intricate process.

“Splitting equity is an incredibly complex business,” says Matthew Bradley, an investor at Forward Partners. “It’s not a decision that exists discretely.

“Startups go through highs and lows, pivot, experiment, fail and succeed – and there are also people involved, which complicates the matter further. To different people, at different times, the split among founders may look more fair or less fair as a result of all of these factors.”

Most importantly, when splitting equity among founders, Bradley advises that leaders should get everything on the table up front so that the reasons for the equity split are known and understood.

“Some founders and business types might benefit from more streamlined decision-making processes,” he says. “If that’s the case, equity shares should probably reflect that. Some teams may well err on the side of consensus and have splits reflecting that.”

As with so many business decisions though, what is “right” is not a matter of numbers or percentages, but about what works for your startup.

600 startups launched per day in London in the first six months of 2016.

“The decision isn’t black and white so what you’re optimising for is what people think – and will continue to think – is fair most of the time,” Bradley adds.

“Importantly, there should be vesting schedules which match one another so that everyone is invested in the business for the same period of time and that people receive their shares in the same style.”

Attracting and keeping the right employees through equity

When it comes to employees and splitting equity, there are similar decisions to be made  and, somewhat confusingly, there’s no one-size-fits-all solution.

“You can be super-generous, super-stingy or somewhere in between,” says Bradley. “This can flow from how the founding team worked things out: if there’s an even-looking split up the top of the company, that’s often a sign that they’ll be more generous with stock options.

It’s much better to have a small slice of a big pie than a big slice of a tiny pie.

“This happens partially as a function of founders creating ESOPs [Employee Share Option Pools], which serves to dilute founders on a pro-rata basis.”

Bradley says there are plenty of other variables at play: “Some businesses require significantly more highly-skilled labour than others, and startups rarely have excess cash for big salaries so stock options can be an important part of the remuneration mix.

“Ultimately, I feel that the set up of ESOPs and the granting of options is an incredibly important part of attracting and keeping talent and aligning employees to the company mission.”

For Rachel Carrell, CEO of Koru Kids, deciding how much equity to give away and when was one of the most difficult decisions her startup faced: “There’s no formula. For us, it’s been important that all senior employees get the same amount, as we felt that set the right cultural norm: that we’re all in this together.

“It’s definitely worth being generous with equity. I took the view that it’s much better to have a small slice of a big pie than a big slice of a tiny pie.”

Believing in your startup’s worth

You’ve come up with a brilliant idea, convinced others to believe in it, and are going to grow your startup exponentially – but it’s important to know how to value your company from day one.

Having a clear vision will prevent the excitement at the prospect of funding from blurring your vision. Ahmed El-Sharkasy, CEO at Knowledge Officer, says this can be a common issue for young business leaders.

“A typical mistake young founders make is to treat funding or joining an accelerator as a goal or achievement in itself, and they’re often willing to give away anything to celebrate that moment and get the cash,” he adds.

“Most experienced founders would give the advice of not giving too much equity away too early on, and to bootstrap up until the point that you are really struggling and can’t continue unless you raise funding.”

According to El-Sharkasy, it’s worth trying to wait until you really need more money before trying to raise funding: “The more traction the startup has, the more solid the ground and the easier the ability to negotiate with investors on terms.

“Lots of young entrepreneurs try to raise money from the idea phase, but at this stage investors are taking a huge risk and will therefore want to take as much equity as they can to tolerate that.

“It’s best to wait until you really need the money.”

Bradley also advises figuring out first of all how much a startup really needs: “This should take the form of a well thought through and substantiated business plan, because without this it’s unlikely than any investor’s interest will be piqued in the first place.”

Most experienced founders would give the advice of not giving too much equity away too early on.

“The founders need to work out how much of their company they’re willing to give away for that cash requirement. At the early stage, the ‘usual’ – insofar as that is possible – is to have an amount for 15 to 25%, which gives the business 12 to 18 months runway.

“Provided that both parties have done their research on comparable businesses in the market, the two parties positions shouldn’t be too far away from one another.”

Tony De Nazareth, CEO of Crowd for Angels, advises that if business leaders believe in their companies and really need funding, they shouldn’t worry about giving away a few extra percentages.

“If you need the money to grow, take it and grow your business,” he says. “In this way, you increase the value of the whole business and while you have a smaller percentage ownership, the value of your investment will have grown to compensate you for your perceived loss.

“Remember too that each subsequent round of funding will be done on the new valuations.”

Focus on smart money

Investors invest, right? But they don’t just invest money – they also invest time, contacts and experience that can be invaluable for growing your business.

When presented with the prospect of a huge cheque, it can be tempting to go for it – but make sure you’re picking the right investors with the right qualities.

“Focus on ‘smart money’,” El-Sharkasy advises. “Find investors who can give you more than just a cheque: people who are experienced in your domain, with whom your visions and goals are aligned and most importantly who can expand your network of relations and partnerships.”

James Kinsella, co-founder of instantprint, agrees that investors are about more than just producing cash: “Although it certainly isn’t possible in every business if you can, retain equity at early stages and fund through alternative means to keep options open at later stages,” he says.

“Although funding drives most startup equity deals, I personally believe that the expertise that investors bring is often more valuable than the actual funding, particularly when it comes the role of mentors.

“Investors can bring a wealth of experience, contacts and skills that it would be impossible to gain elsewhere.”

Matthew Dunne, founder of Local Vets, says the involvement of investors in his business has been just as valuable as the money they brought with them: “The 15% of the business that I decided to sell has brought value far greater than cash alone.

“Our investors have opened doors and made introductions and the publicity surrounding our funding campaign has enabled us to get in front of key industry players. Don’t underestimate the value which your investors can create.”