What is Equity in a Startup?
Equity represents ownership of a startup — typically expressed as a percentage of shares of stock. Early on, startup founders like you may need to give up a big chunk of equity to match the risk investors take by funding your startup. But as your startup grows quickly and shows more success, your startup equity increases in value. As a result, investors are typically willing to pay more — or accept less equity in exchange for their funding. What’s the difference between stock, shares and equity? “Stock” and “equity” are often used interchangeably. Stock is a general term — much like equity — that describes an amount of ownership interest in your company. Shares, on the other hand, are how your startup’s stock is divided. How do co-founders share their startup’s equity? There’s no one way to determine the equity split between you and your co-founder. More often than not, they default to a 50/50 split or another equal distribution to avoid an uncomfortable conversation. However, it’s an issue that can lead to big problems in a company’s future if not properly aired. How should your employees understand equity? As you hire, you will likely offer equity in addition to a salary and benefits. Because cash is usually tight at a startup, you may use equity to help offset below-market salaries. Having equity as an early employee means they will own a portion of your business they’re helping to build. It is basically deferred compensation based on the hope that they will someday own a piece of a valued startup — but equity packages vary tremendously. So, you and your employees should do their homework to understand the nuances of equity as deferred compensation. How does vesting work? Your employees’ equity grants will usually be paid out according to a four-year vesting schedule. With that, they’ll receive a fraction of an equity package each month, and four years later they’ll have their entire package. Often a vesting schedule comes with a one-year “cliff.” This means if someone leaves the company for any reason within the first year — even in the event of a termination — they’re not entitled to any equity benefits. The takeaway: Equity can have many upsides for your startup and your early hires. However, managing startup equity can also be tricky — for you as a founder, your investors and employees. Understanding the answers to the questions above and more is essential. Read or listen to my SVB Startup Insights article and learn even more about how to manage startup equity.
As a member of Silicon Valley Bank’s Startup Banking team, I’m in market and helping Southern California founders and seed-stage technology companies in the enterprise software, fintech, and frontier tech spaces.
Associate at Silicon Valley Bank | Formerly @Ikigai_fund | Contributor @MyBlockExplorer #sustainableinvesting #blockchain #fitness