Founder must-knows: Economic terms that founders should understand.
There are mainly two things that investors care about when making investments:
Economics refers to the return investors will get in a liquidity event (e.g. a sale or an IPO).
Control refers to the mechanisms that allow investors to exercise control over a business or veto certain decisions.
It’s important to note that founders receive common stock when they start a company.
Whereas investors receive preferred stock when they invest in a company.
In my opinion, all founders should really understand:
- Employee Pool
The liquidation preference is the most important economic term after price.
It impacts how proceeds in a liquidity event — usually the sale of the company — will be shared.
It’s important to define what a liquidation event could be.
A liquidation event is one in which shareholders receive proceeds for their equity.
- Changes of control
How a founder’s stock vests is also very important.
Since equity is another form of compensation, vesting is the mechanism to earn equity over time.
Stock and options typically vest over four years.
Where if a person leaves the company before the end of the four-year vesting period, the vesting formula applies, and they receive only a percentage of their stock.
The employee pool is the amount of equity that is reserved for future employees.
Additional employee options ultimately end up in the hands of future employees, but it’s important to know that investors typically have any additional employee options come out of the old shareholders.