Understanding Equity: A Guide for Technical Co-Founders

I want to let you know that most startups never make it to the market. I don’t want to disappoint you, but these are the facts.

According to a report by CB Insights, about 70% of startups fail before they even get to the market. This may seem difficult to hear, but it’s the reality of the startup world. If you’re a technical co-founder or thinking about becoming one, you should understand how equity works and how it can affect your potential payout.

What is Equity and How Does it Work?

Equity is the amount of ownership you have in the company. As a co-founder, you will usually receive equity in exchange for your contribution to the company.

Why Negotiating Your Equity Matters

Equity dilution will occur when your company scales and attracts investors. It’s imperative to negotiate your equity early on to ensure you receive a fair percentage of ownership.

Negotiating Your Equity: A Real-Life Scenario

Equity negotiations are crucial for any startup founder, but it’s not just about the percentage you’re offered. In fact, it’s about understanding how that equity will be affected as the company scales. To better understand this, let’s take a look at a real-life scenario:

The Company and the Numbers

Our example company is a Delaware-based startup that has just secured a Series A funding round of $5 million. The pre-money valuation of the company is $10 million, and the post-money valuation is $15 million.

The Founder’s Equity Stake

In this scenario, Javier was offered 5% of equity while Sara negotiated 15% of equity. Let’s see how it will turn out for Javier and Sara in the long run.

Assuming that both Javier and Sara get diluted by 10% in subsequent funding rounds, this is what will happen:

Javier’s 5% Equity:

In the subsequent funding rounds, Javier’s equity stake would be reduced to 4.5%. If the company exits to IPO at a valuation of $500 million, Javier’s equity would be worth $22.5 million. After paying taxes, assuming a 25% tax rate, he would take home $16.8 million.

Sara’s 15% Equity:

In the subsequent funding rounds, Sara’s equity stake would be reduced to 13.5%. If the company exits to IPO at a valuation of $500 million, her equity would be worth $67.5 million. After paying taxes, she would take home $50.3 million.

Beyond Percentage: Additional Questions to Ask

While the percentage of shares you’re offered is essential, other questions will also determine if you’re getting a fair deal. Here are a few examples:

1. What is the vesting schedule?

The vesting schedule outlines when you will gain ownership of your shares. It’s essential to understand the vesting period and any acceleration clauses or conditions that may impact your ability to receive your full equity stake.

2. What is the capitalization table?

A cap table is a breakdown of the company’s ownership structure. Request a copy of the cap table to know who else holds equity and how much.

3. Are there any outstanding stock options or warrants?

Stock options and warrants can impact the value of your equity stake. Ensure you understand if any outstanding options or warrants exist and how they may impact your ownership and payout in the long run.

4. What is the company’s growth trajectory?

It’s crucial to consider the potential for dilution as your company grows. Learn about your company’s plans for future funding rounds, growth, and expansion.

5. What are the terms of the company’s funding rounds?

The terms of funding rounds can impact the value of your equity stake. Inquire about the terms of the most recent funding round and future funding plans. This will give you an understanding of the company’s value and potential for growth.

The Bottom Line

When joining a startup, it’s common to hear about receiving more equity in exchange for a lower salary. While this can be a tempting offer, it’s important to consider the long-term implications for both yourself and the success of the company.

Before making a decision, carefully evaluate the potential risks and benefits and consult with a financial advisor if necessary. Remember, equity should not be the sole focus — a fair and balanced compensation package is key for both personal and company growth.