Entrepreneurship: Equity



Over the last couple of days, I have learned a few things that should be kept in mind if you are going to set up a business with other people.

Firstly, there is no fixed standard for dividing the equity among the founders and the core team members. A person can be the founder, co-founder or an employee of the new set up. A major chunk of the equity is held by the founders and the investors. The remaining equity is distributed among the employees based on what value they bring in and when do they join the company. The earlier an employee joins a start up, the more share of the sweat equity he gets. The risk taken by an early employee is covered by salary to some extent.

If a person has joined the company on Day 1 and is not drawing any salary, he should be designated as co-founder. If he has joined the company after it has run for a couple of months, he would be designated as an early stage employee of the company. He can possibly become a part of the core team. He may or may not be offered equity in the company.

Now, what does equity mean? Suppose, A is offered 5% stake in the company. So, if the company is worth 100 bucks, A owns Rs 5 in the company. If the company’s net worth increases to Rs 1000 in the next few months, A’s share becomes Rs 50. He still owns 5% share. Now suppose that an investor, I, agrees to invest Rs 9000 in the company. In return, the company offers 50% stake in the company to the investor. Remaining 50% is divided among the employees and founders of the company according to the percentage they held before I invested. So, A now holds 2.5% (5% of 50% ~ Rs 450) in the company. This is how the equity dilutes as the company grows.

Another point that should be kept in mind while joining a startup in its early stage is that you should get at least what you would have earned, if you had kept your earlier job. This needs further explanation. Suppose B was getting Rs 5 Lakhs/annum in his earlier job. B decides to join a startup. The total value of offerings (equity + salary or only equity if not drawing salary) by the startup should be at least 5 lakhs or more. So, if the startup would worth Rs 1 Crore after an year. B should get at least 5% equity, if offered only equity.

Finally, the numbers would mean anything only if the company grows and becomes successful. So, the focus should be on building a strong team, which would make the company successful. There should be a point when the team members should stop worrying about equity and start working on their idea.