Equity- the stake you or someone else has in a business. Having equity in a company means you have the incentive to see it grow and succeed. Whether a founder, employee, or investor, equity owners want to see a return on their investment.
As a founder, you want to know how much equity you can or should give away. The answer: it depends.
When taking investment from early Angel investors, selling 10% to 20% of equity is the general rule. There is a lot of risk and exposure in investing early. As a founder, don’t forget the amount of risk and exposure you have; you don’t want to give away too much too soon.
Giving away company equity in a startup
Founders can reward their early employees by giving them some equity ownership of your business. This can range from 0.1% to 6%, depending on their role and how early they join the company. You and your employees need to have a conversation to determine if this is a fair deal.
How to value startup equity
There are a few factors that play into the value of start-up equity:
- Time to exit (assuming success)
- Potential exit price
If you decide to continue to raise additional funding, you will continue to dilute the company equity pool. What was 10% ownership of the company may become 8% after a Series A. You still own the same number of shares, but the total number of shares has increased.
Assuming that the business is a success, how long until the exit or sale of the business? Three years? Five years? At what price are you selling the business? The sooner your exit, the less risk meaning you get a higher valuation. That’s because investors will not recognize the value of their equity until the sale and the price might be lower or higher than expected (as low as zero!)
How much capital should I raise?
There is conflicting advice on how much capital a business should raise and, proportionally, how much equity to give away. Some experts will say to raise as much as you can, while others will advise only to raise what you need. This advice hinges on other factors like economic conditions – downturn or bullish–and how much demand for your business you’ve generated.
The legal cost plus the work of fundraising will steer founders towards a path of raising as much as possible all at once. When beginning your funding round, remember to build in the cost of legal and take note of the greater economy.
On the other hand, founders minimize dilution by raising as little as possible.
A startup CFO, like those at CFOshare, will be able to guide you toward the best decision for your business.
You will often need more than one round of funding and you are looking to raise a minimum of 12 months of runway. The path to funding is different for each business as is the timeline and the amount of equity given. Remember, with each round of funding, you are giving away more equity and diluting the overall pool.
Pre-seed: Less formal, sometimes called a ‘friends and family” round.
Seed Round: Funds come from angels or accelerators, funding is typically used on key hires, testing the product/market, and further project development.
Series A: You’ve got a proof of concept, your pro forma has more actual data, and the goal is to secure funding that allows for scaling.
Series B, Series C, and Beyond: Your business model has proven traction even if profits might still be scarce. Acquisitions are being considered and your company is valued high, especially if you are in Series C.
What does the debt to equity ratio mean for a company?
If you have a debt-to-equity ratio of 1.5, your company uses $1.50 in debt for every $1 of equity. This is closely related to leverage and measures the total debt relative to the amount of investment and earnings retained over time.
Why does this matter? If you are looking for an additional round of funding, future investors will use this ratio to determine if your business is in financial distress or over-leveraged. For some tech startups, it is not even possible to raise debt, so the debt to equity ratio is a non-issue. But product companies and e-commerce businesses often carry debt, so keep an eye on your leverage by watching the debt to equity ratio.
How to calculate Series A funding debt to equity ratio: take the total liabilities and divide them by the total shareholder’s equity (both numbers can be found on your balance sheet).
Still confused or have more questions on how much equity to give away? Contact us at CFOshare to talk through a strategy that we tailor to your business.
About the Author
Chelsie is the Vice President of Business Development at CFOshare. She helps small business owners improve their accounting and financial planning by surveying their company’s needs and aligning solutions internally or through CFOshare’s outsourced team.
At CFOshare, their team of specialized, full-time W-2 employees work together to deliver superior results to your small business. That means you can expect industry best-practices from a range of experts whether it be a debt specialist, cost accountant, real estate guru, startup specialist, or pricing strategist.