How To Structure a Startup Ownership

How To Structure a Startup’s Ownership Fairly

 

One of the biggest challenges facing startups is deciding how to structure a startup ownership fairly. As new employees or investors come on board, ownership percentages will change, but establishing a dialog early on about ownership and the value of contributions is essential.

Founders Agreement

Having a “founders agreement” will help prevent misunderstandings. It should specify how much time each founder puts in, what happens if one founder isn’t pulling his or her weight, and the founder’s salaries, or if they even take a salary.

The Founder’s Split

Starting with 100 or 1,000 shares of equity makes it easy to divide ownership. Shares of equity are not stocks; issuing stock is an option to be discussed with a financial adviser. If two founders each contributed equally to the idea and both had the skills to make the idea a reality, then beginning with a 50/50 ownership split makes sense, assuming both brought an equal amount of capital to the table. Unfortunately, both founders rarely contribute equal amounts to the project. Founders who wait to determine who contributes the most time and who’s skills are invaluable to the company’s success often decide on an unequal split.

Two successful founders working with laptop computer at the office

Why Two Founders are Ideal

Ideally, startups should have two founders, which leaves enough equity after fundraising for each person to have a major stake in the company, plus each founder can have a leadership role. In addition, there is less chance of personality conflicts, which investors view as a plus when they are selecting startups to back.

Salary Replacement

If founders need outside talent that they cannot afford to pay yet, a small stake in the company can replace a portion of the person’s salary or represent a one-time payment for a service. Startups must pay employees a salary, even if they supplement it with a share in the ownership, because, initially, a startup is worth very little.

The percentage of equity that a startup should give an employee depends on the employee’s experience, his or her network of contacts and whether the hire will be an asset during funding rounds.

Avoiding Resentment

While those who share in the startup’s ownership in the early stages stand to gain enormous financial rewards, they also take the largest risk. Founders may end up resenting early investors who offered very little for a stake in the company while latter-stage investors will pay ten times the amount for the same stake, however, this type of thinking is flawed. The company may never have flourished without the initial investment.

Typically, a startup’s founders only retain 20 to 30 percent of the company, while the rest goes to angel investors, venture capitalists and employees.

Vesting

A set vesting schedule is important because it protects the company. If a founder leaves early on, before the startup becomes profitable, taking his or her equity and skills, it would be disastrous for the startup.

LLC or CorporationFounders should get legal and tax advice about establishing their startup as an LLC or a corporation to avoid significant liabilities and paying higher taxes initially.