How Much of Your Company Should You Give to An Investor?

The numerous variables in play for each entity create circumstances as unique as fingerprints. So, there isn’t just one answer. Perhaps it would be useful to imagine the metaphorical pie, and to think about how you define “investor.” Placing your investors in different groups will also help you to determine how to share your growing pie.

The Big Pie Picture

When you start your company, you might own 100% of a small entity with little to no assets (thus, no value). As you grow, you’ll own a smaller percentage, but it will be part of a much larger pie. In other words, 100% of nothing doesn’t have much value, but 50% of a $1 million pie starts to look like something. As you continue enlarging the size of your pie with each new round of funding, your equity stake will be reduced, but the value of your holdings should be significantly higher. So, thinking about “value” as opposed to “percentage” is probably a better way for you to think about this question.

Founders and Employees

Founders often assume that the best way to initially divide equity is to do so equally or in fixed splits. What that means is that a percentage of ownership is allocated among founders (or founders and employees) without changing. So whether you divide the pie 50/50, in thirds or however you allocate percentages, that share will remain the same (except, of course, that they’ll be proportionately diluted at each funding round).

It’s a pretty inflexible model and often leads to conflict and sometimes even a company’s extinction. That’s why innovative equity sharing models are becoming increasingly popular. The dynamic-split model is one variation that enables company owners to be more flexible in adjusting equity allocation according to the weighted contributions of each owner. We discuss these different models in more depth here, where you can learn more about how alternative equity allocation works.

As for employees, you need to consider not only current employees, but also future employee stock options. Reserving about 10-15% of your company’s stock for this purpose is the norm, but again, that’s a guideline.

Advisors

Let’s say you start with a co-founder. You might carve the pie 50/50 at first, but later decide you could use someone with experience to help you make a larger pie. So you hire an advisor with knowledge, experience and a network in your industry. The appropriate percentage of equity that you should offer an advisor will depend on their depth and breadth of experience. It will also depend on which round of financing you’re in. You can learn more about these guidelines in another piece I recently posted here.

As I point out in the advisor equity post, there are no hard and fast rules about assigning advisor equity, but there are some guidelines that show an average range of 0.2% to 1% is the norm.

Seed, Series A, Series B Investors

When you start getting into the seed, Series A and Series B rounds, you’re going to experience further dilution.

When you’re in the seed round – usually family and angel investors – 10% to 25% is the average range, with a median 15% dilution to be realistically expected.

As you advance to the Series A round, 25% to 50% dilution is the typical range.

By the time you reach Series B, an estimated 33% is the norm.

Here’s a chart that could offer you some additional guidance:

You can find more information in this recent post, where we discuss the usual percentage of shares that go to seed, Series A and Series B rounds.

Vesting Requirements

You’ll also want to ensure that your advisors, employees and co-founders don’t unfairly benefit in the event of an early exit. Vesting and cliff periods are critical to preventing this from occurring.

Vesting periods are usually four years, with rights accruing only after one year. If someone who is assigned an equity share in your company departs within the first year and your agreement doesn’t specify a vesting cliff, s/he will reap the financial benefits without providing the promised value to facilitate your company’s growth.

Therefore, all early equity owners should have a minimum vesting period, requiring them to contribute to the organization’s growth for at least one year before they can access the value of their ownership percentage. If they leave before the end of the first year, they forfeit their ownership. If they continue with the company beyond the initial year, they can start to accrue a percentage of their ownership (for example, an additional 25% each year for four years, with full vesting after the vesting period has been satisfied).

Protect Your Equity Stake

You’ll want to have an attorney review all your funding documents so that you understand what you actually own and what you’re sharing. While each round of investment presents a new valuation, you’ll need to ensure that there are minimal – if any – restrictions on your equity, such as vesting periods that give you less than what you might think you own.

These simple guidelines are offered to you in order to give you some idea of what the range of possibilities looks like to many startups. It’s not recommended that you rely on any of these general parameters as a substitute for sound legal advice. You’re going to encounter questions that are very specific to the unique circumstances of your company, and therefore require competent legal advice. This includes everything from vesting cliffs to intellectual property and other issues beyond the horizon.

Feel free to check out LawTrades to speak with an experienced startup attorneys that can not only help with your fundraising paperwork but also advise you on deciding how much of your company you should offer investors – and whether that means “how much” as a percentage, as part of the valuation or something else.