Many mega ventures started with a startup; they started small, unaware that they would end up getting recognized by a larger audience and that their products and services would create a greater demand among the users.

The traction they gained further aroused the interest of the people to work with and encouraged investors to take a keen interest in their business.

Today, companies like Facebook (now Meta), Microsoft, Google, and Apple are global giants, catering to the needs of the world.

Now you see the journey of the startup is just not about working on the idea and then becoming a global giant it is also about navigating the complexities of the distribution of the equity.

Equity distribution is important to protect the interests of all those who are contributing to the successful running of the startup business.

But before that lets understand what does equity distribution mean?

What is equity distribution?

When you want to know who owns a company, you check who holds the majority of shares.

But we all know a startup is successful only because of the people who have contributed an equal amount of hard work to get things done, which is why they are granted a share of ownership in the startup, and that is called equity distribution.

In the initial phase of the startup, the founder owns 100% of the shares, but as the startup keeps growing, the equity is distributed accordingly.

If you have more than one founder, then the shares could be distributed as per the situational requirement; it can be 50:50, 40:40:60, or 60:40, whatever way it fits the working requirements.

Is equity distribution important for a startup?

The answer is: YES! It is important for a startup to distribute equity due to many reasons.

1. Incentivize the founders and team

   Distributed equity is the main factor that keeps the founder(s) and team motivated. As the proper growth of a startup is in everyone’s favor, it motivates everyone to remain aligned with the long-term success of the company.

2. Attracting talent

   It is hard for any startup to compete against big companies based on salary alone and equity serves as a valuable tool for attracting talent, offering startups a unique advantage by making them appear more reliable and credible to potential hires.

3. Retaining employees

   Equity helps in retaining employees for the long term because when the company grows and becomes more valuable, their equity stake becomes more valuable as well.

4. Fundraising

   Equity is often used as a form of currency in fundraising. Investors receive equity in exchange of capital, thus allowing and helping the company to grow without taking on debt.

5. Ownership and control

   Equity distribution determines who is the owner of the company and has great control over setting the directions for the startup to prosper.
   It is always necessary and important to distribute the equity fairly to avoid conflicts later in the success.

6. Alignment of interest

   When everyone has a stake in building a startup, it becomes crucial for everyone to remain on the same page and work together as a team to achieve the goals and objectives that lead to the success of the startup.

7. Exit Strategy

   Exit strategy planning for equity distribution involves determining how ownership interests will be distributed among shareholders or equity holders when you plan to sell your startup or make a mega-significant change.
   All in all, equity distribution impacts the potential returns for founders and investors in the event of an acquisition or IPO.

What is the equity mechanism in a startup?

In a startup, equity represents who holds what share of the company, and it is typically the owner of the startup that holds the majority of the share.

Further, it is being diluted with time and the growth of the startup as more shares will be issued to employees and investors.

Employees are mostly granted equity as part of their compensation package (stock options or restricted stock units). It is like involving your employees in the success of your startup.

Investors, like venture capitalists or angel investors, provide funding to the startup in return for equity, like you see in the reality show Shark Tank.

The amount of equity they receive is determined by the valuation of the company at the time of investment and the amount of funding they provide.

When the startup grows and keeps reaching new heights, its valuation increases, leading to more rounds of funding and dilution of existing equity holders.

Also, if you think of exiting, then at the time of sale or IPO, equity holders will have the opportunity to realize the value of their shares.

How to distribute equity in a startup?

Distribution of equity starts with determining how the ownership of a startup will be allocated among founders, employees, and investors.

• Determine ownership structure

  Decide how much equity each founder will receive based on their contributions, roles, and responsibilities.
  This is often determined at the start of the startup and keeps getting adjusted as the startup keeps growing.

• Equity for employees

  It is always good to consider offering equity to key employees, advisors, and consultants to incentivize their contributions.
  You can do that through stock options, RSUs, or other equity-based remuneration plans.

• Equity for investors

  Analyze and decide how much equity you will be able to offer investors in exchange for funding. It is always negotiated based on the valuation of the company and the amount of funding needed.

• Vesting schedules

  When you implement a vesting schedule for equity grants, you want to ensure that founders, employees, and other equity holders earn their shares over time. This further helps to align incentives and encourage long-term commitment.

• Equity allocation plan

  For this, create a formal equity allocation plan that gives a clear picture of how equity will be distributed among founders, employees, and investors.
  This must include details like the total number of shares outstanding, the percentage of equity allocated to each party, and any restrictions on the equity.

• Legal and tax considerations

  Talk to legal and tax advisors to ensure that the equity distribution plan complies with relevant laws and regulations.
  Consider the tax implications for both the company and the recipients of equity.

• Communication and transparency

  Communicate the equity distribution plan to all shareholders clearly to avoid any confusion and make sure it is in everyone’s interests.
  Transparency can help build trust and foster a collaborative culture within your startup.

• Review and adjust

  Review the equity distribution plan and make adjustments as and when required. Usually, changes are made based on the startup’s needs, growth, and funding requirements.

Equity distribution in your startup should be allocated to the following stakeholders:

Phases of equity distribution in a startup

Equity distribution in a startup typically keeps changing at various stages of startup’s growth and the roles played by its founders, employees, and investors.
Here are the common phases of a startup:

1. Founding Stage

   Equity is initially distributed among the founders based on their contributions. As the founder or founders are the ones who came up with the idea, initial capital, and more, this is why they hold the majority of the share, and it is often done through a founder’s agreement or a similar document.

2. Pre-Seed/Seed Stage

   When a startup seeks external funding, equity then may be allocated to early investors, it could be angel investors, or seed-stage venture capitalists, in exchange for capital to grow the business.

3. Series A, B, C etc

   As the startup grows, it may be willing to raise additional funding through successive rounds of financing, each represented by a series (e.g., Series A, Series B). Equity is typically distributed to new investors in these rounds, as well as to existing investors who may participate in follow-on investments.

4. Employee Stock Option Plans (ESOPs)

   In order to attract and retain talent, startups often portion out equity for employees in the form of stock options.
   These options will allow employees to purchase shares at a pre-decided price, which usually vests over time.

5. Advisor/Consultant Equity

   Startups may distribute equity to advisors or consultants who provide valuable guidance or services to the company. This equity is often granted as stock options or restricted stock units (RSUs).

6. Mergers and Acquisitions (M&A)

   If your startup is acquired, then the distribution of equity to the shareholders will be done based on the ownership of the one who is acquiring it. The terms and conditions of the acquisition, including the valuation of the company, will determine the value of the equity distributed.

7. Initial Public Offering (IPO)

   When it comes to an IPO, your startup’s share would be offered to the public for the first time, and equity would be distributed to the startup’s existing shareholders, including founders, employees, and investors.

Bottom line

The bottom line is that, in the journey of a startup, equity distribution will continuously change as the startup grows and evolves.

As every organization progresses from a small startup to a medium or larger one, the distribution of shares changes accordingly. The percentage of equity offered depends entirely on what is best for the growth and success of the startup.

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