The Right Way to Structure Your Startup’s Equity
Whether splitting equity with a co-founder, hiring early employees, or raising funds, understanding ownership is important. This article will help you manage equity wisely from day one.
Ever pitched to investors or accelerators and noticed how one of the first questions they ask is: “Who owns how much of the company?” That’s where equity comes in!
Equity ensures that everyone who contributes- whether it’s a co-founder, an early employee, or an investor- gets a fair share of the value they helped create. But when you’re building a company, it’s easy to get caught up in the hustle- developing your product, landing customers, and pitching to investors. Most often, this critical factor gets overlooked.
In this article, we’ll break down the real dynamics of equity, its types and how to structure your equity from day one. We’ll help you answer some key questions like-
Who owns what?
How much should you give to a co-founder, an early employee, or an investor?
& more.
Equity: Definition
Equity determines the percentage of a company that a person or entity holds. Equity holders benefit financially from company growth but may not always have decision-making power (e.g., minority shareholders).
Equity is typically divided into shares, which represent proportional ownership in a company. For example, if a startup has 1 million shares outstanding, and an investor owns 100,000 shares, they have a 10% ownership stake in the business.
So, if someone has equity in your startup, does that mean they own it? Not necessarily. Let’s take a closer look at how equity and ownership are related- but not always the same.
Ownership vs. Equity: Key Differences
While ownership refers to having control or rights over a business or asset, equity specifically represents ownership in financial terms, usually in the form of shares.
A founder may have ownership in a company without necessarily having equity if structured through alternative agreements (e.g., contracts, partnerships).
Types of Equity
Equity in a company can take many forms, depending on who holds it and how it is structured.
1. Founder Equity
Founder Equity is the initial ownership split among the company’s creators. While some founders opt for an equal split, others allocate ownership based on contributions, responsibilities, or future commitments.
To ensure long-term commitment, founders often have vesting schedules, meaning their equity is earned over time rather than granted upfront.
Many start off thinking they’ll own a majority of their company forever, only to realise that their stake gets smaller with each funding round.
A founder who starts with 100% may end up with less than 10% by the time the company exits. That’s not necessarily a bad thing- sometimes a smaller piece of a much bigger pie is worth more- but it can feel like losing ownership of something you built from the ground up.
2. Common Stock
Common Stock is the most basic form of equity, typically issued to founders, employees, and early investors. It usually comes with voting rights, allowing holders to participate in company decisions.
However, in case of an acquisition or liquidation, common stockholders are paid last after all debts and preferred shareholders are settled.
3. Preferred Stock
Preferred Stock is mainly issued to investors such as venture capitalists or angel investors and comes with special privileges like liquidation preferences, anti-dilution rights, and dividend payouts. These privileges give investors financial protection and often more influence over company decisions.
It can be:
Participating Preferred Stock – Investors get both their liquidation preference and a share of remaining profits, making it extra favourable to them.
Non-Participating Preferred Stock – Investors only get their liquidation preference (and don’t participate in additional profits).
4. Employee Equity (Stock Options)
Stock Options (as part of an Employee Stock Ownership Plan or ESOP) allow employees to purchase shares at a fixed price after a vesting period, giving them a stake in the company's success. However, options can lose value if the stock price doesn’t increase.
It’s a great tool to attract talent, align incentives, and retain employees by giving them a stake in the company’s success.
5. Restricted Stock Units (RSUs)
Restricted Stock Units (RSUs) are a type of equity compensation commonly offered to employees, especially in late-stage startups and publicly traded companies.
Unlike stock options, RSUs are granted outright- employees don’t have to buy them, but they must meet certain conditions (like staying with the company for a set period) before they can own or sell them.
6. Convertible Equity
Convertible Equity is a flexible investment tool that allows startups to raise capital without immediately determining how much of the company they are giving away. Instead, the investment "converts" into equity later, typically during the next funding round when a valuation is established.
It is typically of the following types:
SAFE (Simple Agreement for Future Equity) – A SAFE is a legally binding agreement where an investor provides capital in exchange for future equity, typically at a discount during the next funding round. Unlike a loan, a SAFE has no interest and no maturity date- it only converts when a priced round happens.
Convertible Notes – Similar to SAFEs but structured as short-term debt, meaning they start as a loan and convert into equity later. Unlike SAFEs, convertible notes accrue interest and have a maturity date, meaning if the startup doesn’t raise a funding round, the investor could demand repayment.
How to Structure Equity from Day One?
Setting up equity correctly from the start is one of the most important decisions you’ll make as a founder.
A typical equity structure looks something like this, with founders holding the majority early on, investors gradually increasing their stake, and an ESOP pool set aside to attract and retain top talent.
If you give away too much too soon, you might lose control of your own company. If you don’t structure vesting properly, a co-founder could walk away with a huge chunk of equity after just a few months. If you don’t reserve enough for future hires, you may struggle to attract top talent when you need it most.
Here’s how to do it right:
1. Founder Equity Split: Fair vs. Equal
One of the biggest mistakes early founders make is assuming that an equal split (50/50, 33/33/33) is the best way to go. While it might seem fair, equity should be based on contributions, roles, and long-term commitment.
Key factors to consider during an equity split:
Who came up with the idea? (Not the most important, but still a factor)
Who is putting in the most effort? (Hours, expertise, and execution)
Who is taking the most risk? (Quitting a job, investing personal funds)
Who is leading the company? (CEO vs. supporting roles)
Who will drive fundraising and revenue growth?
2. Vesting Schedules & Cliff Periods
A vesting schedule ensures that founders earn their equity over time rather than receiving it upfront. This prevents someone from walking away early with a large ownership stake.
A recommended vesting schedule in startups is 3-4 years with a 1-year cliff. Here’s what that means:
1-Year Cliff: No equity vests during the first 12 months. If the co-founder or employee leaves before completing a year, they receive nothing.
After the Cliff: Once the first year is completed, 25% of the equity vests at once. After that, the remaining equity typically vests monthly or quarterly over the next 2-3 years.
3. Setting Up an Option Pool for Employees (ESOP)
A well-structured Employee Stock Option Plan (ESOP) is key to attracting and retaining top talent.
Recommended Size: 10-15% of the total equity reserved for future hires.
Who Gets It? Early employees, advisors, and key hires (not all employees).
Vesting: Usually 4 years with a 1-year cliff, similar to founders.
Strike Price: Typically set at the fair market value during issuance.
“Top tech startups like Airbnb and Stripe have used generous ESOPs to attract high-calibre talent even when they couldn’t pay market salaries.”
4. Allocating Equity for Investors
When raising funds, you must allocate a portion of your company to investors. The earlier the round, the higher the dilution, so plan accordingly.
Typical Equity Distribution by Stage:
Pre-seed: Investors take 5-15%
Seed: 15-25%
Series A: 20-30%
Series B+: Further dilution, but the goal is to maintain founder control
5. Legal Agreements & Documentation
To avoid confusion and legal disputes, always document equity agreements.
Key Documents Needed:
Founder Agreement – Defines roles, responsibilities, and equity split.
Cap Table – Tracks ownership stakes, vesting schedules, and dilution over time.
Employee Stock Option Plan (ESOP) – Governs how employee equity is distributed.
SAFE/Convertible Note Agreements – If you raise early funding before pricing your startup.
Final Thoughts
When building a startup, you need the right people on board- co-founders, early employees, and investors who believe in your vision. But how do you fairly compensate everyone when cash is tight?
Equity, in general, is about who contributes, stays, and benefits as a company grows. And, not all equity comes with decision-making power- some shares include voting rights, while others are purely financial stakes.
A small business owner (e.g., a bakery owner) has 100% ownership but no equity because the business isn’t structured with shares.
A startup founder may have 60% equity in the company but gradually lose ownership control as investors buy in and board members gain influence.
An employee with stock options has equity but no control over the company’s operations.
Also, structuring equity for the future is just as important as getting it right initially. As your startup grows, new challenges will arise- bringing in co-founders, hiring key employees, and raising multiple funding rounds. While we’ve outlined some common ways to structure ownership, there’s no one-size-fits-all approach. Every startup is different, and the right equity split depends on your team, vision, and long-term goals.
So, take the time to map out your structure, seek advice when needed, and, most importantly, do what’s right for you and your team.
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