How much equity should founders own?
"Raising venture capital is the easiest thing a startup founder is ever going to do"
- Marc Andreessen
Building business is hard, and raising venture is the tiniest step but even that is full of surprises if you haven't planned well. Most businesses come to me at pre-series A stage where they are trying to raise something between $0.5-2M. Recently, I have come across startups where active founders hold significantly less equity (less than 40%). At this stage, founders are the only management team, so founders + management team <40%. This is a big negative for us, and I'll assume for most of the funds. Hence, in all these cases, we didn't move forward even when the business looked decent otherwise.
What's the problem with less equity?
Begin with the assumption that almost all startups fail. It's absolutely critical to have motivated founders to increase the chances of success. As an investors, getting a larger piece of the equity pie is worth "zero", if the lack of motivation of founding team leads to failure. We are funding you at a stage where the go-to-market needs to be worked on, the team needs to be hired and even the business model hasn't clearly evolved. Even at series A stage, founders are trying to find some of these answers. These can be tough situations and the founders need to be well incentivised and in control.
If we do a simple math- if investors take 20-30% equity at pre-series A, and then again at series A, the overall dilution from today can be 40% or more. Hence, if active founders (plus management team) hold less than 40% today, it will be less than 25% by the end of series A. While this number looks fine once you have raised multiple rounds, it can make some investors nervous at series A.
How to avoid this situation
- Treat the equity as gold and use it wisely.
- Giving equity to management team (or people involved full time in your startup) to save cash is wise. As long as equity has right vesting schedule and is with the people fully involved in the business, it's fine.
- Be careful giving it to non-operating resources or temporary/part time workers.
- Try to have some buyback option in case your situation requires you to give equity. That can help in controlling the dilution later.
Survival is definitely the first priority, but always keep your equity structure in mind!
Director at Aryan HR Consulting Pvt Ltd
5 年You are right Dinesh I think when the stage comes to raise funds and the founders/co-founders see the amount of money they are getting they forget their motivation in setting up their venture. They forget that unless the venture is their lifeblood and they are fully charged up in running it, the venture will more likely falter or go in a direction that they will ultimately regret.? People lose their way when they see the $$$.
Congrats Dinesh Singh??? ?? Let us know if we could be of service! Jenny Hong
Building AIEngineer I Building Agix I Angel Investor I Failed Twice and let me try a third time :)
5 年Good article Dinesh. I learned certain things from it, thanks for ?writing it.