Hi, startuppers. Previously, we wrote about Pitch Deck and how to prepare it. Today, we would like to attract your attention to the cornerstone topic – when and how to split startup shares?
When your startup is just starting out, resources are always in very short supply!
You may not have a lot of capital on hand to buy the equipment you need. Or, you may not have enough to build the perfect team to help your business grow.
And sure, you would need money to do all this… but you don’t have any.
It’s a frustrating catch-22 situation!
This is where unlocking the equity in your startup can be something to play to your advantage.
Offering shares to people in exchange for money and skills can help grow your business. However, before you start handing out equity-like candy, there are a lot of things you need to be aware of.
In this article, we’ll be looking at what shares are, which stakeholders may be interested in them, and the potential issues with giving out too much equity.
We’ll also look at some alternatives to giving out shares that may work for your business.
What are shares?
Shares, also referred to as equity, refer to the percentage of the startup that you, or another person, own.
Think of your startup like a cake. By giving away equity, you are giving other people slices of cake. Some slices may be small. Other slices may be large. The more cake you give away, the less delicious cake you will have for yourself!
Typically, shares are exchanged for investment in your business. We’ll go into more detail about who may hold shares later on in this article.
Shareholders will receive a percentage of profits equal to the number of shares they hold. They may also have other rights like voting on business matters, attending annual meetings, and inspecting the company records.
If your startup is liquidated, the shareholder also has the right to claim a proportion of the assets in relation to the number of shares they own.
If the shareholder wants to part ways with your startup, they can sell or give their shares to someone else. They can give them back to you, or an outside investor.
Who is a stakeholder?
According to Investopedia, the definition of a stakeholder is “a party that has an interest in a company and can either affect or be affected by the business.”
In relation to shares, a stakeholder is anyone who holds at least one share in your startup. Stakeholders will do all they can to see your new business grow and thrive as they stand to gain money from the shares they have.
Let’s take a look at the people who can be stakeholders in your business.
Also known as you! In a startup, the founder will start out with 100% of the equity. This figure will go down as they give shares out to other people. This is commonly known as equity dilution. It is rare for a founder to give away 100% of their shares though. They will typically hold back a substantial amount of equity for themselves
An angel investor or venture capitalist will help your startup grow by giving you valuable capital, as well as their time and expertise. However, this help does not come for free. An investor will expect shares in exchange for their support of your business
If you are looking for the most skilled people to join your business, but you don’t have a lot of money, equity may be an option. Employees of a company may receive shares. An additional perk of joining your startup will also work. The key advantage of giving employees shares is that they will become more invested in your startup, working hard to grow the business and bring in revenue. In fact, employees with equity in a startup work eight hours more a week than those that don’t! As an alternative to giving equity away, you may give staff the option to buy shares in your startup in order to raise additional funding
Family or friends
You may give shares to family and friends as a gesture of goodwill or to say thank you for providing financial support. If yours is a family-run startup, it may be that all of your stakeholders are close family!
Other third parties
It may be that people you don’t know too well become stakeholders in your startup. This is quite rare, but it can happen. For example, if a founder or investor leaves, they may decide to give or sell their equity to someone outside of the business. This can be a risky strategy as you may not know if these people share your vision and will do what is best for your business
How many stakeholders can have shares in a business?
As many as you need.
Bear in mind though that the more stakeholders you have, the fewer shares will be worth and the less control you will have.
Think carefully about whether a stakeholder in your business needs equity before you give it to them. Is there something else you can provide them in exchange for their support?
How many shares should I give to stakeholders?
The number of shares you give away will depend on the stakeholder’s contribution to the business. As a rule of thumb, the more capital and time they invest, the more shares they should receive for contributing to your startup.
A good strategy is to have 100 shares in your business. That way, each share is worth 1%, and it makes it easy to work out how much equity and voting rights each stakeholder has.
You may have to give away more shares to get the people you want to work with to come on board. For example, an in-demand investor may request more equity to be involved in your startup.
Not sure how much equity to give away to stakeholders? Consider the following:
- Work out how much money you need to raise to grow your business
- Look at how much of your startup you’re willing to give away
When you have these two figures, you’ll know how much you have to give in order to get the outcome you want.
Majority and minority shareholders
The person who holds over 50% of shares in a business is known as the ‘majority shareholder’. This means that they have a lot of influence over how the startup is run. If there is a majority shareholder in a startup, it is usually the founder.
A minority shareholder is someone who holds less than 50% of shares. They have less influence over how the startup is managed.
A minority shareholder still has fundamental rights though, which can vary depending on which country you’re in. For example in the UK, 75% of shareholders must agree on a special resolution like changing the name of a company. This means any stakeholder with 25% of shares or more can block the resolution.
Stakeholders can also work together to push their decisions through the board.
For example, let’s say you have three stakeholders in a business, A, B, and C. Each stakeholder holds 33% equity. If A wants to appoint a new director to the board, there is nothing to stop B and C from coming together and using the equity they have to block A’s proposal.
Alternatively, if there are two stakeholders with 50% equity each and they keep disagreeing, they will never be able to get any decisions made! If you have two founders, you might want to introduce another stakeholder to prevent deadlock.
In conclusion, you are free to give as many shares away to a stakeholder as you feel appropriate.
However, be aware that the more equity you give them, the more power they will have in your business. You will also want to be mindful of who could potentially come together to form a majority group.
When should I give shares to stakeholders?
The simple answer is… whenever you’re ready to do so.
Startups give shares to people in exchange for capital or experience. When you are in need of either of these for your business, you can use your shares to get them.
Remember that the less established your startup is, the less your shares will be worth. This may mean you have to offer more of them to get what you need.
Bear in mind that you don’t necessarily have to give away shares to grow your business. If you’re bootstrapping your startup and don’t need to give away shares to cover expenses, then the equity in your business can be all yours.
Alternatives to giving away shares in a startup
If you want to get ahead but don’t want to give away precious equity, there are a few options available to your business. Here are some of the things you can do instead.
- You can operate a profit share scheme for employees. This is when you give someone a percentage of your profits over a set period of time. That way, your staff are still encouraged to work hard without holding any shares
- You can provide phantom stock. This is when you reward staff for achieving share price growth, without them having shares in the business. Similar to a profit share scheme, they are working hard for a reward, using your share price as a baseline
- If you want involvement from an investor without shares, you can ask an investor for a private loan instead. This can be an excellent alternative to getting a loan from a bank or building society
- You can launch a crowdfunding campaign where you ask multiple investors for small amounts of money. You may choose to give investors a small reward for taking part
If you are willing to offer shares initially but want them back when your company starts to grow, you can offer a share buyback agreement to an investor. This is when you give an investor shares in exchange for capital as usual, but under the proviso that you can buy their shares back from them in the future.
Some investors may be happy to do this and others may not be, so check with your prospective investor before you come to a deal.
Navigating the world of company shares and equity can be tricky!
Shares are valuable for raising capital and getting the best people to work with, but with each share you give away, you lose a little bit of your startup.
You should always consider the potential risks to your business when giving away shares. We’d recommend consulting a lawyer before you start to consider giving away your equity.
If you want to lay down some rules before you start to offer shares, a good option is to put together a shareholder agreement. This document will detail the rights and obligations of the people who hold shares in your company, and they will need to agree to them before being given equity.
For example, if a shareholder wants to sell their shares, you can put in a clause where they must give you the option to buy them back first. This reduces the risk of unwanted third parties owning a share of your business.
A lawyer will be more than happy to put this document together for you, and it will give both you and your startup peace of mind.
Need a little extra help when it comes to equity? Get in touch with You Are Launched!
There are a lot of rules when it comes to equity and shares. We have given you a simple breakdown in this article but if you need some friendly advice about the best situation for your startup, get in touch!
You Are Launched has been working with lean startups, accelerators, and venture capital companies since 2014, helping them get the resources needed to grow their business.