Hi there! We hope that this series on startups helps you pursue your vision. (If you haven’t read parts 1 and 2, be sure to check them out!)
Today we’re diving into the magical world of corporate structure, specifically ownership structure. A little knowledge about setting up your company can do a lot for later attracting talent, securing funding, and making your new company a joy to drive.
Starting a company is like setting up your own little democratic society, with voters, a constitution, and elected officials. In this post, we’ll focus on the voters, who in the case of a company are the owners. In a corporation they are “shareholders.” In an LLC they are “members.” We’ll focus on corporations, since most growth-oriented startups form as corporations.
We the People
Your product is great—you know it, we know it—but turning it into a reality depends 90% on the people you work with. You need capable, dedicated teammates to share ownership of the vision (because let’s face it, there’s a high chance you won’t be able to pay them much, if anything, at the start).There are several ways to think about this.
You’re going to naturally divide up ownership differently depending on roles. You can think about this in terms of different levels of your inner circle. We like to think of there being four, concentric “inner circles.” Starting from the center moving outward there is 1) founders, 2) co-founders, 3) clutch team-members, and 4) early employees.
Founders are the people who have been with you since the beginning, sharing the vision, the blood, sweat, and tears. These individuals deserve a significant chunk of ownership in the company and a say over what happens with their shares.
Now how is a “founder” different from a “co-founder” in this model? For lack of a better word for it, a Co-founder might not be around from the beginning but they could be a big player in the industry or an important early business partner who is prepared to put in significant sweat equity while bringing something strategically important to the table, such as expertise, funding, or connections. They might get a big chunk of equity, but not being in your innermost circle they might get less control.
Clutch team-members are those experts you need on your team, that 10x developer or that sales person right out of The Wolf of Wall Street, the early team member providing truly unique value but who is demanding a significant salary. How will you recruit them when you can’t pay top dollar? By giving them a slice of the pizza: equity. What better motivation to excel at work than owning a piece of the business? That said, don’t confuse equity with significant control. You and your co-founders will want to maintain control of the company, but your A-team will have a stake in the future beyond your typical early employee and at least a nominal vote on major decisions.
Speaking of early employees, this, the largest of the inner circles, is comprised of those special souls willing to work at a startup despite an uncertain future and crazy hours. Let’s face it—you want top-level talent at entry-level prices, not because you don’t want to pay them more but because you can’t, at least not right now. So early employees get a piece of pizza too, but it’s likely to be stock options instead of actual stock, meaning they’ll have an upside but not a vote.
These people deserve recognition, and you can give it to them with shares or options. Real pizza is a nice touch, but it won’t suffice. (Don’t be that kind of company 😡).
Let’s Order “Pizza”
When you form your company, you get to decide how many pieces of pizza to start with. Ok, we’ll stop with the metaphor. You get to decide how many shares make up your company. A common sweet spot is to start by authorizing 10,000,000 shares—it sounds like a lot, but trust the process. You may ultimately have hundreds of stakeholders. These 10M shares act as a reserve, with only a portion put into circulation at the start. The rest stay in your treasury for future needs, like attracting investors or incentivizing employees.
Next, set a low par value, the nominal monetary value of each share. A par value as small as $0.0001 or $0.00001 per share minimizes initial taxes for recipients and provides plenty of room for growth. Think small for now; you’ll appreciate it later when your company thrives.
As you issue shares, reserve most for future growth. Only the issued shares count toward ownership at any given moment. For instance, if you issue just 2M of your 10M authorized shares (20%) to the founders, that 2M counts as 100% of the company. The rest are out of circulation, waiting for future use.
That future, when additional shares are issued, is when dilution happens. For example, if you and a co-founder each own ½ of the company’s 2M issued shares, and then an investor is issued 1M more, all three parties now own ⅓ of the company. While dilution reduces individual ownership percentages, it often comes with growth of the overall value of your company. You own a smaller percentage of the pizza, but the pizza got bigger in absolute terms, and your ⅓ is worth more than your ½ was.
Plan strategically, and your ownership structure will be a powerful tool for attracting talent and investors while fueling your company’s success!
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