In the world of startups, where big ideas and ambitions collide, there’s a key concept that can make or break the journey: sharing equity among founders. Over the years of providing legal advisory services to startups, we have seen a number of founders fail in getting this foundational step right before reaching out to us.

It’s one of the reasons for creating this free guide.

We will be using an imagined company know as moneytracka, a fintech startup. The founders here shall be Kemi Edun, Obi Eddi, Marcello Ike and Hassan Hussein.

Let’s dive into what Equity means and why it’s a crucial puzzle piece for a successful startup.

Startup equity is the amount of ownership that founders, investors, and employees have in a startup. It represents the percentage of the startup’s shares each stakeholder owns. Startup equity is mostly expressed as a percentage, such as 10% or 20%. In Moneytracka’s case, we have four founders. Kemi, Obi, Marcello and Hassan all own 25% each. That’s 100/4 = 25%. The company represents 100% divided by the number of founders who have decided to take equal shares.

This is what a simple calculation looks like

Percentage Ownership = (Number of Shares Owned / Total Number of Shares Outstanding) × 100

For instance, if Kemi owns 280,000 shares of a company that has 1 million shares outstanding:

Percentage Ownership = (280,000 / 1,000,000) × 100 = 28%

This calculation shows that Kemi owns 28% of the Moneytracka’s equity.

Founders own 100% of a startup when it first starts. As the startup grows and raises money, founders may give up some of their equity to investors in exchange for funding. Employees may also be granted equity as part of their compensation package.

Think of equity like slices of a pie that represent ownership in a startup. It’s not just about owning a piece; it’s about everyone having a fair share that reflects their contribution.

To understand the concept of equity better, we need to briefly touch on the types of equity.

TYPES OF EQUITY

Here are some common descriptions of equity.

1. Common Shares:   These are the most basic form of equity ownership in a company. Common shareholders have voting rights and a stake in the company’s profits, but their claims are subordinate to preferred shareholders in terms of dividends and liquidation.

2. Preferred Shares: Preferred shareholders enjoy certain preferences over common shareholders. This might include a fixed dividend rate or priority in receiving dividends and assets during liquidation.

3. Ordinary Shares: Ordinary shares is another term used for common shares in Nigerian company law. They represent the basic ownership interest in the company.

4. Founder’s Shares: These are shares typically issued to the founders of the company. They might come with specific voting rights or vesting schedules that align with the founders’ contributions and commitment to the business.

5. Redeemable Shares: These shares can be bought back by the company after a specified period or under certain conditions. This type of share provides flexibility to the company and can be useful in specific situations.

6. Non-Voting Shares: As the name suggests, these shares don’t carry voting rights but might have other financial benefits, such as dividend entitlements.

7. Convertible Shares: Convertible shares can be converted into another class of shares at a later date. This might be a way to incentivize early investors or employees with the potential for higher returns in the future.

8. Employee Stock Options: While not exactly equity shares, employee stock options grant the right to purchase shares at a predetermined price in the future. This is a common way to incentivize employees and align their interests with the company’s success.

It’s important to note that the specific rights and characteristics of each type of equity can vary based on the company’s articles of association, shareholder agreements, and applicable Nigerian laws.

Going forward, what are the factors that infulence the allocation of equity among these founders?

FACTORS INFLUENCING EQUITY ALLOCATION.

When it comes to divvying up the ownership pie amongst the founders of Moneytracka, several key factors come into play. Let’s delve into these influential elements that shape how equity is distributed within a startup:

1. Role and Responsibilities of Each Founder:
The roles that founders assume within the startup’s structure carry weight. Those who take on pivotal leadership roles or spearhead critical functions might be allocated a larger share of equity to reflect their level of responsibility and decision-making authority.

2. Contribution to the Initial Idea, Development, and Funding:
Founders who brought the initial spark of the idea that led to the startup’s creation often receive recognition for their visionary input. Those who poured resources, whether financial or intellectual, into nurturing the idea and getting it off the ground may also merit a larger slice of ownership.

3. Skills, Expertise, and Experience Brought to the Startup:
Each founder brings a unique toolkit of skills and experience to the table. Those who contribute specialized skills that are crucial to the startup’s success might be rewarded with a larger equity share. This could include technical skills, industry expertise, or a track record of successful ventures.

4. Time Commitment and Dedication to the Venture:
The amount of time founders dedicate to the startup can impact their equity allocation. Those who invest significant time, effort, and sweat equity into the venture’s growth and development often receive a proportional share to acknowledge their dedication.

FORMS OF EQUITY SHARING STRATEGIES.

There are various ways of splitting equity. They all have their Pros and Cons. Let’s take a look at some of them.

1. Dynamic Split:

A dynamic split is when the shares of ownership in a company change over time based on how much each person contributes. If someone does more work or helps the company grow, they get more ownership. For example, let’s imagine that Marcello, in addition to performing his CEO duties, decides to invest all his personal money into the company. This form of equity split suggests that he can request for more equity to be allocated in exchange of these extra help. It’s like sharing a pizza where the slices get bigger if you do more for the group.

Here are some Pros and Cons of Dynamic Equity Split:

Pros:

• Adaptability: Reflects changes in roles and contributions over time, ensuring that equity remains aligned with the evolving needs of the startup.
• Incentivizes Growth: Founders are motivated to continue adding value, as their equity share can increase with their contributions.

Cons:

• Complexity: Regularly adjusting equity can be administratively complex and time-consuming.
• Uncertainty: Frequent changes in equity distribution might lead to uncertainty and instability among founders.
• Resentment: Frequent adjustments can also cause resentment if founders perceive others benefiting disproportionately from changing circumstances.

2. Equal Equity Split:
An equal equity split means dividing ownership in a company equally among all the people involved. Everyone gets the same amount. Reminds us of the first example we gave of Moneytracka. It’s simply Kemi, Obi, Marcello and Hassan allocating equal percentage of equity to themselves (25% each). In simpler terms, it is sharing the pizza equally amongst the founders. It’s simple and can avoid disagreements when starting a company.

Equal Equity Split Pros and Cons:

Pros:

•  Simplicity: It’s straightforward and easy to implement. Each founder gets an equal share, which can help prevent conflicts during the early stages of a startup.
• Perceived Fairness: Equal splits can be seen as fair, especially when all founders are starting at the same level without distinct differences in their contributions or responsibilities.

Cons:

• Misalignment: If contributions and roles are not equal, founders might feel that they’re not being adequately rewarded for their efforts.
• Resentment: If one founder ends up putting in more work or has a more critical role, resentment can build over time as the equity split doesn’t reflect the actual effort put in.

3. Weighted Equity Split:
In a weighted split, ownership in a company is divided based on the value each person brings. The more someone contributes, whether it’s money, time, skills, or responsibilities, the more ownership they get. It’s like sharing a pizza based on the quantity of ingredients of efforts into making the pizza. This way, it feels fair because everyone’s share matches what they put in. If Kemi brought in more money than the others, more shares of Moneytracka will be allocated to her would be allocated to her.

 

Weighted Split Pros and Cons:

Pros:

• Fairness: Equity distribution more accurately reflects each founder’s contributions, skills, experience, and responsibilities.
• Motivation: It provides an incentive for founders to take on more responsibilities and contribute significantly to the startup’s success.
• Reduced Conflicts: Clear criteria for equity allocation can help reduce disagreements later on, as the split is based on measurable factors.

Cons:

• Complexity: Implementing a weighted split requires defining criteria, which can sometimes be difficult to objectively measure.
• Subjectivity: Determining the value of each founder’s contributions can lead to disputes and differences in perception.

HOW DO YOU DECIDE ON WHAT EQUITY SPLIT STRATEGY TO PICK?

In practice, the most suitable equity split strategy depends on the startup’s unique circumstances and the dynamics among founders. Many startups opt for a combination of strategies, such as initially starting with a relatively equal split and then transitioning to a weighted or dynamic split as roles and contributions become more defined. It’s crucial for founders to have open and transparent discussions about equity distribution to ensure everyone is on the same page and to prevent potential conflicts in the future.