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How To Sell Equity Responsibly

Startups usually raise equity capital through investors (angel investors) and venture capitalists. Once equity capital is raised, the ownership of the company becomes diluted. It's important that founders understand how to sell equity responsibly so that they do not mistakenly sell their entire company.

Cap Tables & Equity
Fundraising
Stock Options & Vesting

Abiola Seriki

September 8, 2022

What is Capital?

Capital is one of the most crucial things needed to run any kind of business. It plays an indispensable role to ensure the day-to-day operations and management of the business. Every business needs capital to pay for salaries and overhead costs; purchase tools, infrastructure & machinery; to increase business productivity and improve the quality of output amongst other things. Capital is a major key for the business to properly function in the market or ecosystem. 

Types of Capital

There are four key types of capital; 

  • Debt Capital: Capital acquired by borrowing from other sources
  • Equity Capital: Capital structured in the forms of shares and stocks issued privately or publicly
  • Working Capital: Capital in the form of liquid assets that are currently available for fulfilling daily obligations.
  • Trading Capital: Capital allotted to buying and selling various securities. 

For startups at their very early or growing stage, founders tend to find various sources to raise capital such as self-financing, crowdfunding, loans & debts, asset sales and issuing company shares (equity).

Equity

Equity is the amount of ownership that shareholders of a startup have in the business. It can also be referred to as the percentage of the startup’s stock sold to its stakeholders, i.e the investors, advisors, employees etc.

Equity Capital is generated through the sale of shares of a company's Stock. Startup founders often sell shares of their startup in exchange for money to run the business. Unlike Debt Capital where the capital is expected to be paid back, cost of equity capital refers to the amount of return on investment shareholders expect based on the performance of the larger market. These returns come from the payment of dividends and stock valuation.

Selling Equity Responsibly

Startups usually raise equity capital through investors (angel investors) and venture capitalists. Once equity capital is raised, the ownership of the company becomes diluted. Founders must record and track all ownership rights properly to prevent future issues. A great way to do this is by using Raise, a platform to manage equity & cap tables. Stakeholders need to be able to review their holdings and also see possible scenarios of the impact of their investments. 

When distributing equity to investors, the percentage of equity that an investor will typically receive is often highly dependent on the company’s valuation and the size of the investment. Some great measures to take before making a decision include:

  • The future of the company: What is the company’s trajectory or roadmap in the short and long term? What will the initial investment help the company to achieve, what will the value of the investment be? Before an investor commits, they will need some convincing about the future outlook of the business and the tendency for them to not run into a loss on investment. 

  • Company Valuation: What is the current value of the company in the market? The valuation of a company greatly impacts the decision that an investor will make. Ensure you have used data-driven solutions to build your company valuation and that the numbers are indeed accurate and not falsified. 

  • Business Operations: Is the business currently in order? Do you have the right set of talents to manage the business? Investors are also concerned about not just the founders but the team. It’s best to avoid giving the investors a reason to doubt the quality of your team. 

Employee Stock Option Plans

Aside from selling shares to investors, startups can also offer employee stock options to employees to help them be more invested in the growth of the business. It’s a great way for startups to hire and retain the best talents, especially at a time when the startup is gaining some sort of traction. 

  • Educate employees about stock options: Let your employees properly understand what stock options are. Transparency and fairness should be the key watchword as employees will be concerned about honesty from the founders. Provide lots of training and case studies to give them an accurate picture of their stock options.

  • Determine the percentage of ownership to be awarded: It’s important to have a clear percentage of equity that you will want to distribute to your employees. Take into consideration the team size; how many people you’d need to hire, the quality of the talent, and the company’s valuation at a given time. 

  • Determine the vesting schedule: the vesting schedule refers to the period in which the employees can access the earnings on their stock options. It’s important to find a timeline that best serves your company. 

  • Determine the types of shares to be awarded: There are various types of equity distribution plans; for example stock options or restricted stocks. Identify the one that’s more suitable for your company. 

  • Offer additional benefits: Beyond equity, you should consider offering additional benefits to your employees, for example, annuities.