Founder's Equity - Explained
How is Equity Distributed to Company Founders?
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Startup Founders and Equity Funding
At the beginning of the life of any business venture, the business has no resources. It is, in fact, a legal shell that must be filled. Founders are generally the sole source of assets in a startup venture. That is, the founders undertake the task of assembling resources necessary to carry out the business value proposition. These assets are transferred to the ownership and control of the business entity. In return for assets invested, the founders receive shares of ownership of the business entity.
Next Article: Co-Founder Equity Split Back to: LAW, RISK, and TRANSACTIONS
Thus far, I have used the word assets to include all value that is transferred to the business. These assets generally consists of financial capital. In addition to funds, however, founders may contribute various other types of value to the venture. For example, founders may contribute:
- Ideation (or contribution of the original business idea, product or service model);
- Work Product or Effort (i.e., equity shares as salary or other compensation);
- Physical Assets (Equipment, Office Space, Inventory, Raw Materials, etc);
- Intellectual Property (Rights to technology, brand name);
- Reputation and Connections (personal relationship, such as with vendors, suppliers, lenders, capital investors, etc.).
Each of these founder contributions has distinct value to the business that is helpful or necessary for carrying out the business value proposition. The contribution of these items may give rise to an allocation of ownership interest (e.g., shares of stock) that represents its value to the corporation. In addition, this transfer to the corporation necessary entails a translation of the specific value into a monetary figure (i.e., it is given a dollar value). The financial value of such contributions is often difficult to determine. Nonetheless, the team will have to decide what number of total shares to allocate to the contributor for each contributed resource. Each share has a prescribed monetary value (either based upon the par value of the shares assigned in the articles of incorporation or based upon some business valuation method).
The allocation of shares for the value contributed may lead to unequal ownership and control among the founders. Naturally, this may lead to dissension within the team.