Venture capital is a critical source of capital for any new startup. However, venture capital does not need to come with overly draconian conditions. Venture capital may be contingent on the funders receiving Board seats, and funding is typically offered in exchange for equity. But just how much equity should venture capital investors receive? If too much is given away, founders may lose control of their own business. Founders must understand how to use equity strategically in order to get the maximum benefits.
Typical Apportionments or Dilution At Each Round Of Funding
Funding must account for the competing interest of founders, the initial seed investors, venture capital investors, and employees who receive equity compensation. This can make it difficult – if not impossible – to come up with a split that everyone considers to be “fair.” While each company has different needs, here is a common scenario at a Series A round of funding with venture capital:
- 20 to 30 percent split between founders
- 20 to 30 percent split between angel investors (or other seed money providers)
- 30 to 40 percent for venture capital providers
- 10 to 20 percent to an option pool to be used for all employee equity compensation
At the time of a Series B round of funding, there are more investors to account for. This can “dilute” some of the equity that founders, investors, and employees were awarded in a Series A round, but the idea is that this will be offset by the added value of the business. A common Series B equity split is:
- 10 to 20 percent to Series B investors
- 20 to 25 percent split between founders
- 20 to 25 percent split between angel investors
- 30 to 35 percent split for venture capital providers
- 20 percent to the employee option pool (be sure to refresh this at each round)
Note that the Series B investors receive less of a share in the company (usually after paying more than Series A investors). This is because their risk is far lower at a stage where the business is more established and profitable.
Whether Series A or Series B, in addition to the typical equity splits for common stock, investors may desire certain deal terms or rights or preferences, which often come in the form of preferred stock.
Equity Disputes Between Founders and Funders Can Derail Any New Company
Disputes among founders are certainly not new in American business history. These disputes have famously cost billions of dollars, and they often leave a business bankrupt. These disputes can even cause personal rifts between family members or spouses. Further, early equity disputes at funding stages are especially dangerous for new, fledgling companies. These businesses are vulnerable. Many startups do not make it past this phase into profitable business operations, and early equity disputes are almost certainly a death sentence for a struggling new business. These disputes can be headed off with effective negotiations about clear equity terms.
Call Us Today to Speak with a California Startup Lawyer
With thorough planning, equity can be used strategically, and founders can maintain control over new business ventures. The experienced California corporate lawyers at Structure Law Group can help your new business capitalize effectively. Call (408) 441-7500 to schedule a consultation.