How Much Equity Are Founders Keeping

Key Takeaways

No founder ever wants to say how much equity they have left in their business. Everybody's open to talk about their salaries for the most part, but not their equity. But I'll bet you $1 right now, like I'll Venmo it to you, that you have more equity than you thought and definitely more equity than your peers. For entrepreneurs, equity is the endgame. It's it's not the salary in that $100 million exit you're dreaming of. Having 20% versus 40% of the business makes a generational wealth of difference. However, I've been reviewing reports and speaking with fellow founders to provide you with a benchmark that you can use to make sure that you aren't getting screwed by your investors. Let's do it. I believe that an ideal founding team should be made up of people who bring an equal amount of value to the company. A 50/50 split is fair if each founder brings the same amount of core skills into the business. We agreed 50/50 partners. If one founder, for example, is bringing just an idea and the other one is building everything, then that's far from an equal split. Now, most founders will start a company to escape their day job, but I think that's a terrible idea. It's a fair motivation, but founders should start companies about things that they're passionate about or things that they have an unfair advantage on. Call it industry knowledge, call it network and contacts. That's what brings value to a company. And that is absolutely maximized the more people that you have in your team. And most companies have two or more founders. And that's been the norm for years. Four plus founding teams are much more common in R&D startups like biotech, hardware, or energy where it's less likely for one person to have all the skills that are needed. This report by the hustle found that new companies established with a solo founder are now more common than ever. But that is not translating into funding, though. Your odds of raising money as a solo founder are much lower. And part of that tends to be that being a solo founder has flags. I don't want to say red flags, but flags. Maybe you're not great at working with others. Maybe you have a small network and that's going to be a problem when you're hiring too cuz hiring is a trust game. Nearly 70% of starter founders hire using referrals, which makes sense. These early employees, they're key to the company. You're giving them equity. You're betting your company on them. Now, that equal founder split distribution is ideal and it's becoming more and more the norm. The trend of equal equity split is growing across all startup sizes, though it's much more common in two founder startups than when you have three or more people. Now, the reality is often that a founder has already put in some work on the project, on the company. Maybe they've put in their own money already. They've invested some capital into building the startup by the time the other founders join. And that would be a fair reason to have a split not be exactly equal. Also, sometimes the cold hard truth is that one of the founders just brings less value or less experience to the company, which is an awkward conversation to have for sure, but one that you need to have sooner rather than later. In Snapchat story, for example, the founder that came up with the idea was also the founder that brought less experience and less value to that equation. And he got kind of screwed. We made a whole video about that. For reference, this is the median equity split for a two-founder team. And here's the one for a three-founder team. But let's look at funding rounds. Now, remember that funding rounds are generally based on milestones. For most software companies, a preede round means the money that you raise to build and launch a product. And then you raise a seed round once you've launched a product, you have some good growth. In SAS, that tends to be upwards of 20 or $30,000 in monthly revenue. And then you raise a series A when you have somewhere in the $2 million in annual run rate. Series B would happen closer to the $5 million mark and subsequent series vary a lot more. Now, there's of course survivorship bias here, but the truth is that most companies die before series A. Out of the hustle survey, 40% of entrepreneurs said that crossing the $500,000 line was the hardest revenue milestone that they had to go through. There's another group that I like to call like R&D startups. Those are your hardware, your biotech companies, some software companies that are building like deep technology, for example, a new LLM model from scratch. Those companies tend to raise more money and don't play by the same rules and the same milestones as the rest. Now, there's not a lot of data in the distribution of equity at preede, especially because many of those rounds are convertible notes. So, how much equity you get actually depends on the terms of the future round. Now, if that didn't make sense, we made a whole video about convertible notes a couple weeks ago. I'm going to link it below if you want to check it out. Now, by the time a company gets to seed, the median founder equity is 56%. Which I'm sure is a lot less than you expected. In other words, the typical company sheds 44% of its shares to investors by the time they raise a seed round. Let's see a scenario of how that would play out. So, let's assume a two founder team with that typical 5545 split that we established before. Let's say that they raise a preede round of $650,000 on a safe note with a cap of $3.5 million. After that, their seed round is a $2 million round with a pre- money valuation of $6.5 million that triggers a conversion of the safe at the cap. Also, investors might have requested them to set up a stock option pool for employees before the round comes in. So, they set up a 2 million share pool, which will be around 11%. And with that, both founders are now down to 56% of shares combined. about 31% of shares for the first founder and about 25% of shares for the second founder. Now I've been adding those values to our cap table template which you can access from slidebean but that is ladies and gentlemen the typical founder equity split at the preceeded stage. Any further round of funding will put founders below that 50% company ownership. And I've stopped counting how many founders are so obsessed with this idea of retaining 51% of their companies. That's honestly mostly Hollywood nonsense. And the reality is very different. And if you want to build a billion-doll startup, you can't front the money yourself. This is the only path. Now that 56% is standard. It's the median, remember? So half of the companies are getting better deals than that and half the companies are getting worse deals than that. And that distribution changes a bit for digital versus R&D startups or physical startups as this report calls them. But in the bulk of all companies, we can see that the worst percentile is founders that have shed about 75% of their equity by the time they get to seed. On the opposite end, the founders who fundraised best or who maybe were bootstrapped and provided their own capital before their preed round, they're able to retain about 75% of the company by the time they get to the first equity round. 74% of entrepreneurs use personal funds to fuel their business. It's almost like a requirement when you get started. The question is whether you can skip an entire round of funding by just bootstrapping. A common pitfall I see is founders who fund their companies through product launch but not all the way to get to seed stage. And that's like a hole between these two rounds where a lot of companies get stuck. By the way, that stat and many others in this video came from the Hustles 2024 entrepreneurship report, which you can download with the link in the description. I've been working with them with dozens of videos about business, startups, and tech. And this report is one of my favorite resources that they published this year. Okay, so moving on. Series A statistically will be another 20% equity hit for the company. And that means that most founders jointly no longer have more than 50% of their companies by the time they get to series A. That doesn't mean that they've lost decision-making power because decision-m power really depends on the board. And that's a video for another day. Let me know if you want me to dig deeper on that. Now, as you can see here, the typical founding team will only have retained about 36% of their original equity by the time they've reached series A stage. If you want to see how a similar round would apply to our example company, that would be more or less an $8 million series A round with a pre- money valuation of $20 million as well as a new stock option pool. Now, remember that series A is the stage where companies tend to hire their first top level executives, which will certainly require a new stock option package, and so on for the next rounds of funding. And this is how a typical equity distribution evolves through series B, C, and D. Now, going back to this percentile chart, there are a few more highlights that we can point out. Firstly, you do have founding teams that dip below 10% ownership at series B. Now, if I were an investor in one of those companies, honestly, that would be a bit of a concern for me because if each founder is only retaining about 2% of their company, then why should their motivation be higher than that of say an early well- paid employee? On the opposite end, no founding team, not even the best fundraisers have over 50% of their companies by the time they get to series B. Now, the name of the game in venturebacked startups is not owning 51% of a medium business. It's owning hopefully 5% of a billion dollar company. Now, check out CEO ownership across rounds of funding down to 10% by the time these companies are getting to series D. And of course, this isn't a game for everyone, and it's not a game for every company. With this amount of funding, this amount of money thrown at a company, investors are going to demand fast scale and anything that doesn't meet that skyrocket growth will be a disappointment and it's going to translate into pressure for the founders. One of our main competitors actually went through this exact predicament last year. They raised hundreds of millions of dollars in funding. They built a great product with all that money, but it was clear that the market opportunity for this space wasn't as big as investors hoped or as big as the founders sold to them. They're alive by all means, but they were forced to restructure the company. They had to fire over 100 people and they just had to convert from this fast growing startup into a more traditional company. Another $1 Venmo bet for the comment that first guesses which company I was talking about. Anyway, there's nothing wrong with wanting to build a business that is not a unicorn. Just understand that venture capital is probably not the path to do it. Venture capital is a win big or die sort of game. So, you really have to know what you're signing up for. So, thanks a lot for watching, guys. Don't forget to download the Hustles Entrepreneurship Report and be sure to check out our video on convertible notes and our video on the Snapchat founder story. Catch you on the next one.