The Two Percent Rule
I thought I would take a moment to do a level reset on equity percentages and provide some perspective on how much equity you should consider giving out to prospective employees, directors and consultants.
The fact is that there are many founders out there that struggle with how much equity to give to executives they want to hire following a seed stage or Series A financing. There always seems to be a huge rush following a financing to hand out equity, which in turn inflates the numbers. There are three simple things you can do to prevent this from happening to your startup: (1) Draft a hiring plan during your financing prep; (2) take some time to do some research about what the “best practice” percentages are; and (3) put the equity percentages you want to give out in perspective.
So, what’s a hiring plan? A hiring plan is a list of positions and compensation you believe you will need to fill in order to round out your team so that you can achieve your near-term milestones following an investment. This list usually consists of COOs, CFOs, VPs of biz dev, senior developers and the like. Depending on the skills of your team, you may not need to hire all these people and hand out equity. The key is to come up with a list of people that give you only those critical skills that you are currently missing that will help get you to point B. Building in a little extra equity as a “reserve” or a “safety net,” or what have you, only winds up being money out of your pocket. So, come up an employee equity pool that will give you what you need near-term and skip the extra margin.
With regard to research, there are a number of resources on the internet about what percentages you should give to who and they are all a little different. Personally, I like the ranges over at Venture Hacks. There are many entrepreneurs out there and many would-be startup executives that will scoff at these numbers and at the notion of receiving less than 8-10% as a CEO or COO in a startup, especially after a startup has received some form of financing. It’s as if anything less than some magical number plucked out of the heavens is negligible, immaterial, and insignificant.
Would you scoff at the notion of having a 2% chance of dying or having your life change forever?
Which brings us to the next point: putting the numbers in perspective. What if I were to tell you that your son had a 2% chance of winding up in jail, or if I told you had a 2% chance of getting cancer? Would you scoff at the notion of having a 2% chance of dying or having your life change forever? I am not a betting man but I would bet that many of you out there would not scoff at that 2%. So, the question remains why would you scoff at a 2% stake in a company that has the chance to do something incredible, something revolutionary, or something that may change the way we live, work, or play?
The point here is that equity stakes in startup companies are handed out too easily, too quickly, and with a total disregard of proportion, measure, or perspective. This haphazard approach by startups has wound up establishing the now all-to-familiar 20-25% employee equity pool figure that creeps into every term sheet. This in turn results in larger than needed dilution of founders’ stakes in startups, and greater greed by all the service providers that surround startup communities across the United States. So, as you prepare your post-financing cap table, or are preparing a term sheet for a seed investor, or are offering a job to that superstar COO, keep in mind the 2% rule and don’t let anyone scoff at your generosity.