Working in a startup delivers a ton of benefits to those working in such an ecosystem. Aside from having to do away with the need for formal attire and whatnot, being a part
and indeed, owning a part— of such a prospective multi-billion dollar company holds more leverage than offers from most traditional companies.
Acquiring equity within a company implies that you have a stake or interest in such business. Therefore, asides from helping the company to grow through your skill and role within the organization and through which you also hone in on your personal skills, you are also incentivized to grow the value of the company in the way that investors and founders of the company are incentivized.
There is a caveat, however —receiving equity in a company may come in different shapes and sizes. Therefore, there is a need to understand how startup equity works.
There are two main ways in which startups —and especially early-stage startups— can be invested. These include:
- Investing in a priced equity round and;
- Investing in convertible securities.
Investing in a priced equity round implies that the investors in a startup purchase the shares or equity in a startup at a fixed price. While investing in convertible securities means the investment thrown into the growth and scaling of the company, is then "converted" into equity.
For many early-stage and seed investors, investing in convertible securities is a preferred funding round for them. These investors are then given convertible notes and SAFE documents. For investors in startups that are in the latter stages, investment is done through priced equity rounds.
Why do startups raise venture capital?
The concept of venture capital is a financing structure that is enticing for startups that require funds if they are to scale the company into one that is extremely profitable. Various big names such as Google, Facebook, etc were venture-backed startups.
It has been established that startups have little to no collateral or assets to offer against the more conventional loans offered by commercial banks. Thus, if an investor were to offer a more conventional loan, there is no guarantee that such investors will recoup the loss, were the company or startup to fail.
By acquiring venture capital, startups can raise money that they are under no obligation to repay, although this comes at a cost. The funds provided by investors usually buy a percentage of the company from the founders, granting the investors rights to a certain percentage of the startup's profits in perpetuity, which could accumulate into a significant amount as time progresses.
Finally, funds garnered from venture capital provide startup founders with valuable support, resources, and guidance from investors that can help shape the company and expand its chances of success.
What is the meaning of equity?
Simply put, equity is ownership. It signifies the ownership of the interest of a certain percentage in a particular company. For investors within the startup ecosystem, this implies that the company's shares are bought for a specific amount of money.
With the passage of time and effective scalability, investors are usually willing to pay a larger amount per share in subsequent funding rounds, due to the prospects of the startup's success. This helps to form a strategic partnership between the startup and the investors, as investors make profits that are proportional to the success and growth of the company. On the other hand, if the startup suffers a loss the investors suffer the same fate as well.
What Is The difference between stock, shares, and equity?
"Stock" and "equity" are typically interchanged. Stock is a broader term that signifies an undetermined amount of ownership or interest in a company. Shares, on the other hand, indicate how a company's stocks are shared. The stocks can be divided into a prospective limitless number of shares that are worth the same value.
As aforementioned, priced equity rounds are situations where the stocks possess the same value and the investors can buy equity into the company by acquiring the shares at the stated price within that time frame. Calculating equity ownership in a firm is usually done by dividing the amount of shared ownership by an investor, by the total number of existing shares. The total number of shares indicates all shares that have been bought, including those shares that will exist in cases where liquidity occurs.
Employees and founders of a startup are usually granted stock options, which grants them the right to purchase a fixed amount of stock within the startup at a pre-agreed price —the strike price. The effect of this is that while the investors or founders or any other person within the above situation may not technically own those shares, those shares have already been accounted for. Thus, those amount of shares cannot be accrued to any other investor and must also be accounted for in the overall number of the company's shares.
Who can own equity in a startup?
The founders, investors, and employees of a particular startup are usually the individuals that own equity in a startup.
Founders may initially own 100% of the startup's equity, although they relinquish a significant amount of such ownership over time to co-founders, investors, and employees. Investors also put money into startups due to the possibility of making significant gains once the company goes public, or in cases of liquidity, where for instance, another company buys out the startup.
Employees are also offered equity in a startup, which serves as part of their compensation package, known as the Restricted Stock Unit (RSU). RSUs are awards of stock shares that are given to employees upon the fulfillment of certain conditions. These stocks are issued through a vesting plan and a further schedule for distribution. They are also issued after these employees have achieved a certain performance milestone or upon being retained by the employer for a specific amount of time. These are usually done as an employee stock ownership plan (ESOP), which allows and encourages employees to acquire ownership in the startup.
Can I sell my shares?
After you have your fully vested stock, or you have duly exercised your veterinary option, you are presented with two options: you can either hold your stock until an exit event is available or sell the stock privately to either outside investors or the company. All these are to be done in accordance with the company approval and laws applicable in such a state.
Finally, in secondary markets, private sales of stocks are currently trending through various services. In cases where such an investor or founder or employer holds such vested options and desires to leave the company, such a person may be required to exercise vested options within a period or forfeit such options.
Conclusion
In conclusion, whether you are a founder, investor, or employer, it is important to know how ownership in companies works because in any circumstances, you are entitled to a certain percentage of interest within the company and it is in your best interest to understand the rights accrued to you.