By Ifty Nasir, founder and CEO of Vestd
Many young businesses fail because of poor concept, cash-flow problems, lack of skills or in-house knowledge.
By using equity wisely, all of these weak points can be overcome.
However, some of the terminology around equity can be a little opaque, making the subject a little confusing for people approaching it for the first time.
So, let’s take a deep dive into what equity is. I’ll demystify the main terms that you need to know and explain how you can manage your equity to supercharge your success.
Put simply, equity is the ownership of assets of a company.
If you are a one-man band and you have no investors, you own 100% of the company. If you sold that company, you would receive 100% of the profits.
When you offer equity shares, you are offering slices of company value to your shareholders. They might not be worth much (or anything at all) when you start out but could grow into something of monetary value over time.
Equity is a valuable tool for growth because you can offer slices of this value to investors in return for up-front cash injections or you can offer it in exchange for the skills you need.
Imagine your equity as a pie that you can slice up and give to people in lieu of (or in addition to) money. You’ll give these slices to people in the form of ‘shares’ or ‘options’.
Options are arguably the best way to distribute equity in most circumstances. By offering them, you are giving somebody the option to buy real shares at a later date at a pre-agreed price.
This works well for all parties concerned as it is the most tax-efficient route and it can also be more incentivising (for reasons I’ll outline later).
Shares are straight-up slices of the company awarded in real time and they incur tax when they are awarded and when they are sold. They have their place, but most founders prefer to give options to employees or consultants.
By giving people Shares or Options, you’ll be giving them skin in the game which means that they will be as driven as you are to see your venture succeed.
Managing your equity in this way creates a team of loyal, determined and enthusiastic people, all aligned in their shared goal of growing your brand to unicorn status (if that’s what your big aim is).
When the company wins, you all win. The more profit this fired-up group generates for your startup, the more profit there will be to go around. Perfect.
Not if you follow a couple of basic rules.
Why conditional equity is your best friend.
So earlier, I mentioned that options can give you greater leverage when it comes to inspiring the team.
The reason for this is because you can set your options to convert into real shares at regular intervals (monthly, quarterly etc). This is known as ‘vesting’ and the longer somebody stays with you, the more shares they’ll have.
So say you give them 1000 options when they start, to vest at a rate of 250 per annum. After four years they’d have access to the full amount, but if they left after eighteen months, they’d only receive 250. This protects you but also enhances loyalty from team members for obvious reasons.
You can also set conditions around business activities if that’s more appropriate.
So for example, if you need an early one-off contribution from a developer to get your app up and running, you might want to set their conditions around that rather than time. So for example, their options would all vest (convert) into shares upon completion of the app.
These things are entirely flexible so think about what would best suit the situation.
Thinking about what’s right for you.
Now you know the basics of equity management, it might be worth sitting and thinking through a few questions about how you might manage yours, such as:
1. Is sharing for everyone or just the key team?
3. What is a meaningful amount to offer?
4. What about offering equity to experts who step in to offer foundational work?
Whatever you decide...
Make it real for your team.
There’s little point in having an equity scheme if your shareholders don’t understand or engage with it.
Create some fanfare around the issuing of the shares and sign up to a digital portal like so that everybody can log in and see the progress of their share value whenever they like.
This incentivises the team like nothing else!
Slice the pie, reap the rewards.
Hopefully, this has given you a solid overview of how you can make your equity work for you but if you have questions, or you’d like to know more, you can speak to a member of our team by clicking or tapping here.