This blog post originally appeared on the Austin Startup Blog.
Today’s guest blogger is Ellen Wood who is the co-founder and CEO of Austin based vcfo, inc. The firm specializes in operational finance and accounting, HR Solutions and recruiting services for companies of all sizes. She can be reached at 512-345-9441.
For most entrepreneurs equity is just a word the lawyers and finance people use when talking about funding. It’s not something that is front and center on a daily basis - but it should be. Equity is everything. You need to take the time to understand it and protect it.
Specifically, equity is ownership. When you start a company, it’s common for someone or a small group of people to initially own 100% of the company. Usually ownership is represented in the form of shares. You commonly hear lawyers talk about incorporating your company with 1,000 or 10,000 or 10,000,000 shares. It doesn’t matter whether you start your company with 1 share or 10,000,000 shares, the value of the company is the same. You do not own more just because you have more shares. The value of your company is based on what the market says you are worth. Your ownership of the company is directly related to how many shares you own as a percent of the total shares.
You will never have more ownership than you do when you start your company. You may have more shares but you will never own a bigger percentage than the 100% you start with. The percent you own over time is the key. Every decision you make going forward that uses equity is going to reduce your ownership. You will use it to recruit key members of your team. You will use it to entice funding sources to invest. You may use it in exchange for services or materials that you would otherwise pay cash for. Make sure you project what the impact is of using equity. You only want to use it as currency if you believe you are getting something that will make the equity you have left worth more than it was before.
I can tell you story after story about founders that have given away large pieces of equity early in the life of their company, not understanding what that meant to their own ownership position. Decisions made in the early days of your company about the uses of your equity are the most important decisions you will make. You can’t undo them and nobody is going to give you more equity to make up for decisions you wish you hadn’t made. To minimize regrets, go beyond the revenue projections all entrepreneurs love to do. Make sure your projections cover at least the first few years of your company. If within that plan you will be seeking funding, plan for using equity there. If you are hiring a top flight team, plan to use equity there. Market data is available to you on what you will have to give in equity for these types of uses. You are making these grants to grow the value of your company. Presumably your projected smaller piece of a bigger value pie will be worth more. That is always the bet. Look at what your ownership is after these equity transactions and make sure you understand it and are satisfied with it. Remember – equity is your most valuable asset so use it judiciously. Make sure your bets are informed ones.