When you're starting your first company, there are a million things to figure out.

One of the most crucial—and sometimes overlooked—aspects is how to split up the ownership of your startup.

his process is called shares allocation, and getting it right from the start can set the stage for your company’s success.

It determines who owns how much of the company, which directly impacts everything from decision-making to profits.

If you’re a first-time founder, you might be tempted to split ownership evenly with your co-founders, but it’s not always that simple.

Imagine building something from the ground up, only to see it crumble because the ownership wasn’t divided properly—that’s a scenario no founder wants to face.

Let’s look at shares allocation in detail.

Key Takeaways

• Align Incentives: 
  Ensure your shares allocation aligns everyone’s incentives with the startup’s growth to maintain motivation across the team.

• Cap Table Clarity: 
  Maintain a well-organized cap table to demonstrate seriousness and sustainability to potential investors.

• Balance Equity: 
  Reassess equity splits as your team grows to reflect each member’s contributions and avoid tensions.

• Create Equity Pools: 
  Set aside an equity pool for future hires to attract top talent without over-diluting ownership early on.

• Legal & Tax Guidance: 
  Seek professional legal and tax advice to avoid pitfalls and ensure that your shares allocation is fair and compliant.

Let’s start-up!

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Why Shares Allocation is Important:

The way you allocate shares can affect your startup in several key ways:

1. Long-Term Success:
Proper shares allocation helps ensure that everyone involved—co-founders, early employees, and even future investors—is motivated to contribute to the startup's growth. It aligns everyone’s incentives with the success of the company.

2. Investor Interest:
Investors want to see a well-thought-out cap table (a breakdown of who owns what). It shows that you’re serious about building a balanced and sustainable business.

3. Team Dynamics:
If one founder owns significantly more equity than others, it can lead to tensions and demotivation among the team, while a fair allocation can foster a sense of shared purpose and commitment.

Unfortunately, not all startups get this right. Many start-up equity disputes arise because the shares weren’t allocated fairly or clearly from the beginning.

This can lead to disagreements, legal battles, and in some cases, the downfall of the startup. Ensuring a fail allocation allows everyone to be on the same page.

Understanding Shares Allocation:

When you start a company, you don’t just divide up the profits and responsibilities—you also divide up ownership in the form of shares.

As soon as you have co-founders, early employees, or investors, it gets more complicated. You’ll need to figure out how to distribute ownership in a way that’s fair and aligns with everyone’s contributions and expectations.

There are two main types of shares you’ll encounter in a startup:

1. Common Shares:
These are the most basic type of shares and are usually issued to founders, employees, and sometimes early investors.

If you’re a founder or early employee, you’ll likely receive common shares.

They don’t come with any special rights, but they do represent ownership in the company.

As the company grows and (hopefully) becomes more valuable, the value of these shares can increase.

2. Preferred Shares:
These are typically given to investors and come with extra perks.

Preferred shares often include things like priority in getting paid back if the company is sold or liquidated.

This means that if things go south, investors with preferred shares are first in line to get their money back before those with common shares.

Investors usually ask for preferred shares because they’re taking on more risk by investing in a young company.

You also need to be aware of these key concepts that are crucial in shares allocation:

1. Equity Pool:
This is typically used to offer shares to employees, advisors, and future hires.

It allows you to bring new talent on board without having to re-negotiate ownership every time someone new joins the team.

2. Vesting Schedules:
Instead of giving someone all their shares upfront, vesting schedules distribute shares over time.

For example, a typical vesting schedule might last four years with a one-year cliff.

This means that if you’re a co-founder, you wouldn’t get any shares if you left the company within the first year (that’s the cliff), but after the first year, you’d start earning a portion of your shares every month until you’re fully vested after four years.

This system ensures that everyone has skin in the game and is incentivized to stick around and help the company grow.

How to Decide on Shares Allocation:

Deciding how to divide up ownership in your startup is one of the most important—and sometimes tricky—decisions you’ll make as a founder.

A 50/50 split sounds fair and easy, right? But while it’s a popular choice, it’s not always the best approach.

This can work if both co-founders contribute equally in terms of time, skills, and resources, but, it’s rare.

One might bring technical expertise while the other focuses on business strategy, fundraising, or sales.

If one founder’s contribution is more critical to the success of the startup, it might make sense to adjust the equity split to reflect that.

Fairness in a startup isn’t just about equality—it’s about equity, meaning that the split should reflect the actual value each person brings to the table.

Does one of you have a unique skill set that’s essential to building the product? Or is someone else putting in more capital or working full-time while the other is part-time?

As your startup grows, you’ll likely bring on advisors and early employees who play a key role in your success. It’s important to allocate shares to these individuals in a way that motivates them without giving away too much of your company.

Advisory Shares:
Advisors can provide invaluable guidance, introductions, and expertise that help your startup navigate challenges and grow faster.

To compensate them, it’s common to allocate a small percentage of shares—usually between 0.25% to 1%—depending on their level of involvement and the value they bring.

Employee Stock Option Pool (ESOP):
To attract and retain top talent, especially when you can’t offer high salaries, you’ll want to create an Employee Stock Option Pool (ESOP).

Typically, startups allocate about 10-15% of total shares to the ESOP to motivate them to grow the company.

Allocating shares i about creating a structure that rewards everyone involved, aligns incentives, and ensures that your startup has the best chance of success.

Common Pitfalls in Shares Allocation:

When it comes to allocating shares in your startup, it’s easy to make mistakes,
but they can have serious consequences.

Over-Dilution

This happens when you allocate too many shares too early in the life of your startup, leaving little room for growth down the road.

It might seem like a good idea at the time, but what happens when you need to bring on more people? Or when you’re raising your first round of funding?

You might barely have any left to attract new talent or investors.

🔥Set aside an equity pool for future hires, and be mindful of how much you’re giving away at each stage of your company’s growth.

Equity Imbalance

Let’s say you start a company with a co-founder, and you both split the equity 50/50.

But as your company grows, you bring on a third co-founder who makes significant contributions, perhaps even more than the original founders.

The original founders might have too much equity relative to their current contributions, while the new co-founder might feel undervalued.

🔥To prevent this, it’s important to reassess and renegotiate the equity split as your team grows and your company’s needs change.

Make sure everyone’s contributions are recognized and that the equity split reflects the value each person brings. It’s also wise to have clear agreements in place.

Legal and Financial Considerations:

Proper legal documentation and an understanding of the tax implications are crucial to avoid any nasty surprises down the road.

Legal Documentation

One of the first steps in your shares allocation journey should be getting the legal documentation right. It might not be the most exciting part of starting a business, but it's one of the most important.

Founders Agreement:
It should clearly outline how shares are allocated among the founders, what the vesting schedule looks like, and what happens if a founder decides to leave.

Cap Table Management:
A cap table is a detailed breakdown of your company's ownership, showing who owns what percentage of the business.
It helps you track ownership stakes, investor shares, and how these might change over time.

🔥Even if you have a solid understanding of equity, legal nuances can be tricky, and having professional guidance ensures you don’t miss anything critical.

Tax Implications

Shares allocation also has significant implications on both your personal taxes and your company’s taxes.

Personal Taxes:
When you receive shares as a founder or employee, you may be subject to taxes based on the value of those shares.
This can include income tax and capital gains tax, depending on how your equity is structured and when you sell your shares.

Corporate Taxes:
Your company may also face tax implications based on how equity is allocated and how it evolves over time.

🔥Consult with both a legal expert and a tax advisor to fully understand the implications of your shares allocation to minimize tax liabilities and maximize benefits for all parties involved.

It’s all about being fair, strategic, and transparent—and knowing when to seek expert advice.

Shares allocation is not just about splitting the cake - it's about laying the foundation for your company's future.

If you haven’t already, take some time to review your shares allocation. Is it fair? Does it reflect the contributions and potential of everyone involved? If you’re unsure, consider consulting with a legal or financial expert.

Making the right decisions now can save you from headaches later and help ensure your startup is on the right track for success.

Your startup's success is in your hands—make sure your shares allocation reflects that.

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