It goes without saying that understanding different types of equity is crucial for Founders when negotiating with investors, structuring the company's capitalisation, and planning for future growth.
Founders should be familiar with these common types of equity:
Common Stock: The most basic type of equity. Common stockholders have voting rights and share in the company's profits, but they generally have lower priority than preferred stockholders in terms of dividends and asset distribution.
Preferred Stock: This type of equity offers certain privileges over common stock, such as a higher dividend rate, preferential liquidation rights, or voting rights in certain situations. Preferred stockholders often have a fixed dividend rate, meaning they receive a predetermined amount of dividends regardless of the company's profits.
Convertible Notes: These are debt instruments that can be converted into equity at a later date, often at a discount to the company's valuation. Convertible notes are frequently used in early-stage startups to raise capital without giving up too much ownership.
Warrants: Options that give the holder the right to purchase common stock at a predetermined price within a specified period. Warrants are often issued in conjunction with other securities, such as convertible notes, to incentivize investors.
Employee Stock Options (ESOs): These grant employees the right to purchase company stock at a predetermined price, often at a discount to the market price. ESOs are used to incentivize employees and attract top talent.
But this is just scratching the surface and a real traditional view on business agreements when it comes to typical equity. We are Founders, of course there are also less traditional and creative answers to the equity equation that we should also be aware of.
Beyond the standard equity structures, Founders can explore these less common arrangements:
Profit-Sharing Agreements: These allow Founders to share in the company's profits without owning equity. This can be beneficial for Founders who want to participate in the company's success without taking on the risks associated with equity ownership.
Phantom Stock: This is a form of non-equity compensation that gives Founders the right to receive a cash payment based on the appreciation of the company's stock price. It's a way to incentivize Founders without diluting their ownership.
Deferred Compensation: This allows Founders to defer a portion of their salary or bonus payments until a future date, often with interest or other benefits. This can be a tax-efficient way to save for retirement or other financial goals.
Profit-Sharing Plans: These plans allow employees, including Founders, to share in the company's profits. This can be a way to incentivize employees and foster a sense of ownership.
Revenue-Sharing Agreements: In certain cases, Founders can negotiate revenue-sharing agreements with investors or partners, where they receive a portion of the company's revenue rather than equity.
Sweat Equity: a term used to describe the contributions of Founders who work in the company without receiving a salary or other direct compensation. It is often valued in terms of equity, meaning the Founder receives shares in the company in exchange for their time and effort.
These alternative arrangements can be particularly useful for founders who have specific financial goals or risk tolerance. However, it's essential to consult with legal and financial advisors to ensure these arrangements are structured appropriately and comply with applicable laws. The important takeaway is that you as a Founder have options and you owe it to yourself to make the right decision, one that will not become regret down the line. Seeking expertise when making equity decisions is crucial.
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