How much equity to give partners or investors?
by Ashok Nayar
I hear this question pretty often from fellow entrepreneurs. “How much equity should I give my partner? He’s asking for too much I think. I don’t know what to do”. Well the simple explanation is that the amount of equity you give should directly equal the amount of value that person contributes. In fact, it should actually be a bit less, so you make a better deal than the company you partner with, or the employee you hire. Paul Graham calculates it the following way:
Obviously “n” here is the % you give away. So, for example, if a company wants 50% of your equity, you have to assume that they’re going to double your value as a company. (1/(1-.5) = 2). But to be truly ahead in the game, you need to give away either
a) less than 50% if you’re assuming they company will only double your value or
b) hope that the company will more than double your value.
In both cases, you’re net ahead so you made a good deal. Of course, there’s an immense amount of subjectivity involved in these kinds of deals, so it can’t come down to a simple formula, but ultimately, something like this probably works. And it’s not as simple as a monetary value add. If you get funding from one of the top firms, while they may only double your value from a monetary standpoint, the subjectivity value add is huge. Like Graham says, simply saying you got funding from Sequoia will get you in the door in 99% of places.
Figuring out the employee value add is similar, but the formula is actually upside down:
In this case, i=the total company value after hiring that employee. So, for example, if you think that by hiring a third partner or employee will increase the total company’s value (in the long run) by 10%, then i=1+.10=1.1:
Therefore, n=.091. What this means is that if you give that employee 9.1% equity, you’re breaking even as a company. You give away a certain percentage of your stock in exchange for the exact same value add. So typically, you should give less than 9.1%. Of course, similar subjectivity comes into play. If you hire one of the best programmers in the valley when there’s a shortage of good people, you’re probably getting a good deal either way.
This is really just math attributed to a subjective decision. Ultimately, it’s probably impossible to gauge how much value any one person will add, or how much value any investor will contribute. But it’s probably not a bad guideline.