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In simpler words, you can say that startup equity means ownership interest. It’s the value of shares that startup owners offer investors for providing capital to.
One of the commonly used words in the tech industry is Startup Equity. While this term means a lot to every fast-growing new business, it’s unfortunate that only a few people fully understand what it means. So, here’s a burning question, what exactly does equity mean in tech startups?
If you don’t know, startup equity has a lot to do with the amount of ownership possessed by shareholders in a business, which is in its first stages of operation. In the rest of this article, I’ll further share everything you need to know about startup equity.
How does equity relate to tech startups?
Many people have this belief that starting up a business from the scratch and pushing it to success only requires having the right idea. Unfortunately, that’s not always the case. Other key factors that contribute to every tech startup’s success are the timing, funding, business model, and a strong team.
Speaking of funding, all businesses, including startups, need capital to purchase assets and manage their operations. One way businesses generate capital is through bootstrapping. However, this method might not be effective for startups looking to generate more capital. In this case, “angel investors” and “venture capitalists” are two other effective options that these tech startups have.
An angel investor is a private investor (or high-worth individual) that provides capital for startups and other businesses. On the other hand, venture capitalists are professional investors that provide capital for businesses. One thing these two investors have in common is that they always want “equity” for providing your tech startup with enough capital.
Now, let’s go back to the burning question of what startup equity means:
Equity is simply the amount of ownership your stakeholders have in your startup business. In case you don’t know, stakeholders are usually investors and shareholders of your business.
Yes, if you generate capital through angel investors and venture capitalists, then these people are automatically stakeholders in your startup. That’s so because they often ask for equity before giving out a certain amount of money as capital.
So, in simpler words, you can say that startup equity means ownership interest. It’s the value of shares that startup owners offer investors for providing capital to run the business.
Here’s a better illustration: let’s say you needed capital to maintain your tech startup. After a lot of consideration, you decided to meet some investors for funding. If the investors agree to provide you with enough capital, what exactly do they stand to gain in return for the money? Here’s where the need for your startup company to provide the investors with “equity” comes into the scene.
Equity vs stocks vs shares: what makes them different?
Equity, stocks, and shares are three different words that most people use interchangeably. Are these terms the same or different?
To answer this question, I’ll say that equity is way different from stocks and shares. There are a couple of technical differences between them and that explains why people mostly use them interchangeably.
Equity, as you already know, is the total amount of ownership that stakeholders have in a startup business. Here’s a good example of what I’m trying to say: let’s say your company has 100 shares. Now, you already met an investor for capital. After negotiating, you decided to offer 10 shares in exchange for the capital you’re getting. What that means is that you just offered the investor a 10% equity stake in your startup company.
Unlike equity, “stocks” is an investment term that represents the portions of ownership of many companies. It often represents the ownership of a fraction of a big company. For instance, Google and Amazon are two companies that offer general public stocks. If you ended up buying from both companies, it means you own stock in Amazon and Google.
Furthermore, the exact indivisible units of ownership in a certain company is “shares.” It’s pretty simple, if you have investors that hold shares in your tech startup, then they are your startup’s shareholders. Let’s say the market capitalization of your company is $10 million. If one share is priced at $10, it means you have exactly 1 million shares to issue out.
Here’s how to calculate percentage equity for startups
Now, let’s talk about how to calculate percentage equity for startups. As a startup owner, it’s important to understand how to calculate your startup equity. You certainly need that, especially when negotiating how much of your company’s profits should go to investors for funding the business.
Percentage equity ownership is the number of shares possessed by an investor divided by your company’s total number of available shares. Let’s use the previous illustration here: your company has 100 shares and you offered an investor 10 of the shares.
Mathematically, % equity = 10/100 ×100 = 10℅.
Who’s eligible for startup equity?
Now that you understand what equity is and how to calculate it, let’s jump to the next question – who is eligible for equity in your startup company?
The answer to the question is angel investors and venture capitalists, as earlier mentioned at the beginning of this post. However, you need to keep in mind that they aren’t the only people eligible for equity in your company.
Are you the founder or co-founder of the startup company? If yes, you certainly are eligible for startup equity in your company.
Government, family, and friends also fall under the same category as angel investors and venture capitalists. If you’re taking any capital from any of these people, they’re certainly eligible for your startup equity.
Your employees can also own a certain amount of equity in your startup. Most startups often attract and hire talents to their businesses by promising them equity. This mostly happens if your startup doesn’t have enough to pay up employees’ salaries.
Conclusion
Equity is the total amount of ownership that your stakeholders have in your business. Stakeholders can always be your friends and family, especially if they’re ready to assist you. They could also be venture capitalists, angel investors, advisors, employees, and top talents.
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