STARTUP EQUITY - Who Gets What and Why? How does it work?

WeAreNoCode - Learn No-Code!
24 Nov 202115:46
EducationalLearning
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TLDRIn this insightful video, Naval Ravikant's advice on equity is discussed, emphasizing its importance for entrepreneurs seeking financial freedom. The video explores who should receive equity, the amounts to grant, and industry benchmarks. It also delves into the differences between salary and share-based compensation, highlighting the high-risk, high-reward nature of equity. Furthermore, the video explains key concepts like vesting, dilution, and option pools, which are crucial for understanding equity distribution in startups.

Takeaways
  • 💡 Equity is more valuable than salary for entrepreneurs as it represents ownership and potential high rewards in a startup.
  • 🚀 Co-founders are crucial and usually receive a significant share of the company due to their early involvement and risk.
  • 🤝 It's important to give shares to employees to retain them and align their interests with the company's success.
  • 💰 Investors provide capital for growth and expect a return on their investment, usually taking a percentage of the company.
  • 📈 Advisors contribute valuable connections and knowledge without full-time commitment and may receive a smaller equity share.
  • 🏢 Contractors should not be given shares as they serve short-term roles and their commitment to the company's long-term vision is limited.
  • 📊 The amount of equity to give out depends on factors such as the individual's role, the timing of their involvement, and their opportunity cost.
  • 🔄 Vesting schedules ensure that shareholders remain committed to the company over time, protecting the company from early departures.
  • 📈 Dilution occurs when more shares are issued, reducing the percentage ownership but potentially increasing the value of the individual shares due to company growth.
  • 🛠️ Option pools are reserved shares for future employees and advisors, allowing for the company to grow and attract talent without renegotiating equity stakes.
  • 📚 Understanding and communicating the mechanics of equity distribution is key to successful negotiations and maintaining positive relationships with stakeholders.
Q & A

  • What does Naval Ravikant believe is essential for financial freedom?

    -Naval Ravikant believes that owning equity or a piece of the business is essential for achieving financial freedom.

  • Why are shares considered the most valuable currency for early-stage entrepreneurs?

    -Shares are considered the most valuable currency for early-stage entrepreneurs because they often don't have large sums of money to pay employees. Instead, they use shares to attract talented individuals to join their startup.

  • What is the primary difference between being paid a salary and being paid shares?

    -Being paid a salary involves low risk and a capped reward, whereas being paid shares involves high risk but the potential for significant rewards if the company is successful.

  • Who are the most important individuals to receive equity in a startup?

    -Co-founders are the most important individuals to receive equity in a startup, as they are taking on significant risk and are integral to building the company from the early stages.

  • Why should shares be given to employees?

    -Shares should be given to employees to provide them with an incentive to stay with the company longer. This is because they will potentially benefit from a large exit or liquidity event, even with a small number of shares.

  • What is the role of investors in a startup and why should they be given shares?

    -Investors provide financial backing to startups with the goal of multiplying their money. They are given shares as a way to potentially profit from the growth and success of the company they invest in.

  • Why are advisors given shares in a company?

    -Advisors are given shares to leverage their knowledge, network, and expertise without the requirement of them becoming full-time employees. They can provide valuable guidance and connections that can significantly benefit the company.

  • What is a common percentage range for equity distribution among co-founders?

    -A common percentage range for equity distribution among co-founders can vary from 50% to as low as 5%, depending on the individual's contribution and the stage at which they join the company.

  • How does the concept of vesting protect the company when giving out shares?

    -Vesting schedules ensure that shares are earned over a set period, typically four years. This prevents individuals from leaving the company shortly after receiving shares and still retaining them, thus protecting the company's interests.

  • What is dilution and how does it affect the ownership percentage in a company?

    -Dilution occurs when more shares are issued, increasing the total number of shares in a company. This reduces the ownership percentage for existing shareholders but can also increase the overall value of the company if done correctly.

  • What is an option pool and why is it important for a startup?

    -An option pool is a set of shares reserved for future employees, advisors, and other key individuals. It is important for a startup as it allows the company to attract and retain talent by offering them the potential for future equity in the company.

Outlines
00:00
🚀 The Importance of Equity in Startups

This paragraph emphasizes the significance of owning equity in a business as a path to financial freedom, highlighting Naval Ravikant's perspective. It discusses the early stages of startups where shares serve as a valuable currency due to limited funds. The paragraph underscores the necessity for entrepreneurs to master the use of equity to attract talent, reduce costs, and increase the chances of startup success. It introduces the concept of equity distribution among co-founders, employees, investors, and advisors, and sets the stage for further discussion on the topic.

05:01
🤝 Equity Distribution Among Co-founders and Early Team Members

This section delves into the details of equity distribution, particularly among co-founders and early hires. It explains the rationale behind offering substantial equity shares to co-founders who take on significant risks during the startup's early stages. The paragraph also touches on the importance of giving employees equity to retain them and align their interests with the company's long-term success. Additionally, it cautions against giving equity to contractors or short-term contributors, using an analogy to illustrate the point.

10:02
📈 Determining Equity Shares: Benchmarks and Considerations

This paragraph provides insights into the factors influencing the determination of equity shares, such as the role in the company, the timing of joining the startup, and opportunity cost. It offers personal benchmarks for equity distribution among co-founders, investors, employees, and advisors, based on the channel creator's experiences and industry observations. The paragraph also presents examples from other entrepreneurs and venture capitalists, illustrating a range of practices in equity allocation.

15:03
🔍 Understanding Key Equity Concepts: Vesting, Dilution, and Option Pools

This section introduces and explains key concepts related to equity in startups, including vesting schedules, cliffs, and dilution. It clarifies the purpose of these mechanisms, which is to protect the company and align the interests of the shareholders with the long-term growth of the business. The paragraph also discusses option pools, which are sets of shares reserved for future employees and advisors. It advises entrepreneurs to be knowledgeable about these concepts to effectively negotiate with and inform stakeholders about the implications of equity distribution.

🎯 Focusing on the Big Picture: The Strategy Behind Equity Distribution

In this concluding paragraph, the speaker stresses the importance of focusing on the bigger picture when distributing equity, rather than getting caught up in small percentages early on. The message is to prioritize the potential for significant returns in a successful company over immediate, full control. The paragraph wraps up with a call to action for viewers to subscribe to the channel for more tips and concludes with a reminder of the importance of strategic equity distribution in achieving long-term business success.

Mindmap
Keywords
💡equity
Equity refers to a share or a stake one holds in a company. In the context of the video, it is the ownership interest in a company that can be given to co-founders, employees, investors, or advisors. It is a crucial tool for startups to attract talent and investment without having to pay high salaries upfront. The video emphasizes the importance of understanding how to use equity to increase the chances of a startup's success.
💡financial freedom
Financial freedom is the state where an individual has enough wealth to cover their expenses without having to work actively for money. In the video, it is linked to the concept of owning equity in a business as opposed to merely renting out one's time for a salary. The speaker suggests that owning a piece of a business can lead to financial freedom through the potential for high rewards if the business succeeds.
💡startup shares
Startup shares are the portions of a company that are given to early employees, founders, or investors. These shares are particularly valuable in the early stages of a startup because they represent a claim on the company's future earnings and growth. The video explains that since startups often lack the funds to pay high salaries, they use shares as a form of compensation to attract talent and investment.
💡co-founders
Co-founders are individuals who start a company together and share in the ownership and responsibilities of the business. In the video, it is mentioned that co-founders are essential for the early stages of a startup and often receive a substantial amount of shares for taking on the significant risk associated with starting a new business.
💡vesting
Vesting is a mechanism used in equity compensation that schedules the granting of shares over a certain period. It incentivizes employees or co-founders to stay with the company for a longer duration. The video explains that vesting typically occurs over four years, with a 'cliff' where no shares are earned for the first year unless the individual stays beyond that period.
💡dilution
Dilution occurs when a company issues new shares, increasing the total number of shares and thereby reducing the percentage ownership of existing shareholders. This is a normal part of fundraising and growth, but it's important for shareholders to understand that while their percentage may decrease, the value of their shares could increase if the company's valuation grows.
💡option pools
Option pools are a reserved set of shares in a company that are set aside for future employees, advisors, or other individuals who will be granted equity as the company grows. This is a strategic allocation to ensure that there are enough shares available for future hires without constantly needing to re-negotiate share distribution.
💡investors
Investors are individuals or entities that provide financial backing to a company in exchange for shares or equity. They are looking to multiply their money by investing in businesses that have the potential to grow. In the video, it is mentioned that investors take on the risk of investing in startups and, in return, they receive a portion of the company and potentially earn a commission for managing the funds.
💡advisors
Advisors are individuals who provide guidance, expertise, or connections to a company without necessarily being full-time employees. They may receive equity as compensation for their contributions, which is typically less than what employees or co-founders receive, given their part-time involvement.
💡risk and reward
Risk and reward is a fundamental concept in business and investing, where higher risk is typically associated with the potential for higher rewards. In the video, this concept is applied to equity ownership, where those who take on more risk, such as co-founders and early employees, have the potential for greater financial gains if the company succeeds.
Highlights

Emphasizing the importance of owning equity for financial freedom, as stated by Naval Ravikant, a renowned investor and entrepreneur.

Shares are the most valuable currency for early-stage entrepreneurs due to limited funds for paying employees.

The skill of using equity to hire the best people is crucial for entrepreneurs to increase their chances of success.

The distinction between being paid a salary versus being paid in shares, highlighting the high risk and reward of equity ownership.

Co-founders are the first and most important individuals to receive equity due to their substantial risk and commitment.

Investors receive shares for providing funds to grow the business, expecting a return on their investment.

Advisors, while not full-time employees, can receive a small percentage of equity for their valuable contributions and connections.

The importance of timing over seniority when it comes to equity distribution, with later joiners receiving less.

The concept of vesting, ensuring that shares are earned over time to retain employees and protect the company.

The cliff mechanism in vesting schedules, acting as a trial period before employees begin to fully earn their shares.

Dilution as a natural part of fundraising, where new shares are issued, and existing shares are proportionally reduced.

Option pools, a set of shares reserved for future employees and advisors, allowing for growth and talent acquisition.

Personal benchmarks for equity distribution, with co-founders receiving 50% to 5% and investors taking 15% to 30%.

The impact of experience and opportunity cost on equity decisions, such as hiring an experienced CTO from Google.

Industry benchmarks for equity distribution to advisors, ranging from 0.1% to 0.2% of the company.

The importance of understanding and communicating the logic behind equity distribution to align expectations.

Transcripts

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