It is very common for startup founders to talk about the ownership of their startup in terms of percentages. This makes perfect sense when providing a snapshot of the startup ownership at any given moment.
But without immediate follow-through it may not be the best way to give a prospective co-founder or new hire an idea of what their getting sweat equity wise to join your startup, even if it is much easier to say “As part of your compensation, you’ll receive a grant of options equal to 2% of the company” instead of “As part of your compensation, you’ll receive 20,000 options.”
If the equity issuance is approved and issued out immediately, even if the startup promises a percentage to the new hire instead of an actual number of shares, there likely is no big issue. The startup and company counsel get together and draft share or stock issuance documents that reflect the actual number that represents the percentage. Done. No Drama.
However, what tends to happen is a lag between (a) the email or verbal agreement between the startup and new hire and (b) the actual papering of the equity issuance. And depending on what happens to the cap table of the company during this lag can ultimately end up resulting as a limited non-dilution right for the new hire during the time period of the lag.
For example, maybe you have email discussions January 1, 2025 with a new prospective hire that she will get “2% of the company.” Now 12 months later, you finally get around to issuing that equity to the new hire. (This happens more than you would think, as often startups ‘just get to work’). But also, during the 2025 year you issued out another 25% to other hires (for purposes of this example we are assuming there is no option pool, etc…and this issue usually happens up front before an option pool might be established).
So now you contact your startup lawyer in order to prepare the documents for this equity issuance. You forward the email chain and presumably your lawyer will ask you this line of questioning:
(1) I assume this 2% is as of the cap table January 1, 2025? This number is 20,000 shares, but if it’s 2% measured as of today, it would be ~25,000 shares.
(2) Do you think the new hire is going to have issue with 20,000 vs the ~25,000 figure?
Most of the time the 20,000 option grant is sent across and there are no issues. New hire signs.
Other times, the new hire will go back to the old email and ask “does this amount of shares reflect 2% of the company?” You go back and explain that it’s 2% of the company as of January 1, 2025.
Surprise…the new hire is not satisfied with 2% of the company as of January 1, 2025 – they want 2% of the company as of the date of the equity issuance document. While these issues are normally resolved, usually and depending on the circumstances, the startup has to concede a bit.
Another rare but related issue is that when the startup does its own issuances, we’ll sometimes see an issuance document mention a percentage of the company rather than an exact number of shares. Now, the most reasonable interpretation is that the percentage figure is “as of the date of the Agreement” but being reasonable isn’t a requirement to join a startup – thus occasionally the new hire claim the percentage figure in an equity issuance document is an indirect non-dilution right. They simply have 2% in perpetuity.
If the clock is ticking on a pending investment round or acquisition, leverage is on their side and you’ll most likely concede in order to get the larger deal done.
Thus, it is VERY important to give actual share numbers when you can – and not percentages.