What is the best way to allocate equity in a startup?
The way of distributing the equity of a startup company is relatively single, usually speaking, there are 2 ways. The first is to distribute according to the proportion of shareholders' capital, and the second is to distribute equally among shareholders. Both ways have their own shortcomings, the first one often results in the uneven distribution of shareholders' contributions and holdings, and the second one tends to weaken the core founders' control over the company, affecting the efficiency of the company's decision-making.
So, how should startups allocate equity to avoid the above problems? Taishan Institute of Management believes that the best effect of equity incentives can be achieved by addressing the following points.
The three principles of equity allocation.
Entrepreneurship is like rowing a boat against the current, only peers with a clear purpose, the same direction, fairness and incentives coexist in order to achieve a long-term, stable relationship. Equity allocation is such a process to the "people", its purpose is not only to establish the rules through the "ugly words in front", but also to clarify the company's genes and values, to reach the shareholders **** knowledge.
In view of the early stage of startups, shareholders and management are usually overlapping, and there is no need to consider the game between shareholders and management, the author believes that the establishment of equity distribution needs to take into account three factors, namely: shareholders in the resource level of the contribution of shareholders in the corporate governance level of the control of the company as well as the future of the company's financing space, of course, there is still room for the decomposition of the three factors, for example, the resource can be broken down by For example, resources can be broken down by capital contribution and investment time, and capital contribution can be further broken down by the value of the company in terms of money, physical goods, and intellectual property.
It is better to choose paid-in capital than paid-in capital.
Unless otherwise provided by law, administrative regulations and decisions of the State Council, the registered capital of the company does not have to experience the capitalization process, the commitment of all shareholders to contribute can be, the period of time for which the shareholders agreed, but this does not mean that the shareholders can "only subscribe to not pay", and does not mean that registered capital The more you do this, the better.
The shareholders' obligation to make contributions under the subscription system is only suspended, and the shareholders are still liable for the company's debts to the extent of their contributions. If the shareholders want to show the company's strength by unrealistically contributing to the high amount of registered capital, then they will face multiple legal risks, for example, when the creditors are claiming from the company, the shareholders' responsibility to pay will be increased, and the shareholders' contributions will be treated as liquidation property if the company is dissolved, and also the shareholders' contributions will be treated as liquidation property. The company's capital will be used as liquidation property, and tax risks need to be considered as well.
Safeguard the control of core founders with a corporate governance structure.
1. In the absence of a special agreement, general resolutions made by the shareholders' meeting need to be passed by 'half' of the votes held by the shareholders, and special resolutions made by the shareholders' meeting, such as resolutions on amending the articles of association, increasing or decreasing the registered capital, merging, dividing, dissolving or changing the form of the company, need to be passed by two-thirds of the votes held by the shareholders;
2, Voting rights are linked to the proportion of shareholding, "however, unless otherwise provided for in the articles of association."
Combined with the actual situation, startups often have multiple founders, coupled with the popularity of equity crowdfunding, it is possible that the core founder's shareholding may not reach the absolute controlling percentage.
Equity allocation program to end up in the business registration.
The capital contribution is the necessary basis for equity allocation, but not the only basis, the final accounting of the entrepreneurial equity allocation program is often inconsistent with the proportion of the capital contribution, some entrepreneurs will use the yin and yang agreement, on the one hand, signed an investment agreement to fix the true proportion of the equity, on the other hand, according to the proportion of the capital contribution to complete the business registration.
However, the legal risk of the above approach is very high, and once involved in litigation, not only is it difficult to protect the entrepreneur's shareholders' rights and interests, but it also consumes a lot of time and costs, resulting in the company's missed opportunities for growth. In this case, we can consider adopting the equity premium approach: first, the entrepreneurs sign an investment agreement beforehand, which specifies the actual capital contribution of each entrepreneur and the proportion of equity; then, the entrepreneurs carry out business registration in accordance with the confirmed proportion of equity and the converted capital contribution, and the shareholders' portion of the capital contribution exceeding the registered capital will be counted as capital reserve.
Use the equity buyback provisions of the LLC.
For startups, it is particularly important that shareholders are like-minded, so equity allocation needs to be considered in both positive and negative dimensions. This means that both the positive aspects of equity and incentives for entrepreneurs in the same boat***, as well as the negative aspects of equity recovery in certain special cases such as exit, divorce, inheritance, etc., should be taken into account.
The repurchase system is an important institutional way to balance the withdrawal of shareholders and the interests of the company, but the company law on the share repurchase of limited liability companies are restrictive provisions, so in the design of the repurchase provisions, attention should be paid to a few issues, first, the repurchase provisions are best carried out by the company designated by the other shareholders, and attention should be paid to the fairness of the repurchase pricing; the second is that the repurchase provisions of the scope of application to be able to cover the company's shareholdings The first is that the repurchase clause should be implemented by other shareholders designated by the company, and attention should be paid to the fairness of the repurchase pricing.
Options pools are better held by the core founders.
For startups, setting aside an option pool is not a new topic. Many entrepreneurs have not paid attention to the issue of option pools, and have either given them away early on when the option system was not yet in place, which in turn led to a lot of controversy, or caused unnecessary dilution of the core shareholders' holdings.
1, the option is essentially derived from the shares held by existing shareholders, but if the shareholders are dispersed by the proportion of the shareholders, it is difficult to unify the operation in the future, and easy to cause disputes and affect the implementation of the efficiency;
2, the option incentive under the system of limited liability company is quite flexible, the use of what positioning and program depends on the company's reality of the choice, the company should be in the company after the establishment of the matching option system for the implementation of the concrete
The option pool should indeed be arranged early on, by way of the proposed equity allocation program, it is divided from the shareholders, by the core founders together with the proxy, the other shareholders can be clear through the agreement on the nature of the proxy rights and disposal restrictions.
Innovative use of corporate law regimes.
The autonomy space of the company law is quite wide, entrepreneurs should fully utilize the autonomy of the constitution of the shareholders to establish their own equity allocation and dynamic adjustment program.
For example, some shareholders are willing to "pay a lot of money, accounting for small shares", then such shareholders can be used in conjunction with the use of agreements and articles of association will be the right to dividends, preferential subscription rights, the right to vote decoupled from the design of the shareholders in line with the needs and strengths of the shareholders of the shareholding structure; and then you can learn from the ideas of the capital instruments, the use of convertible preferred shares, liquidation preferences and other ideas to do the design of equity distribution. Preferred rights and other ideas to do equity distribution design.
The distribution of equity for startups is not inherently complex, but entrepreneurs should really pay a lot of attention to it. If you can spend a small amount of time in the early stages to rationalize the relevant issues, you can play a multiplier effect, helping the company's benign development.
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