How to distribute shares in an Internet start-up: The market

A friend of mine states that, when differences have to be resolved with fairness and equity criteria, “external legitimate criteria”, i.e. objective criteria external to the interested parties, should be used. Here we go.

The entrepreneur’s response

Charlie Tillett was CFO of NetScout for 10 years. Before leaving the company in 2000, he completed two rounds of financing for 6 and 45 million dollars and the IPO in August 1999. He now provides advice to technology start-ups. In 2003, he gave a presentation at MIT, which summarizes much of what he learnt and which I believe is excellent. According to Tillett, the percentages at the time of the IPO were something like this:

  • Founders: 35.1%
  • Key employees: 5.3%
  • Stock plans: 3.5%
  • Advisors: 1.1%
  • Investors: 55%

If you are interested in a more in-depth view of these numbers, I have put the presentation data in this spreadsheet, which describes how the percentages change during the financing rounds. Two scenarios are included:

  • Scenario 1: A company receives 570,000 dollars from business angels and 5,700,000 dollars in a first round from venture capital investors. This is the case described above.
  • Scenario 2: A company receives three rounds: 745,000 dollars, 7,450,000 dollars and 7,450,000 dollars.

The investor’s response: key employees and stock plan

Guy Kawasaki is a former Apple evangelist who converted into a VC with Garage Technology Ventures, a venture capital firm in Silicon Valley. He is author of the famous book “The Art of the Start“, and talks regularly on entrepreneurship in his blog and at presentations around the world.

Kawasaki wrote a post recommending a range of percentages for “key employees” and “stock plans” in a company that raises a first round of 1-3 million dollars and has no more than 15 employees:

Key employees:

  • CEO (“adult supervision” brought in to replace the founder): 5-10%
  • Vice-presidents: 1.5-3%
  • Architect (the “main” (wo)man, though an individual contributor): 1-1.5%

Stock plans:

  • Senior engineers: 0.3-0.7%
  • Mid-level engineers: 0.2-0.4%
  • Product managers: 0.2-0.3%

Kawasaki advises not to just latch onto the top end of the range but to consider the salary, cash bonuses, geographic location and, most importantly, the perceived value. If you notice, you’ll see that those percentages are in line with Tillett’s percentages in a similar company phase. Other influential factors are entrepreneurs’ training, their “star” status and the company’s performance. For example, the standard for a veteran CEO at Silicon Valley is 10%. However, Pierre Omydiar, the founder of eBay, hired Meg Whitman as CEO for 6.6% (eBoys, page 58). Larry Page and Sergei Brin, founders of Google, hired Eric Schmidt as CEO for 6%. Niklas Zennström and Janus Friis went further and did not hire a CEO and distributed only 1% among their 150 employees. Nevertheless, when the size of the pie (sale of eBay) was 2.6 billion dollars, plus 1.5 billion dollars if certain objectives were met, the employees are unlikely to harbor a grudge.

The investor’s response: Board and advisors

Brad Feld is another VC with a blog. He works at Mobius Venture Capital where he has invested in (and is member of the board at) companies such as FeedBurner and NewsGator (he seems to have a soft spot for RSS ;) ). He writes about concentrating on the reward for board members and the advisory board. Again, his recommendations are similar to those in Tillett’s presentation:

  • Board: from 0.25% to 1% vesting annually over 4 years per board member and single trigger acceleration in the event of a change of control. Vesting means that the person does not own the shares but has the option to acquire them at a symbolic price at a specific time. Assume that board members receive 1% with an annual 4-year vesting. Each year they can exercise their option to acquire 0.25%. If they leave the company before the term ends, they lose their unvested options. Acceleration means that they can exercise all their options once in the event that the company changes control (e.g. the company has been sold or floated). Board members should understand those terms clearly and not receive cash compensation (only reimbursement for expenses incurred on behalf of the company) and they should be given the opportunity to invest in each financing round under the same conditions as venture capital.
  • Advisors: there are no figures. This will depend on the value perceived for their contribution. Their contribution is smaller than that of a board director and, therefore, their percentage is also smaller. Feld recommends not using vesting with advisors. Since they tend to provide a larger contribution at the start, it is better to deliver shares (not options) for a year and reassess the situation annually in order to ensure that the relationship maintains the expectations of both parties.

Tomorrow: How to distribute shares in an Internet start-up: Google

By David Blanco
Saved in: Entrepreneurs, Internet, Venture Capital | 2 comments » | 14 October 2006

2 comments in “How to distribute shares in an Internet start-up: The market”

[...] This ends the series of posts on “How to distribute shares in an Internet start-up“. There is no (and there will never be any) single answer since the actual percentage will depend on the company, the perceived value of the collaborator/investor, the stage at where the company is, and your ability to negotiate. However, we detect certain correlation in the answers from Charlie Tillett, Guy Kawasaki, Brad Feld and the Google case. Using external objective criteria gives a very useful pattern for establishing realistic expectations for everyone and increasing the likelihood of an agreement. [...]

[...] Tomorrow: How to distribute shares in an Internet start-up: The market [...]

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