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Startup Shares 101: Navigating the Complexities of Share Calculations
In the intricate world of startup finance, understanding share calculations is crucial. What seems like a straightforward counting exercise quickly becomes a nuanced exploration of different share types and calculation methods. Let's break down the three key ways startups measure their shares.
Startup Equity Compensation: The Basics
For startup founders and entrepreneurs, equity compensation is more than a recruitment tool. It builds an ownership culture, attracts top talent, and aligns employee incentives with company growth. Understanding the fundamentals of equity plans helps you design a structure that supports long-term success.
Corporate Conversion: Navigating Business Structure Transitions
As your business evolves, the legal structure that worked in your startup phase may no longer be the best fit. Corporate conversion - the process of transitioning from one entity type to another - can help align your company’s structure with your growth, funding, and succession goals.
Foreign Qualification: An Overview
Determining where your startup needs to qualify to do business can be a complex challenge, especially in an era of remote work and digital commerce. This memo provides critical guidance on understanding when and where your startup may need to qualify to do business.
FAQs
Open allWhat is the difference between a stock warrant and a stock option?
Warrants are typically issued to investors or lenders as part of financing deals, while stock options are usually granted to employees as compensation.
Does preferred stock always convert to common stock?
Preferred stock often includes conversion rights, especially during IPOs or acquisitions, allowing investors to switch to common stock if it provides better returns.
Why do investors prefer preferred stock?
Preferred stock reduces investor risk by guaranteeing certain returns and giving them priority over common stockholders in liquidation or acquisition events.
What is the main difference between common and preferred stock?
Common stock represents basic ownership with voting rights but no guarantees, while preferred stock provides investors with priority in dividends and liquidation.
What’s the most important thing to remember about dilution?
Dilution is part of the growth journey. A smaller slice of a much bigger company can be worth far more than a larger slice of a small company.
Do employees experience dilution too?
Yes. Employee stockholders are diluted just like founders and investors when new shares are issued.
How can founders minimize the impact of dilution?
By carefully planning equity allocations, using vesting schedules, and reviewing the cap table regularly, founders can manage dilution strategically.
Is equity dilution always bad for founders?
No. While ownership percentages decrease, the value of your shares may grow if the company’s valuation increases after a funding round.
What happens if my startup skips a 409A valuation?
You risk IRS penalties, employee tax liabilities, and potential challenges to the legitimacy of your equity compensation program.
Why is my 409A valuation lower than my investor valuation?
Investor valuations reflect potential future value, while 409A valuations reflect the fair market value of common stock today.
How often should a startup get a 409A valuation?
At least once every 12 months, and sooner if there are major business or funding events.
Why is a 409A valuation required?
It ensures your stock options are priced at fair market value, protecting employees and the company from IRS penalties.
How do RSAs and RSUs affect investors?
Both create dilution, but investors often prefer structures that are clearly documented and aligned with the company’s stage. RSAs may be easier at incorporation, while RSUs are common once valuation increases.
Which is more favorable for employees—RSAs or RSUs?
It depends on company stage. RSAs can be advantageous early on, while RSUs may be more predictable in later-stage or pre-IPO companies with higher valuations.
Do RSUs qualify for the 83(b) election?
No. Only RSAs (and certain stock options) are eligible for the 83(b) election. RSUs are taxed when delivered, typically at ordinary income rates.