How to divide equity in a business between a founder and investor fairly

Often, an entrepreneur will have an idea that can transform an industry, but they lack the financial capital to make it happen. On the other side of the coin, there are no shortage of people searching for profitable opportunities in which to invest their extra cash.

Without the qualities that each party brings to the table, a business cannot happen. The real issue is this: how can one divide ownership of a business fairly between a founder and an investor? In this article, we will address the issues surrounding this thorny problem…

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Founders should retain the lion’s share of equity

Despite the assistance that venture capitalists provide a startup, the vast majority of the hard work will be done by the founder. In light of this, it would be a mistake to give away too much power and ownership of the business to a third party.

This isn’t to say that external investors aren’t important, but the founders should be careful to insert language in any agreement that protects their interests in the years that lie ahead.

No matter what happens, the founder should always have a majority equity stake, plenty of stock options, and a parachute clause to protect them financially from termination by an executive board.

Try to solicit convertible loans or debt financing from investors instead

When a founder is seeking out financial assistance from investors, the first approach should be to attempt to solicit convertible loans or debt financing rather than offering equity.

This tends to work more often than not, as both of these financing vehicles are more attractive to investors rather than having ownership in a company.

This is mostly due to tax issues surrounding equity stakes, which can result in a more substantial tax bill compared to the previously mentioned alternatives.

Hash out equity stakes before any money is accepted

If equity stakes are offered to a potential investor,  it is important that a concise agreement is agreed upon before any form of financing is accepted from an investor.

Most founders and investors have a great deal of separation when it comes to the financial worth of a business, as the entrepreneur behind it tends to have an inflated idea of the value that it brings to the marketplace.

These days, startups can have a practical value that is close to zero before any real money is made, so if  any cash offer is made by an investor,  it should be seriously considered:  just be sure to hash out a contract that makes ownership stakes and other benefits clear before receiving financial assistance from a VC.

Avoid investors that draft agreements that are legalese-heavy

While there are investors out there that want to help entrepreneurs grow their businesses, there are plenty more that are only in it for themselves.

The latter crowd drafts agreements that are heavy on legal terms which benefit them disproportionately, all in the hope that their potential victim won’t read the fine print.

Watch out for language that seeks to take veto and anti-dilution rights away from the entrepreneur, among other tricks.

Five reasons why gut feelings matter

Many business leaders have made decisions that they have regretted at a later date. On the surface, logical analysis suggested that it would be a smart play, but their inner voice felt that something was amiss.
Some may dismiss them out of hand, but there is a lot of evidence to suggest that so-called gut feelings aren’t just real, but they should also occupy a prominent position in every entrepreneur’s toolkit.

In this article, we will discuss five reasons why gut feelings matter, and how they can make a difference in any business…

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1) They fill the gap of incomplete information

It is almost impossible to have all the facts available when an important decision has to be made. In virtually all high-risk, high reward situations, there is an element of the unknown that must be embraced.

In the absence of certain facts, gut feelings can help protect a company from making a potentially disastrous misstep, or it can nudge it in the direction of a deal that will likely have a long term payoff for everyone involved.

2) They can sniff out unsavory and dishonest characters

As rewarding as the business world can be, there are a lot of pitfalls along the road to success.  While many are in business for the right reasons, there are plenty of bad actors looking to take advantage of every “sucker” they happen to come across.

It’s impossible to know the past history of every person looking to strike a deal, so it often comes down to what an entrepreneur thinks of a person, which is often based on the feeling that they are getting from them.

If they are acting shifty and seem to be hiding an ulterior motive, this bad gut feeling can be legitimate grounds for deciding to not enter into a business arrangement with a particular individual.

3) They are a highly productive engine of creative ideas

The logical and analytical side of the mind is great at what it does, but one thing that it struggles with is coming up with creative ideas.

When it comes to conceiving ideas that the world has not seen before, the gut feelings that lie within every capable business person is where they are generated.

The creative part of the mind is amazing at coming up with patterns that are likely to find resonance with certain sets of the population, so don’t be afraid to trust what it comes up with (so long as responsible analysis is done before implementation)

4) They shine when swift decision making is required

If only all decisions in life came with the requisite amount of time to make them properly. Many crucial choices have to be made at a moment’s notice; it is at these times when an entrepreneur’s intuition comes into play. A successful entrepreneur usually gets to where they are by listening to their gut. It’s important not to lose this 6th sense.