editione2.1.1
Updated September 12, 2022Understanding the value of stock and equity in a startup requires a grasp of the stages of growth a startup goes through. These stages are largely reflected in how much funding has been raisedβhow much ownership, in the form of shares, has been sold for capital.
Very roughly, typical stages are:
Bootstrapped (little funding or self-funded): Founders are figuring out what to build, or theyβre starting to build with their own time and resources.
Series Seed (roughly $250K to $2 million in funding): Figuring out the product and market. The low end of this spectrum is now often called pre-seed.
Series A ($2 to $15 million): Scaling the product and making the business model work.
Series B (tens of millions): Scaling the business.
Series C, D, E, and beyond (tens to hundreds of millions): Continued scaling of the business.
Keep in mind that these numbers are more typical for startups located in California. The amount raised at various stages is typically smaller for companies located outside of Silicon Valley, where what would be called a seed round may be called a Series A in, say, Houston, Denver, or Columbus, where there are fewer companies competing for investment from fewer venture firms, and costs associated with growth (including providing livable salaries) are lower.**
βcautionβ Most startups donβt get far. According to an analysis of angel investments, by Susa Ventures general partner Leo Polovets, more than half of investments fail; one in 3 are small successes (1X to 5X returns); one in 8 are big successes (5X to 30X); and one in 20 are huge successes (30X+).*
βcautionβ Each stage reflects the reduction of risk and increased dilution. For this reason, the amount of equity team members get is higher in the earlier stages (starting with founders) and increasingly lower as a company matures. (See the picture above.)
βDefinitionβ At some point early on, generally before the first employees are hired, a number of shares will be reserved for an employee option pool (or employee pool). The option pool is part of a legal structure called an equity incentive plan. A typical size for the option pool is 20% of the stock of the company, but, especially for earlier stage companies, the option pool can be 10%, 15%, or other sizes.
Once the pool is established, the companyβs board of directors grants stock from the pool to employees as they join the company.
βtechnicalβ Well-advised companies will reserve in the option pool only what they expect to use over the next 12 months or so; otherwise, given how equity grants are usually promised, they may be over-granting equity. The whole pool may never be fully used, but companies should still try not to reserve more than they plan to use. The size of the pool is determined by complex factors between founders and investors. Itβs worth employees (and founders) understanding that a small pool can be a good thing in that it reflects the company preserving ownership in negotiations with investors. The size of the pool may be increased later.