In the previous issue, we explored how a cap table records who owns what in a company. But before a cap table can be maintained, there has to be a decision about how that equity is divided in the first place. That decision (equity allocation) is one of the most consequential a founding team will make, and it is often made quickly, informally, and without a clear framework.
Equity is a tool for aligning interests, retaining and rewarding the people who helped build the company. Getting it right from the start is far easier than correcting it later.
Usually, equity is distributed across three main groups: founders, employees, and investors. Each group has different expectations, time horizons, and involvement with the company’s growth.
Founder Equity
How founders split equity among themselves is usually the first equity decision a startup makes. Equal splits are common because they feel fair, but they do not always reflect the reality of who is contributing what, or for how long. A few questions worth working through before locking in a structure:
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- Is one founder working full-time while another has a day job?
- Who originated the core idea versus who is executing it day to day?
- Are contributions likely to shift as the company matures?
Whatever the split, it should be accompanied by a vesting schedule, typically four years with a oneyear cliff. This means no equity is earned in the first twelve months; after that, it vests monthly or quarterly. Vesting protects the company and the other founders if a co-founder walks away with a large stake after a minimal contribution to the company. Without it, an early departure can leave the cap table permanently encumbered.
Common friction points include verbal agreements about splits that are never formalized, vesting schedules added as an afterthought, and acceleration provisions that are agreed upon informally but never properly documented.
The size of the founder’s stake is an important signal for investors, ensuring their commitment with the long term success of the company.
Employee Equity
Equity is one of the primary tools for attracting and retaining employees. Most startups create an Employee Stock Option Pool (ESOP) to reserve equity for future team members. At seed stage, this typically represents 10–15% of the fully diluted cap table (as explained in our first edition). Sizing the pool correctly is essential. Too low and it is exhausted quickly, requiring a dilutive top-up at an inconvenient moment. Too high and it dilutes existing holders without providing a corresponding benefit.
Options (the most common form of employee equity) give the holder/employee the right to buy shares at a fixed price in the future. They vest over time, just like founder equity, and they only become valuable if the company’s share price exceeds the exercise price at the time of exercise. Frequently overlooked issues include granting options without formal board approval, setting an exercise price that is difficult to defend, and failing to explain to employees in plain terms how their options actually work — and what conditions must be met for them to pay off.
Investor Equity
Investors receive equity, in shares or as a right to receive shares, in exchange for capital. As we explored in the Cap Table Issue, the investments dilute existing shareholders. Founders sometimes focus heavily on the valuation at which investment comes in while underestimating the dilution effect downstream
Modeling the cap table after conversion — including the option pool and all outstanding instruments — gives a clearer picture of what the post-investment structure actually looks like. A SAFE that seems small at signing can represent a meaningful slice of ownership once it converts in the context of a round with multiple investors.
A Simplified Equity Allocation: Seed Stage
| Holder | Security Type | Typical Range | Key Consideration |
|---|---|---|---|
| Founders | Common Stock (Vesting) |
50–70% | 4-yr vest / 1-yr cliff |
| Employees (ESOP) and Early Advisors |
Options for Common Stock |
10–15% | Pool sized to hiring plan and formalize |
| Seed Investors | SAFEs / Priced Round |
15–25% | Model postconversion dilution |
Maintaining Discipline Over Time
As previously stated in the Cap Table Issue, as a company raises capital, hires team members, and brings on advisors, the equity structure evolves. Staying on top of a few habits tends to prevent the most common problems:
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- Avoid the promises. Equity commitments made informally, for example in a meeting, over email, or in a conversation, but never documented rarely hold up cleanly. Every equity promise should be tied to a formal grant agreement, a vesting schedule, and a board approval.
- Apply the changes immediately. Whenever a grant is approved or a new instrument is signed, the cap table should be updated at the same time. Waiting until a financing event to reconcile these items converts a simple administrative task into a time-consuming reconstruction exercise.
- Model before you commit. Before granting a block of options or signing a fundraising instrument, running a simple scenario — what does the cap table look like after this? — takes a short time and can reveal effects that are not immediately obvious.
- Size the option pool to your actual hiring plan. Expanding the pool later is possible, but it typically requires board approval and creates dilution. Building in enough runway from the start avoids that conversation at an inconvenient moment.
In the next article, we will turn to fundraising instruments (such as SAFEs, convertible notes, and priced rounds) and explore how founders can evaluate them with the right questions in mind.
