Startup equity: design the terms, not just the percentage

Startup equity is ownership in a company—or, for instruments such as options, a right to acquire ownership. A percentage alone does not tell you what someone owns, when they earn it, how much it costs to acquire, or what they could receive in a sale.

For founders, the task is to make those terms coherent across the founding team, hiring plan and financing strategy. This guide uses venture-backed corporations as the model; the legal and tax details below are specifically US-oriented, not universal rules.

Start with the instrument

“Equity” can describe materially different arrangements:

Instrument	What the recipient gets	What to clarify
Common stock	An ownership stake, often used for founders	Vesting, repurchase rights, voting rights and transfer restrictions
Stock option	A right to buy shares at a specified exercise price	Grant size, price, vesting, expiration and departure terms
Preferred stock	Ownership with negotiated preferential rights, typically issued to investors	Liquidation preference, conversion and voting protections
SAFE	A contractual right to future shares, rather than an immediate stock issuance	Conversion terms and dilution under the actual agreement

Carta explains the distinction between common stock, preferred stock and options. Y Combinator’s SAFE documentation describes how its instrument converts into stock in a priced financing.

Do not describe an option grant as shares already owned. Likewise, do not assume two people with the same ownership percentage have the same economic or governance rights.

Allocate founder equity around future responsibility

Before negotiating a split, write down each founder’s expected commitment: full-time start date, operating responsibilities, cash contribution, existing work or IP contributed, and the risks each person is taking.

For a technical team, “built the prototype” and “will own engineering, recruiting and production reliability for years” are different contributions. The split should reflect the company you intend to build, not only work already completed.

Y Combinator’s Michael Seibel recommends equal or near-equal splits for genuine co-founders, arguing that founders often overweight early work. Treat that as a starting principle, not a rule for someone joining part-time or with substantially different responsibilities.

Separate ownership from decision-making. Document how operating decisions, board appointments and disagreements will be handled rather than expecting the equity split to answer every governance question.

Use vesting to address departure risk

Vesting determines when a recipient earns the right to retain shares or exercise options under agreed terms. Founder stock may already be issued but remain subject to company repurchase rights while unvested.

Seibel describes four-year vesting with a one-year cliff as a typical Silicon Valley arrangement: 25% vests at the first anniversary, followed by monthly vesting of the remaining grant over the next three years.

For founder stock, ask counsel to document the company’s rights over unvested shares, any credit for prior service, and what happens on departure or acquisition. See the mechanics of cliff vesting before adopting a schedule.

Turn hiring equity into a budget

An option pool is a reserve for future grants, not an additional founder or investor. Size it from the hiring plan: roles needed before the next financing, proposed grants, refresh grants and a justified buffer. Carta’s option-pool guide recommends this bottom-up approach rather than choosing a percentage by default.

For every offer, communicate:

• The instrument and proposed number of shares or options.
• The percentage on a stated, dated fully diluted basis.
• What that denominator includes, including the unallocated pool and treatment of convertible instruments.
• Vesting, exercise price where applicable, and the deadline to exercise vested options after departure.
• Whether the grant has received the necessary approval.

An offer letter promising options is not the same as a formally approved option grant, as Carta notes. Avoid promising a fixed exercise price before the approval process is complete.

Keep advisor grants separate from employee hiring assumptions. Define the work and relationship first; the startup advisor guide covers compensation and exit terms.

Model dilution before accepting capital

Ownership percentage = holder’s shares ÷ the relevant total share count.

The denominator matters. Carta’s equity guide recommends comparing grants using fully diluted ownership rather than raw option counts. For an option grant, use the underlying share count to calculate potential ownership—not shares already owned. Specify the calculation basis; “1%” without it is incomplete.

Consider a simplified priced round, with no SAFEs, notes or pool expansion:

• The company raises $2 million at an $8 million pre-money valuation.
• Post-money valuation is $10 million.
• The new investor owns 20%; existing holders collectively retain 80%.
• A founder’s 60% stake becomes 48%.
• A subsequent round selling another 20% reduces that stake to 38.4%, assuming no other changes.

Pool increases add another effect. A pool top-up included in pre-money capitalization dilutes existing holders before the investment; a post-investment increase spreads dilution across holders, including the new investor. Carta explains this distinction.

Request a post-financing ownership model that includes every convertible instrument and the proposed pool—not just the headline valuation. The cap table guide covers the modeling workflow.

Ownership is not the same as exit proceeds

Suppose one investor has invested $2 million, owns 20% on an as-converted basis, and holds a 1× non-participating liquidation preference. All remaining shares are common. The company sells with $5 million available for shareholders, after debts and transaction costs, with no other preferences or adjustments.

The investor chooses between its $2 million preference and converting to common for 20% of $5 million, or $1 million. It takes $2 million. Common holders collectively receive $3 million, not the $4 million implied by multiplying 80% by the sale proceeds. Cooley explains this preference-versus-common payout choice: non-participating preferred holders do not receive both.

Model downside, middle and upside exits. For options, also account for exercise costs and taxes. A financing valuation is not cash available to the recipient.

Close the paperwork and tax loop

Before issuing equity, have counsel confirm the approvals, agreements and applicable securities-law requirements. Keep the cap table aligned with the executed documents.

For US taxpayers receiving substantially nonvested stock for services, discuss a Section 83(b) election immediately. It can change when income is recognized, but it is not automatically beneficial. The IRS Form 15620 instructions specify filing no later than 30 days after the property transfer, with a next-business-day rule if the deadline falls on a weekend or legal holiday. Cooley explains the potential downside if value falls or shares are forfeited.

Before making an equity promise, be able to answer four questions: what instrument, what calculation basis, what vesting terms, and what cash or tax exposure? That is a more useful offer—or financing discussion—than a percentage on its own.