Best Practices in Equity Management for Growing Businesses

As founders, effective management of your company’s equity is vital. Good equity management involves carefully handling ownership stakes in the company to ensure all parties’ rights are fair and transparent. This practice helps key stakeholders maintain control over the company’s direction. Clear and well-documented equity management can also help you prevent disputes, secure investment, and attract talented employees. Poor equity management can lead to disputes, loss of control, and potential financial difficulties. This article will explain several best practices in equity management that reduce the risk of legal disputes and encourage stable growth. 

What is Equity Management?

Equity management refers to the processes and practices of handling ownership shares within a company. For founders, this includes determining how to allocate shares among:

• yourself and your co-founders; 
• your company’s employees; and 
• its investors.

Proper equity management is essential for several reasons. The following table outlines some of these reasons.

For instance, consider a startup with two co-founders and several early employees. Without a clear equity plan, there can be confusion about ownership percentages that could lead to disputes and dissatisfaction. A well-structured equity plan detailing share distribution among both founders and their employees can help prevent such issues and align all parties with the company’s goals.

Best Practices in Equity Management

1. Define the Equity Structure Clearly 

Establishing a clear equity structure as early as possible, ideally from the beginning of your startup, is vital. You should decide on the types of shares and how you will allocate them, communicating and documenting these details clearly to avoid misunderstandings. 

For example, you might specify that founders hold 60% of the equity between them while early employees receive 10%, setting aside the remaining 30% for investors in early funding rounds. 

2. Create and Maintain an Equity Management Plan

Equity plans outline how companies will manage, allocate and vest equity. It is critical to remember that your company’s equity distribution is likely to change over time. For example, as you go through each funding round, you will acquire new investors, and your company’s ownership structure will evolve. 

For this reason, you should regularly update your equity plan to reflect such changes. Doing so helps to track ownership changes and maintain transparency. A robust plan that considers potential future changes will also help you manage the risk of equity dilution. 

3. Use Vesting Schedules 

You can implement vesting schedules, which enable parties such as founders and employees to earn their shares over a set period. For example, a vesting schedule might allow parties to earn their shares over four years. This schedule can motivate founders and employees to remain with your company long-term by preventing individuals who depart prematurely from receiving their total share allocation. 

4. Use a Shareholders’ Agreement 

You should draft a comprehensive shareholders’ agreement. This document is a legally binding agreement you will share with your company’s shareholders. It should specify the terms for buying, selling, and transferring shares.

Seeking legal advice about your shareholders’ agreement is a good idea. An expert lawyer can review your existing agreement or draft one for you. Legal advice can help mitigate risk in your equity management approach and ensure this foundational legal document is legally sound. 

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Key Takeaways

Effective equity management is vital for the smooth governance of your startup business. You can avoid potential conflicts and ensure fairness among shareholders by:

• defining equity structures as early as possible;
• creating detailed equity management plans;
• using vesting schedules; and 
• keeping shareholder agreements up-to-date in line with changes in your company’s ownership structure. 

It is a good idea to seek professional legal advice to support your good equity practices further. If you require legal advice about equity management in your business, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

Frequently Asked Questions