Founder shares: mistake #1

by Kamal Hassan

So you’re going to start a company. You and your partners sit down and issue each other 1,000 shares each. Simple … right?

You’ve just committed your first business mistake.

If you are going to take other people’s money into your company, you just forced yourself to do a share split or revalue your shares as the company grows. This is extra complexity (and legal costs) for you.

The solution is simple: start with a few million shares.

The way to think through the math is like this:

  • take the price you would be happy to sell your company at if it works as you dream it will (e.g., $50 million)
  • the share price at that time should be a few dollars per share, e.g., $5.00 (look at public company share prices)
  • so the company will have 10,000,000 shares issued when it is told
  • when you sell the company, the founders may own, e.g., 40% of the company
  • that means founders will have 4,000,000 shares when it is sold … so start with 4,000,000 founder shares today

You can easily change this calculation to match your plans for your company. In most cases, high growth entrepreneurs will end up with numbers in the millions.

What happens if you ignore this advice and issue 1,000 shares to start?

Well, let’s assume that you do an A round of financing raising $2M for 30% of your company, where before the financing the founders still own 80% of the company. At this point your 1,000 founder shares will be worth around $3.7M ($2M / 30% * (100-30%) * 80%).

That means each share is worth $3,700.

If someone wants to invest $10,000 in your company, they can only invest exactly $11,100 and in return you will give them 3 shares. You can see how that becomes very awkward, very quickly.

So do yourself a favor: start by issuing a few million in founder shares.