Understanding Startup Equity and Funding: A Critical Insight for Investors and Employees

When considering offers for equity in a startup or a house, it is crucial to seek comprehensive information about the funding structure and valuation. This knowledge is essential, especially for equity in a business, which is an investment carrying an expectation of income and profit.

Investor Mentality vs Employee Mindset

When joining a startup, you can adopt an investor mentality, which involves reviewing all historical capital contributions and valuations, assessing product stages, customer quality, management team quality, and market attractiveness. This approach ensures a thorough understanding of the company's potential and risk. Alternatively, you can simply accept pay in equity and hope for the best, which aligns more with an employee mindset.

Investor-Level Due Diligence

As an investor, you are entitled to conduct a full due-diligence review, including examining financial records and the company's capital structure. You should seek information about the company's funding rounds as well. For example, asking to see the investor pitch deck or an executive summary can provide valuable insights.

When offered shares or options, you should inquire about the number of outstanding shares, both now and after all incentive shares are given out. This will give you a better understanding of your ownership stake and the overall valuation.

Questions to Ask: A Balanced Approach

To balance the request for information, it's important to be mindful of potential pushback. Here are some reasonable requests to make:

Investor Pitch Deck: Ask to hear or have a copy of the investor pitch deck or executive summary. This document typically outlines the company's growth strategy and financial plans. Outstanding Shares: Request the total number of outstanding shares and the number after all incentive shares are distributed. Divide your shares by the total to determine your ownership percentage. Board Composition: Inquire about the board members and whether a single individual or entity holds a majority stake. Additionally, ask about institutional investors and their stakes, then research them online. Number of Shareholders: Ask about the number of shareholders to get a sense of the company's growth and stability.

These questions are designed to provide a plausible deniability and do not necessarily require detailed information about individual shares and valuations. After the fifth round of funding or if the company recently closed a funding round, you can ask for specific disclosures.

Conclusion

While seeking investor-level information about funding rounds and equity valuation is crucial, it's essential to be tactful and understand the potential pushback. By asking for information in a balanced and reasonable manner, you can gain valuable insights into the startup's dynamics. Remember, gaining this knowledge can help you make informed decisions about your involvement and the potential for future returns.