Equity Calculators vs DIY Methods: Advantages and Disadvantages for Startup Founders

Startup Equity Calculators vs DIY Methods

What is Equity?

Equity refers to an amount of capital that signifies a portion of a company’s owners invested or owned. Issuing stock helps firms raise funds, attract investors, and build a solid basis for development.  Usually, it is distributed among founders, technical cofounders, investors, advisors, and employees in exchange for services or seed money using startup equity calculators or by DIY equity calculation. 

So, in short, equity is when a businessperson hands over a percentage of their company’s future earnings and growth in exchange for labor and financial support. In addition, Employees and investors who accept equity, do so in the hopes that the business will eventually succeed and they will be able to cash out with high returns in the future. 

Types of Startup Equity

There are various types of startup equity, some of these include –

1. Common Shares

An individual’s initial investment in a startup is known as common shares or common stock. Entrepreneurs offer venture capitalists common shares coupled with the right to a portion of the company’s assets. The people who own the common stocks of a startup are more involved in how the enterprise runs and carry a larger responsibility as the startup grows.

2. Stock Options

The second type of startup equity is stock options. It is a great way to grant equity to employees while the company is still growing. With stock options, employers offer employees the option to purchase stocks at a predetermined price based on fair market value. If an employee purchases stocks, they can enjoy the benefits from the company’s growth in due course of time, once they have met the holding requirements.

3. Preferred Stock

Preferred stock, which gives investors a share in the business but not the voting rights that owners of ordinary stock have, is another option available to startups. Individuals with preferred stock have a stronger claim to the assets of a company than those who own common stock. So, if a startup is liquidated, preferred stockholders are paid first, thereby receiving more financial security in exchange for less business control.

4. Angel Investors

Angel investors are like venture capitalists. They are wealthy individuals and private investors who usually invest their own personal money in startups, rather than from a capital firm. The advantage of angel investors is that they will provide a lot of money for the startup to grow but in return for their investment, they would often want a lot of control over the company.

Now that we know what startup equity is, let us check out the basics of startup equity calculation. 

How to Calculate Startup Equity?

Startup Equity Calculators

Simply put, the equity of a startup is the net difference between its total assets and its total liabilities. The formula for calculating shareholders’ or technical co-founders’ equity is:

Shareholder’s Equity = Total Assets – Total Liabilities

For example, the equity of a company with USD 1 million and assets and USD 500000 in liabilities is USD 500000 (USD 1000000 – USD 500000)

Startup equity forms the premise of examining a company’s net worth. This equity is the organization’s net worth, or the amount of money that would remain for shareholders if all liabilities were paid off and all assets were liquidated.

In the above formula, the calculation seems easy as the figures are simple. However, finding out the equity of a startup with complex figures and data can be quite challenging. In such a context, a startup equity calculator comes to the rescue. What is it all about? Let us find out!

Pros and Cons of Startup Equity Calculators

A startup equity calculator is a tool through which you can evaluate a startup’s equity. It can be used to negotiate with investors or venture capitalists and can help set employee compensation. 

Pros of a Startup Equity Calculators:

1. Clarity

A startup equity calculator provides transparency and clarity by helping you understand the potential value of your equity. It takes into account several factors, such as strike price, vesting, and the number of shares you are granted.

2. Data-backed Decision Making

An equity calculator is based on sound data, which helps make accurate and precise calculations. So, you can make informed decisions. Besides, it also helps to know the potential upside of your equity stake.

3. Fairness

The third benefit of startup equity calculators is fairness. These calculators ensure justice and equality by enabling you to compare offers across different companies. You can easily evaluate the percentage of ownership you are getting rather than just the raw number of options. The culmination is a fair and just equity distribution based on individual contributions, roles, and risks taken.

4. Standardization

An equity calculator standardizes the evaluation process by using the same methodology to calculate equity for different stakeholders. This helps quantify each co-founder’s contribution for a more accurate division of the equity in the company.

5. Usage

Last but not least, the startup equity calculator is easy to use.

Cons of a Startup Equity Calculators:

1. Oversimplification

Equity calculators can simplify complex scenarios. They offer an idealistic estimate and real-life outcomes may differ due to market fluctuations, company performance, etc.

2. Idealistic Equity Split

Founders and technical cofounder’s equity distribution is intricate and depends on an array of variables. Calculators may simplify by assuming equal splits and not accounting for unique and invaluable contributions.

3. Lack of Context

Calculators do not consider qualitative aspects and the contextuality of a scenario, such as team dynamics, company culture, personal fit, etc.

4. Static in Nature

Equity values change over time. However, startup equity calculators are static. They provide a stagnant snapshot, whereas reality evolves as the company grows and prospers. 

Pros and Cons of DIY Equity Calculation

DIY Equity Calculation

DIY or Do It Yourself equity calculation is when you manually and individually strive to devise the equity split for your startup. 

Pros of DIY Equity Calculation:

  • The primary benefit of taking the DIY route in equity calculation is that you are attuned to the dynamism of the process. 
  • You can take into account the unique contributions, roles, and responsibilities of each individual, including founders and investors, to come to a fair and strategically decided distribution. 

Cons of DIY Equity Calculation:

  • The major demerit of DIY equity calculation is, of course, the cumbersome mechanism. 
  • The process can be extremely grueling and time-consuming, and you might need extra helping hands.

Wrapping It Up

So, there we have it, an overview of the DIY v/s equity calculator approach and their pros and cons. The key is to use discretion and choose the route that resonates with your current situation. Moreover, even when you use an equity calculator, it is imperative to combine it with due diligence, negotiation, and a thorough understanding of equity terms.

By Harsha Nair

Harsha shares insights to help entrepreneurs navigate challenges in the startup world. Her blogs offer practical advice, strategies, and resources for business success.

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