Starting a company is a fine balance of risk and reward. You’ve most probably left a salaried job, and are using your savings to start building your vision. After bootstrapping your business to this point, you raise funds to accelerate growth and development. Bootstrapping founders often don’t pay themselves a salary. But what happens once there’s cash in the business post-funding? And how are founder shares fairly distributed to ensure the early investors and founders are aligned?
We’ve run the numbers on SeedLegals to find out. By leveraging data points collected from hundreds of UK funding rounds on our platform, and with circa 50% of our user-base raising their first and second funding rounds, we’re excited to share this snapshot into early stage funding deal terms.Here’s a look into what’s being agreed behind the scenes in these early, but crucial, first investment negotiations.
To Salary or Not to Salary?
During term sheet negotiations, founders and investors agree how much the founders will be compensated. Most of the upside is always in the form of founders’ shares, but most founders will also receive a salary. Paying founders a salary means that they won’t need to moonlight and can stay focused on growing the business. On the flip side, extra capital available for growth and development can go a long way to boosting the business forward in the early stages. This is what our users are deciding in their first funding rounds:
Our data shows that the decision to take a salary very much depends on the size of the round. For rounds of £150k or below, around half of founders secure a salary. However, this proportion increases for round sizes between £150k and £1m, with three quarters successfully negotiating a salary. Interestingly, this proportion remains consistent above the £150k inflection point, whether the round size is £200k or approaching £1m.
Founder Salary vs. Company Valuation
Once it’s agreed that the founder will earn a salary, we’ve uncovered that the amount is significantly correlated with the valuation of the company. You might have fun using our results to predict your own salary! (Or for investors, founders salaries). The results: For every £100,000 increase in valuation, founder salary tends to increase by roughly £1300 per year.
Founder Shares & Vesting
Another key point in term sheet negotiations is the question of how much equity the founder still owns after the investment, and the conditions those shares are subject to. It’s in the investors’ interest after all to ensure that founders stay within the company, and not walk away with a sizeable chunk of the equity rendering the company essentially un-investable for future rounds. On the other side of the table however, founders have worked hard to build their company from the ground up. The question of ownership is a hotly debated issue. A common way to satisfy both parties is the use of founder share vesting, where both founders and investors agree that part or all of the founder(s) shares be withheld for a certain amount of time after the investment. The ‘vesting period’ is the length of time it’s agreed that the founder(s) needs to stay in the company in order for their shares to be fully returned to them.
So, how common is founder share vesting in early stage rounds? For pre-series A deals, our data shows that two thirds of deals include founder share vesting in the term sheet, with the majority of those agreeing to a 3 year vesting period. Interestingly, we also found out that the inclusion of founder share vesting was not correlated with whether or not the founder will earn a salary post-investment.
During the vesting period, shares are returned to founders bit by bit, usually on a monthly or quarterly basis. However sometimes a delay is built into the vesting schedule, called a ‘Cliff’, where the first tranche is only released after an agreed period of time. This is designed to ensure founders are committed to staying in the company for at least the initial Cliff period, since they would otherwise leave the company without any shares vested. Our data shows a third of funding rounds include a cliff period in vesting schedules, and of those the vast majority opt to do the first share release at the 12 month mark.
The date at which the shares start to vest is also agreed in the term sheet. Vesting usually commences on the date the investment closes. However our data shows that 40% of the time, founders and investors agree that the fairest start date is prior to the funding round, selecting either the date the founder joined the company, or the date that the company was incorporated. Counter-intuitively, we also noticed that the earlier the date from which shares start to vest, the longer the ‘vesting period’. So, if you ask for your investor for your vesting to start earlier, expect them to push for a 3 to 4 year vesting period.
Solo Founder vs. Co-Founders
Our data also allows us to survey the startup scene for wider trends, and we thought we’d leave you with one that we thought was particularly interesting. Whilst solo founders account for a relatively high percentage of early stage funding rounds, it seems that investors might favour businesses with two founders over one: