January 02, 2006

How many founders and angels is too much?

Will Price provides a VC's perspective:

On Founders:
A typical Series A sees the following equity ownership distribution: VC syndicate 50%, option pool 20%, founders 30%. Each subsequent financing will see founders diluted by roughly 20% per financing, such that after three rounds the founder shares represent 30%*.8^2, or 19.2% of the company. The per founder math is very simple - founder shares/# of founders. It almost seems redundant to state that too many founders can greatly impact the downstream economics of the founders, however, I have seen very smart, experienced founding teams launch with 5-6 founders and come to realize later that the per founder ownership in the entity creates real incentive problems. The VCs will rarely take less than 40-50% of a Series A and the pool is almost always 20%. Therefore it is important to think through the distribution of the remaining shares to ensure that each member of the team is truly required to get the company off the ground. Teams of 2-3 founders seem to be the norm and cap table issues, questions about equity (wrt fairness), often arise if the team gets much bigger.

On Angels:

All things being equal, the number of common shareholders is inversely proportional to a VC firm's interest in funding a company. The brutal reality of company formation is that often one must take capital from as many angels as necessary. While a small number of qualified angels can add needed runway and perspective, too many angels creates shareholder issues that may impact downstream financings, acquisitions, and legal liability. In raising angel money, try to limit the number of investors required to hit the financing target. When shareholder consents are required - financings, acquisitions, etc - the logistics of rapidly getting approvals can be problematic. I have seen some buyers require full shareholder consents, even if not legally necessary, in order to limit downstream problems relating to minority shareholder lawsuits.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.