The Equity Equation

July 2007

An investor wants to give you money for a certain percentage of
your startup. Should you take it? You're about to hire your first
employee. How much stock should you give him?

These are some of the hardest questions founders face. And yet
both have the same answer:

1/(1 - n)

Whenever you're trading stock in your company for anything, whether
it's money or an employee or a deal with another company, the test
for whether to do it is the same. You should give up n% of your
company if what you trade it for improves your average outcome
enough that the (100 - n)% you have left is worth more than the
whole company was before.

For example, if an investor wants to buy half your company, how
much does that investment have to improve your average outcome for
you to break even? Obviously it has to double: if you trade half
your company for something that more than doubles the company's
average outcome, you're net ahead. You have half as big a share
of something worth more than twice as much.

In the general case, if n is the fraction of the company you're
giving up, the deal is a good one if it makes the company worth
more than 1/(1 - n).

For example, suppose Y Combinator offers to fund you in return for
7% of your company. In this case, n is .07 and 1/(1 - n) is 1.075.
So you should take the deal if you believe we can improve your
average outcome by more than 7.5%. If we improve your outcome by
10%, you're net ahead, because the remaining .93 you hold is worth
.93 x 1.1 = 1.023.
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