Equity is a fundamental building block in fundraising for startups.

A shared ownership stake in a company creates the mechanism for distributing the results of a collective effort.

For investors, equity translates into the potential for a substantial financial return from the company’s performance. For founders, it’s about the tangible realization of their entrepreneurial dream, distributed to those fighting for it, be it employees, management executives, or other key stakeholders.

Today, we’ll take a quick look at why equity matters and what value it creates for both parties.

Why equity matters? — A two-way road.

"Equity investments are essential for numerous reasons.

Firstly, equities offer the highest long-term returns compared to other asset classes, such as bank deposits, bonds, and real estate. Secondly, for any investor building a diversified portfolio, allocating a portion of their capital to public or private company shares is crucial, as this does not limit the potential for high returns. Finally, equities are an excellent way to align the interests of various stakeholders, from employees to consumers and suppliers.

By owning shares, they share and amplify a company’s success, effectively becoming capital providers. It creates strong local companies aligned with national strategic interests and contributes to efficient and sustainable economic development. On an individual level, owning shares leads to the development of financial literacy, which, in turn, better allocates economic resources on a macro level.”

Says Mihnea Craciun, Managing Director at Endeavor Romania.

Investors approach equity strategically to maximize their financial gains while mitigating risk. They view equity as an investment opportunity, anticipating that the company's growth will increase the value of their stake. This potential for high returns is an attractive incentive for investors to support promising startups.

However, equity goes beyond mere financial rewards.

It grants investors a voice inside the company offering advice and guidance when needed and enabling them to bring a contribution through their expertise. This shared ownership fosters a sense of accountability and alignment of interests, ensuring that investors and founders work towards a common goal: achieving sustainable success.

For founders, equity instills a sense of ownership and responsibility, driving them to pursue excellence and strive for groundbreaking achievements. The prospect of financial rewards is a powerful motivator, encouraging founders to push the boundaries of execution and develop a successful business.

Equity also serves as a validation of the founder's idea and execution capabilities. Securing equity during the fundraising process signals to the market that the startup holds promise, attracting further investment and talent.

Founders can tap into the benefits of equity through employee stock option plans to attract top-tier talent, secure valuable partnerships, and expand their market reach.

Giving & receiving equity. 2x value-added.

"An African proverb says, 'If you want to go fast, go alone; if you want to go far, go together.' For an entrepreneur starting a startup, having a brilliant idea or identifying a perfect niche can give a great start.

For more sustainable and long-term growth, attracting valuable people and rewarding them through equity ownership programs could be crucial. Few things motivate better than having skin in the game, feeling directly the contributions to the company's success or the risks involved".

Says Sabin Galceava, angel investor and negotiation consultant, in the article About parents and angel investors

For investors.

• Access to capital: Equity allows investors to gain exposure to innovative ventures, providing them access to high-growth opportunities.
• Potential for high returns: Equity offers the prospect of substantial financial gains as the company's value increases over time.
• Dividends: Companies may also pay dividends to their shareholders, which are a portion of the company's profits distributed to its shareholders.
• Diversification of investment portfolio: Equity investment diversifies an investor's portfolio, mitigating risk and enhancing overall returns.
• Networking opportunities: Equity participation opens doors to valuable networking moments within the startup ecosystem.
• Impact on society: By supporting innovative startups, investors can contribute to societal progress and develop groundbreaking solutions to global challenges.

For founders:

• Access to expertise and capital: Equity funding provides founders access to the expertise, resources, and networks of experienced investors, accelerating their company's growth.
• Control: Equity ownership grants founders a say in the company's decision-making process, allowing them to shape its direction and ensure its vision is executed.
• Long-term commitment: Retaining a significant amount of equity, such as 50 to 70% of the company's total equity, makes founders to remain with the company for the long term, ensuring continuity and stability
• Flexibility and autonomy: Equity funding allows founders to retain flexibility and independence in managing their company, ensuring creative freedom and alignment with their vision.
• Alignment of interests with investors and stakeholders: Equity creates a shared sense of ownership and alignment of interests between founders and investors, fostering collaboration and collective success.
• Fulfillment of entrepreneurial aspiration: Equity allows founders to realize their entrepreneurial dreams, making a tangible impact on the world through innovative ventures.

Future thoughts

As we already saw, giving and holding equity in startups holds a dual promise.

This interplay of giving and receiving equity, underlined by shared goals and risks, forms the common ground of a thriving startup ecosystem.

Holding equity as a company founder, investor, or employee can undoubtedly lead to these stakeholders becoming future entrepreneurs and investors. The experience gained from being involved in a successful company and the financial resources acquired through equity ownership empower individuals to embark on entrepreneurial ventures or invest in promising startups.

The PayPal mafia serves as a prime example of this phenomenon.

Founders like Peter Thiel, Elon Musk, and Reid Hoffman have succeeded remarkably with their companies. Once they have reached a successful exit, they become active startup ecosystem supporters. Peter Thiel, Elon Musk, and Reid Hoffman have started investing in countless other startups and coaching founders and continue shaping today's technological landscape in one way or another.

In the startup world, we call this “The Mafia Effect,” and this shows the transformative power of equity ownership.

Read more articles about startups, financing, and equity ownership on our blog.