Design
Equity Distribution 101
How to Start a Cap Table and Distribute Equity in an Early-Stage Holding Company (vs. Subsidiary Company)
Starting a capitalization table (cap table) for an early-stage holding company is a critical step in organizing ownership, determining equity distribution, and planning for future growth. The unique structure of a holding company—managing multiple subsidiaries or business ventures—requires careful consideration when distributing equity across the parent holding company and its subsidiaries. The approach to equity distribution can differ significantly depending on whether equity is shared at the holding company level or within individual subsidiaries. Below is a guide on how to start a cap table and best practices for distributing equity in both scenarios.
Part 1: Starting the Cap Table for an Early-Stage Holding Company vs. Subsidiary Company
1. Identify the Founders and Initial Stakeholders
Holding Company Level: Begin by listing the founders and initial investors of the holding company. Their ownership is in the parent entity, which holds controlling shares in its subsidiaries. In this model, founders and early stakeholders own equity in the parent company, which in turn owns the subsidiaries.
Example: If you, as a founder, own 30% of the holding company, and the holding company owns 80% of a subsidiary, your effective ownership in that subsidiary is 24% (30% of 80%).
Subsidiary Level: In some cases, founders or early investors may be given direct equity in individual subsidiary companies instead of or in addition to holding company equity. This can happen when a particular venture requires specialized skills or contributions.
Example: If you want to incentivize a co-founder for a specific subsidiary, they may receive direct equity in that subsidiary, which operates somewhat independently from the holding company’s ownership structure.
2. List Types of Equity
Holding Company Equity: The parent company typically issues common stock to founders and employees, while investors often receive preferred stock with rights such as liquidation preferences or anti-dilution protections. This equity represents ownership in the holding company and indirectly provides a share of all subsidiaries.
Benefit: Holding company equity aligns incentives across the entire portfolio of subsidiaries, providing broad exposure to growth across ventures.
Subsidiary Company Equity: Subsidiaries can issue their own stock if you choose to give specific individuals (e.g., subsidiary management) direct ownership stakes in that particular business. These shares may also come with different rights or preferences than holding company stock.
Benefit: Subsidiary equity allows key employees or investors to benefit directly from the success of a specific venture rather than the holding company as a whole. This can be useful if certain ventures are expected to outperform others.
3. Allocate Initial Ownership
At the Holding Company Level: Founders, investors, and employees can be allocated equity in the holding company, which then owns the majority of shares in the subsidiaries. This centralizes ownership and simplifies governance. Typically, you’ll keep 10-20% of equity in reserve for future employees and growth.
Example: If a holding company owns three subsidiaries, founders and early investors are likely to have an interest in the entire portfolio through their holding company shares.
At the Subsidiary Level: In some cases, equity can be directly distributed to key employees or co-founders within a specific subsidiary. This gives those individuals a direct stake in that entity rather than the broader holding company.
Example: A CTO hired to run a tech-focused subsidiary may receive 5-10% equity in that subsidiary but hold no direct ownership in the other ventures within the holding company.
4. Tracking Dilution and Future Rounds
At the Holding Company Level: As the holding company raises more funds and brings on new investors, the cap table will reflect the dilution of existing shareholders at the parent level. This dilution affects ownership in all subsidiaries indirectly.
Example: If a new investor purchases 10% of the holding company, they effectively own 10% of all subsidiaries.
At the Subsidiary Level: Subsidiary-level equity can be diluted independently if that subsidiary raises its own round of funding. This is typically more complex because you’ll need to manage equity structures at both the holding and subsidiary levels.
Example: If a specific subsidiary raises capital, the holding company’s ownership in that subsidiary will be diluted, but holding company shareholders may not be directly diluted in other ventures.
Part 2: Distributing Equity within the Holding Company vs. Subsidiary Companies
1. Determine Equity Allocations Across Ventures
Holding Company Level: In most cases, you will allocate equity at the holding company level, meaning founders, investors, and employees receive shares in the parent company. This provides them with ownership across the entire portfolio of subsidiaries.
Benefit: This approach ensures all stakeholders benefit from the success of the entire portfolio, spreading risk and aligning incentives across ventures.
Subsidiary Level: For key employees or co-founders of specific ventures, you may want to offer subsidiary-level equity. This means their stake is tied directly to the performance of a particular subsidiary rather than the whole holding company.
Benefit: Subsidiary equity can attract top talent to a specific venture by giving them direct ownership and a more focused incentive to drive that subsidiary’s success.
2. Creating Equity Incentives for Early Employees
Holding Company Level: An employee option pool is typically created at the parent level, allowing early hires to own equity in the entire holding company, thus benefiting from all subsidiaries.
Example: If the holding company has a 15% employee option pool, employees will have ownership in every subsidiary under the holding company’s umbrella.
Subsidiary Level: For employees critical to the success of a particular subsidiary, you may consider issuing equity only within that subsidiary. This creates a more direct link between the employee’s performance and the success of the venture they’re focused on.
Example: A COO of one subsidiary may receive options in that specific company, with vesting tied to its growth milestones.
3. Aligning Incentives Between Holding Company and Subsidiaries
Holding Company Equity: Equity distributed at the holding company level ensures that employees, founders, and investors are aligned with the overall portfolio strategy. The success of one venture boosts the value for all shareholders.
Benefit: This can reduce friction between subsidiaries, as stakeholders are incentivized to support the broader portfolio, knowing they benefit from any venture’s success.
Subsidiary Equity: In cases where key stakeholders are more focused on one venture, direct subsidiary equity can provide stronger motivation to excel within that specific business.
Benefit: This structure can make subsidiaries more agile and independent, as teams are fully dedicated to driving growth in their specific areas.
4. Offering Equity to Advisors and Consultants
Holding Company Level: Advisors and consultants may be given equity at the holding company level to ensure they are aligned with the overall growth of the portfolio. A common range is 0.5-2% for advisors.
Example: A strategic advisor who assists across multiple ventures may be better suited to receive holding company equity, as their impact will benefit the entire portfolio.
Subsidiary Level: If an advisor or consultant is brought in to assist with a specific subsidiary, you may allocate equity within that subsidiary. This is common when the advisor’s expertise is highly specialized to one area.
Example: A marketing expert brought on to help scale a consumer product subsidiary may receive equity in just that business unit, rewarding their focused contribution.
5. Investor Equity Allocation
Holding Company Level: Investors in the holding company typically receive equity in the parent entity, which owns shares in all subsidiaries. This simplifies their ownership stake and aligns them with the overall portfolio strategy.
Benefit: Investors share in the success of all ventures, allowing them to benefit from the portfolio’s diversification.
Subsidiary Level: In some cases, investors may prefer to invest directly in a specific subsidiary if they are particularly bullish on that business. This requires separate cap tables and agreements for each subsidiary raising funds.
Benefit: Investors can make targeted bets on the highest-growth ventures within the holding company, potentially receiving a higher upside from that specific venture’s success.
Part 3: Key Considerations for Equity Distribution in Holding Companies vs. Subsidiaries
1. Vesting Schedules and Cliff Periods
Holding Company Equity: Vesting schedules for holding company equity are typically standardized across the portfolio, usually a 4-year vesting period with a 1-year cliff. This ensures long-term alignment across all ventures.
Benefit: This helps create a unified culture where key employees, founders, and investors are focused on the overall portfolio’s success.
Subsidiary Equity: You may customize vesting schedules at the subsidiary level, linking vesting to performance milestones specific to that venture.
Benefit: This allows you to tie an individual’s equity more directly to the success of the subsidiary they are responsible for.
2. Dilution Protection and Anti-Dilution Clauses
Holding Company: At the parent level, anti-dilution provisions and pro-rata rights apply to the entire holding company’s portfolio of ventures. This protects early investors across all subsidiaries.
Subsidiary Equity: Anti-dilution provisions within subsidiaries can be tailored to protect investors or key employees specific to that venture, especially if a subsidiary raises its own capital.
3. Equity vs. Cash Compensation
Holding Company Level: Employees or advisors may receive a combination of cash and holding company equity, ensuring they benefit from the overall success of the portfolio. This is common when resources are constrained, and equity provides long-term upside.
Subsidiary Level: Employees working within a single subsidiary may receive cash and equity within that specific venture, especially if they are key to its growth.