Because most startups will be financed by one of several different methods—venture capital, loans, or stock sales—an equity agreement is essential. The inherent risks involved in a new business usually means that whoever is financing it will want a degree of control and equity in any assets. An equity agreement will clearly state the amount of equity granted to the financer, its cash value, how the new entity will be able to redeem the financer’s equity, and at what point the entity may issue new shares that may dilute the financer’s equity.
A critical part of the equity agreement is setting the amount of actual control that the financer will be able to exercise on corporate decisions and for how long. Often, a venture capitalist will want control directly proportional to the percentage of equity. Because the equity agreement has a vast effect on the new entity, care must be taken in the drafting, and the agreement should be tailored to the particular entity’s needs. Many law firms that are involved in setting up new companies will have model equity agreements on hand.
Many venture capitalists may require their own equity agreements. It’s critical that entrepreneur understand exactly how the agreement will effect their company. An hour spent with a corporate attorney to review the document is a sound investment.