Fore a startup, equity distribution determines who controls the company, who participates in its growth, and how the relationship between co-founders and shareholders is structured.
These decisions carry long-term consequences for everyone involved, and our article covers the three main ways equity moves in an early-stage company and why proper legal documentation matters.
How equity moves in early stage companies
Equity in startups is mainly distributed:
- At incorporation
- Through new share issuances, or
- By way of transfer
It is rarely an ‘either or’ situation, and startups that go through rapid growth or significant pivots may utilise several or all three in a short amount of time.
Dividing equity at incorporation
When a company is first incorporated, the founders may agree on how shares are to be split among themselves. This initial allocation is reflected in the share allotment statutory forms and recorded in the register of members under the Companies Act 2016.
The split does not have to be based on capital aloneFounders regularly allocate equity on the basis of contributions in kind, such as:
- intellectual property
- technical expertise
- industry networks, or
- commitment to the venture (also known as sweat equity)
What matters is that the basis of the split is agreed and clearly documented between co-founders from the outset.
Issuing new shares to investors
When a startup company looks to raise capital, the most common mechanism is the issuance of new shares to the incoming investor, which dilutes the percentage holdings of existing shareholders proportionally.
The price at which new shares are issued may be derived from the company’s pre-money valuation and considering the nominal stamp duty it attracts. This is a practical consideration for any founder entering a funding round and is discussed in our article on 5 Company Valuation Methods for Malaysian SMEs.
New shares issued to investors can be ordinary or preference shares, depending on the terms agreed between the company and the investor, as each carries its own benefits and trade-offs.
Transferring existing shares
A share transfer is more commonly associated with bringing in a strategic investor. No new shares are created, and founder instead sells part of their existing shareholding directly to a new party.
Total share capital remains unchanged and other shareholders are not diluted. What changes is who holds the shares. Where a Shareholders’ Agreement is in place, the transfer must comply with any transfer restrictions it contains.
Finally, share transfers are subject to ad valorem stamp duty based on transaction value, a cost consideration founders and incoming investors should factor in when structuring the arrangement.
Maintaining a live cap table
Across all three scenarios, founders should maintain a current cap table: a record of who owns what shares, at what price, and since when.
As the company goes through funding rounds, share transfers, or the grant of options, the cap table tracks how ownership evolves and how each shareholder’s percentage is affected. A current and accurate cap table is also essential for investor due diligence.
The value of a Shareholders’ Agreement
Whether equity is distributed at incorporation, through new share issuances, or by way of transfer, a Shareholders’ Agreement provides the legal framework governing how shares are held, transferred, and protected. This applies to any company with more than one shareholder.
A Shareholders’ Agreement can customise the rules on share transfers, establish pre-emption rights, set out what decisions require shareholder approval, and provide founder protections that survive dilution across subsequent funding rounds.
Let ELP structure your startup equity
Whether you are dividing equity among co-founders, preparing for an investment round, or documenting a share transfer, we are experienced in providing startups in Malaysia with legal support, and can assist with the drafting and review of your underlying agreements. Contact us for an initial consultation.
