There’s no way around it; splitting up equity between founders is hard. At best, you’re making educated guesses.
Nobody can predict exactly who will provide what value to the company or whether past performance will translate into future performance in this particular startup venture. In addition to that uncertainty, you are also dealing with the ego and anxiety of founders on the brink of making a big life decision.
This article will help give you some guidance to inform the discussion between founders. There is no set formula. Ultimately, the best outcome is when founders mutually agree on a split that makes everybody feel valued, respected and motivated.
Considerations for Splitting Founder Equity
The ultimate goal of splitting equity among founders is to achieve fairness. Fairness means that each founder is appropriately compensated for their contribution to the company, both at launch and moving forward. However, fairness does not necessarily imply an equal split. Several factors should be taken into consideration when making this decision, such as the contributions of each founder, their experience and their role in the company.
The team must determine individual stock ownership early on to clarify roles, expectations, and establish a foundation for the future as the company grows and management roles are established. Founders can consider many other ways of splitting equity. Some factors to consider include:
- Founders’ experience and skills
- Founders’ contributions to the company
- Founders’ roles in the company
- Founders’ financial contributions
- Founders’ risk tolerance
- Founders’ expectations for the future
There is no one-size-fits-all approach to splitting equity. The best approach for your company will depend on your specific circumstances.
Methods for Dividing Equity
There are various ways to divide equity among founders. One method is to base equity on each founder’s contribution to the business. This may result in a founder who invests more time, money, or resources receiving a larger percentage of the equity. However, this method can be complex and lead to disagreements.
Another method is to split equity equally among the founders, which Y Combinator recommends to all their startups. Building a startup is a 7-10 year commitment, so differences in contribution that seem significant now are likely negligible in the long run. Startups succeed or fail based on execution, not some brilliant idea or piece of intellectual property on day one.
Additionally, it’s important to motivate the founders to build a great company, so they need to see they have an equal stake in the success. Otherwise, resentment can build, creating unnecessary founder conflict and demotivating the founders. The argument for splitting equity evenly boils down to the fact that all of the work is ahead of you and you want everybody to be fully invested in the process.
Ultimately, the decision on how to divide equity will depend on the specific circumstances of each startup and what works best for all parties involved. Founders should have open discussions about expectations and contributions before making any decisions about equity.
Focus on Contribution Not Percentage
When building a successful startup, it’s crucial to ensure that the team has the right mix of core competencies. While most founders may have deep expertise in a specific area, it’s important to recognize that a team with complementary skills is necessary to ensure the startup’s success. Equity is provided to incentivize contributions.
Focus not only on percentage ownership but also on contribution. Founders should prioritize individuals who are essential to expanding the size of the pie rather than solely focusing on the size of their own slice of the pie. Remember that the success of the startup depends on the success of the team as a whole. Therefore, founders should strive to create a collaborative environment where each team member’s strengths are utilized and valued. By doing so, the team can work together to achieve the startup’s goals and ultimately succeed.
Vesting Schedule for Founders’ Equity
In addition to deciding how to divide equity, it’s essential for every founder to have a vesting schedule. It is highly likely that one of the founders will not be working with the company 12 months after incorporation for various reasons— maybe they won the lotterly and want to go sit on a beach somewhere; maybe they are contributing less value than expected; maybe they’ve lost interest or maybe they realized that they just aren’t comfortable with the risk anymore. Whatever the cause, it is not in the company’s interest to let them leave with 20-30% of the company.
To avoid such a scenario, all founders should be on a vesting schedule that ensures they earn their equity over time. Vesting serves as both a reward and a motivator for founders. The reward is that the longer they add value to the company, the higher their stake in the company. The motivator is that if they are not adding value to the company, they will have less (or potentially no) ownership in the company.
A typical vesting schedule for a founder is a four-year vesting schedule with a one-year cliff. Implementing a vesting schedule can prevent potential issues and conflicts in the future. It ensures that all founders are committed to the company’s success and have an incentive to stay involved long-term. Additionally, it provides clarity and structure around equity distribution, making it easier for everyone to understand their rights and responsibilities. If you would like to learn more about vesting, click here.
Allocating equity among startup founders is a difficult process with no set formula. The goal is to achieve fairness and ensure that each founder is appropriately compensated for their contribution to the company both at launch and moving forward. Founders should consider a number of factors, such as their experience, skills, contributions to the company, financial contributions, risk tolerance and expectations for the future when deciding how to split equity. It is important to focus not only on percentage ownership but also on contribution. Additionally, all founders should be on a vesting schedule that ensures they earn their equity over time. The ultimate goal is to achieve a mutually agreed-upon split that makes everyone feel valued, respected and motivated.