How to Split Equity Among Founders?Posted by: Mariya Parackal | On: 13th Oct, 2020 | Startup
One of the major issues faced by many founders at the start of their startups is to decide how to split equity among the founders. There could be thousands of questions that come into mind and would make it even harder to come to a decision. This becomes more complicated if you join hands with family and friends.
The very subject related to splitting equity amongst co-founders may lead to a major source of conflict in the coming future. Once your startup starts getting higher valuations. That is the reason that most of the co-founders decide on, how to split the equity into the early stages itself. These decisions have a lasting effect on the company and the co-founders. The split should be fair enough, to avoid complications in the future.
The Basic Mantra is Fairness
With changing times, personalities, different ways of working styles, and issues about the contribution which emerge on a high note. One founder may be providing higher funds while on the other founder might be spending more hours on the business. Here the question pops up is how to distribute equity?
The person who is spending 60 hrs a week may have a comparison with the person who is spending just 40 hrs a week on the company. So the bigger question is, is it fair? Don’t be greedy. Greed and fear have killed more startups all other reasons combined. The former person may feel that he/she is more committed and should be making the final decisions for the company.
As it is quite evident that the equity split determines the decision making power of the co-founder. If the split is equal among co-founders it will call for consensus. As the question is about fairness, this may put the founders in a dilemma, they might be unable to resolve issues, which may jeopardize the running of the business in a negative manner.
These all dilemmas would lead to resentment and frustrations will rise, which will lead to confusion, and the team as a whole would become dysfunctional.
Common Issues Faced
These are the common issues faced by co-founders as in when the question to decide upon equity comes into the picture:
- I was the very first person who came up with the idea to start up the company, so I must get more equity.
- We decided on a certain percentage of the split at the beginning itself.
- I started working on the project way before we started the company.
- I did not draw any salary until now, whereas my co-founder did draw a salary.
- I was working hard and as a full-time, while my co-founder started working late and part-time only.
- I am wiser and experienced than my co-founder.
- The capital was raised very early, and my co-founder came into the picture later.
- My co-founder came in after my MVP was launched.
Many founders make the mistake of splitting the equity on the work done when the startup came into being. The variations in the early years should not have a major impact on the equity splits in 2-10 years of span.
It is very prudent to have a vesting period for cofounders to earn their equity. A period of 2-6 years is common. If founders are drawing less salary from the market rates, treat the difference as their contribution.
God forbid but if the startup is on the verge of failing, the co-founders need every bit of motivation and co-operation to revive the chances of the success of the company. Higher the equity higher are the chances of the success of the company, hence bringing in founders with less equity will have an adverse impact on the motivation and future chances of success of the company.
If you give a small amount of equity to your co-founder this also does not help in building a positive image. It brings in doubt in the mind of the co-founder and further leads to self-doubt and lower motivation and unhealthy competition. This is a very risky scenario, as the investors may have a negative image of the team as a whole. You need to picturize very good team players to attract major investors, as they will see you as a whole team and not as a separate entity.
Should a formula be followed to split equity?
The answer is YES.
Founders Pie Calculator:
This method was created by Frank Demmeler, and states the method of quantifying the many and various elements that call into the decision process of splitting up of equity among the founders. This formula sums up all the considerations regarding the business value, acumen, and commitment in five different categories.
It gives negotiation upfront to everyone as to how they value each other. With the help of such a type of conversation at the beginning itself, it builds trust and confidence among the founders’ relationship and sees to it that all are equally satisfied in the end.
The five basic categories of the Founders Pie Calculator are:
- Business knowledge
- Commitment and risk
- Domain expertise
To illustrate this, Dammeller has used an example of a high technology startup which came from the four founder team from a university program. This enlists as given below:
- The first and foremost the inventor who got the idea in the first place.
- The business guy who opens up the door for the startup with the best industry knowledge.
- The technologist who is like the right-hand man of the inventor.
- Last but not the least, the researcher who is not a great contributor, but is always around when needed.
Different other ways to split equity
As there is no such accurate or a perfect method to split equity as all have their potential ups and downs. Here are a few enlisted below:
- Split equity based on individual commitment and value: The important question to determine here is that what everyone will bring to the table, how they contribute, and which skills matter more and why for the success of the business.
- Based on business experience: having someone in the team who has prior experience of a vast network of prospect investors, experience in raising funds, can be of vital importance and lead to higher equity splits for such co-founder.
- Split equity based on risk: if a person is quitting his job and contributing as a full-time founder, and on the other hand a person is working as a part-timer. The former will be given more weightage, and get a higher equity split.
There are several concerns that co-founders tend to have about splitting equity amongst themselves. However, splitting equity is only going to do good for your company -especially if you are running a startup organization. Just be fair and equal as much as possible.
If you need to check the equity shares for each founder based on your input you can use our equity calculator.
Try to fill out as many of the questions as possible and get the perfect result.