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How to Divide Founder Equity: 4 Criteria to Discuss
It’s extremely rare that a startup begins with just one person. Less than 5% of all NextView portfolio companies began with a sole co-founder, as opposed to a founding team. And while there is something special about the initial group that comes together to form a company, frequently not all co-founders are equal in terms of title, ownership, responsibilities, and other dimensions. Consequently, one of the most challenging items that co-founders tackle together as a team is determining the equity split amongst the founding group of individuals.
How do you divide founder equity? And do it fairly? Here’s where the challenge comes in. There isn’t a magical formula. There isn’t a hard & fast rule of thumb. For that very reason, and because every single situation is unique, there are so many different resulting methods and outcomes of doing so.
I believe that the first thing to remember in dividing founder equity is that equitable doesn’t mean equal. The first major threshold to cross is deciding if the founding equity split is going to be literally equally, as typically someone in the team often believes that should be the case, or at least considered. However, more often than not, the goal should be an equitable result – one that is both fair and impartial – not exactly the same for all.
The way to accomplish an equitable result in splitting founder equity is to instead focus on a framework that everyone buys into from the outset. The process matters just as much as the outcome for everyone to feel content with the result. Rather than just starting with a zero-sum negotiation around specific figures, the dialog should begin with a conversation about how you’d like to decide, not just what you’re going to decide.
The criteria for a framework doesn’t need to be an intricate formula which attempts a cost accounting of everyone’s contribution to the decimal point. However, the following dimensions are important factors to consider:
- Experience/Seniority/Role. Every founding team is different in terms of whether co-founders are peers or near-peers, or if there are broad disparities in terms of seniority and experience. Founding splits typically acknowledge that more senior founders or teammates in C-level positions will have a larger founders’ equity percentage than more junior or staff-level co-founders.
- Capital Investment & Sweat Equity. Sometimes some of the co-founders provide personal startup capital (hard cash) at a company’s inception. Often they will receive a larger portion of founders’ common equity as a result, rather than structuring their capital as a separate investment via preferred equity or convertible note. In other cases, some co-founders might forgo salary early on (if their personal circumstances permit) to earn an additional share of “sweat” equity. Both of these are typically reflected in the founder equity split.
- Prior & Ongoing Involvement. A co-founder’s equity should also be reflective of their on-going involvement in the company. In my experience, too often the bulk of the attention is paid on what’s been contributed to the company to date, rather than the more important issue of what is going to be contributed in the future. Occasionally, one or more of the co-founders won’t be involved on a full-time basis going forward – those co-founders that are there for the long haul and working full-time should have a larger chunk of equity (typically multiple times that of co-founders not working full-time on the venture). Co-founder equity should have vesting periods (or lapsing repurchase rights) so if a co-founder departs substantially earlier than others, their stake in the business is accordingly smaller.
- Ideation/IP. Sometimes a portion of founders’ equity splits are attributed to “who came up with the idea” or to actual IP that’s brought into the business at inception. For most software and internet startups (unlike biotech or other deep tech startups), the hard IP coming in isn’t usually an issued patent, but rather an existing code base that one co-founder brings. In general, successful startups are based on execution and not merely idea, so I personally attribute a small portion of the split to this factor, though entrepreneurs do use it in their frameworks.
My recommendation would be to split the founder equity decision into two entirely separate conversations at two different times. The first is a discussion about the framework of how, without attributing any figures to the inputs. Then, in a subsequent conversation, work together to attribute actual numbers to each of the criteria to result in a final outcome.
The process here is what matters most, in terms of people feeling good about where they resulted, despite what can be a contentious discussion, with the eye that everyone will look back years later without regretful feelings. If executed successfully, a solid process will provide the foundation for trust in building a company going forward.
Once an agreement is in place, there is a final step which shouldn’t be overlooked: write it down immediately! Put whatever the agreement reached to paper, even if the company is not incorporated or legal counsel hasn’t draw up the founder stock paperwork. Literally write something like “We the founders of XYZ agree to the following schedule of founders equity ownership: John Doe – 20%; Jane Doe – 40%; Mike Smith – 40%” with each co-founder signing and keeping a copy. Again, I’d include just few bullets points about the roadmap utilized to the figures, both emphasize the process for people to fully internalize, and to avoid any itching for (attempts) at renegotiation at a later date. (Subsequently, the CEO will have the company’s law firm formally draw up founder common stock paperwork to issue.)
The process for dividing founding equity isn’t a fun one. And so often co-founders put off the equity split question for much longer than they should. This situation often occurs where is a close personal relationship between some or all of the co-founders, as former co-workers, friends, or college roommates. If we’re all friends, we can just be comfortable with the notion that we’ll “figure it out later,” right? But personal relationships transcend organizations, which is the precise reason that delaying or avoiding the conversation often results in the process being more awkward than it needs to be. Once a team is working on a project in earnest, even if it’s still at the nights-and-weekends phase, co-founders should go ahead and discuss this topic.
Lastly, as the company progresses beyond it’s infant stage, the more solidified these founder splits become. Time sets these percentages that they become difficult to un-/re-do. And once there are new third-parties at the table, like outside investors, then the structure really becomes set.
All the more reason that one of the first tasks that a founding team should do together is the why, how, and what of dividing the founder equity equitably.