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How to Divide Founder Equity: 4 Criteria to Discuss
Editor’s note: Understanding how to divide founder equity at a startup can be tricky, even to the point of reaching emotional riffs between founders. Below, Lee Hower offers advice for approaching these equity discussions objectively and properly. In addition to being a co-founder of NextView Ventures, Lee was an early member of PayPal and a founding team member at LinkedIn, so he speaks as both a former entrepreneur and a VC.
I like to say that “there are only co-founders” — it’s extraordinarily rare for a successful business to have just a sole founder. But not all co-founders are equal in terms of title, ownership, responsibilities, and so forth. As a result, one of the trickier things co-founders tackle is determining the equity split amongst the founding group of individuals.
There’s no magic to this, and there’s no hard and fast rule. Across both the startups I’ve personally been involved in (PayPal and LinkedIn) and the startups in which I’ve been an investor, I’ve seen a broad range of co-founder equity splits.
Sometimes co-founders put off the equity split question for some time. This is often the case where there was 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 delaying or avoiding the conversation often results in it being more awkward than it needs to be. Once you’re 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.
Additionally, you should put whatever agreement you reach to paper, even if you have not yet incorporated or had your legal counsel draw up the founder stock paperwork. For example, you can type out a simple letter saying something like, “We the founders of XYZ agree to the following schedule of founders equity ownership: John Doe – 20%; Jane Doe – 40%; Mike Doe – 40%.” Then have each co-founder sign it, with each co-founder keeping a copy. You can then work with your law firm to formally draw up founder common stock paperwork either then or subsequently.
It’s also worth keeping in mind that regardless of how the founders’ common stock is divided, there will be future issuance of stock that will dilute the founders over the lifecycle of the company. You don’t really need to worry about how much common stock will be set aside for an employee option pool or how much preferred stock might be issued from raising future VC rounds in order to determine an equitable founder stock division. But all the co-founders should keep in mind if they own X% today, their share will likely be smaller (though still usually quite substantial) down the road.
The most successful approaches to splitting founders equity typically involve establishing a framework that all the co-founders buy into at the outset.
This needn’t be some terribly complex formula that tries to do a cost accounting of everyone’s contribution to the decimal point. But they frequently capture some of the following dimensions:
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 folks or folks in C-level positions will have a larger founders’ equity percentage than more junior or staff-level co-founders.
2. Capital Investment & Sweat Equity
Sometimes some of the co-founders provide personal startup capital (hard cash) at a company’s inception, and 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.
For example, when we started LinkedIn at the end of 2002, each member of the founding team essentially had a couple chunks of founders’ common stock. One chunk was based on the experience level and role of the co-founder. Next, those that were forgoing some or all salary prior to Series A got an additional chunk for that. And lastly, a chunk of our CEO Reid Hoffman’s equity was attributed to the fact that he provided the initial ~$750K in seed capital for the company.
3. Prior & Ongoing Involvement
A co-founder’s equity should also be reflective of their on-going involvement in the company. For example, it’s not uncommon for there to be a couple co-founders at the inception of a company. But sometimes, for a variety of reasons, 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.
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, the hard IP coming in isn’t usually an issued patent, which is obviously different for biotech or other kinds of startups. Sometimes, however, there’s an existing code base that one co-founder brings. In general, successful startups are based on execution and not an idea, so I personally attribute a pretty small portion of the co-founder equity split to this factor, though entrepreneurs sometimes use it in their frameworks.
Once you have the framework, it’s simply a matter of having the conversation and reaching an agreement.
Yes, sometimes these conversations take a few sessions, and at times the conversations can be contentious. But this is one of the very few times in a startup’s life where the co-founders are playing a zero-sum game. And ultimately, no matter what split you work out, building a successful business and growing the pie of the whole company’s value is what will really matter for all the co-founders.
Questions about founder equity splits? Leave a comment below or tweet NextView Ventures @NextViewVC