How to divide founders equity
Deciding who gets what isn’t easy. Don’t beat your head against the wall.
Figuring out how to divide the equity at the beginning is one of those things every founder struggles with. Recently, I’ve been both advising and going through this process for myself and found a surprisingly broad set of resources but most offering very vague particulars.
The goal of this post is to:
- List some simple questions to ask yourself
- Pinpoint one simple method to provide a baseline
- Highlight a few key resources to further educate yourself
This post is not aimed at any one business type although given the amount of writing on the topic it tends to skew towards more technical business types. This post will not get into all the fine details of vesting that prudent founders will have to consider (potentially in a future post).
So you are ready to start a business?
At this point you may have figured out if you want to do an LLC, an S-Corp or a C-Corp (taxes and liability being key factors) but even before this there may be some hesitation on how you are going to divide up the initial equity.
- How much should my co-founder get?
- What if they are only working part-time on it?
- What if one parter puts more money than another partner into the business?
- What should an advisor receive? (via Mike Crill)
- What if a founder leaves?
- What happens if I bring in a co-founder after already raising equity? (hint: annoying taxes and paperwork)
For the more complex questions you really have to get a great lawyer!
A simple place to start
Start with a matrix of key factors that founders bring to the table (you can always add additional rows if you want to get more specific but Demmler’s starting point is simple).
*One row I like to add is capital so you can be clear on how much you are leaving out for investors or how things would change if one founder is investing more cash $$ than another.
The company wouldn’t exist if it weren’t for the original idea, and that is certainly worth something, BUT there’s a lot of truth in the saying, “A successful business is 1% inspiration, and 99% perspiration.”
Business Plan Preparation
The development of an initial business plan is a surprisingly difficult and time-consuming effort. To pull together and organize all the thoughts of the founding team, filling in the blanks, identifying and reconciling the differences, and producing a document that captures the essence of the business and helps persuade banks, investors, board members, and others to support the company is a mammoth undertaking, as anyone who has done it will attest.
Again, the plan is a necessary element of starting the business, BUT execution against the plan is where the real value lies.
To what degree do you and your partners have meaningful experience in the business of your business? Knowing the industry, having relevant experience, and having a Rolodex full of accessible contacts can greatly improve the company’s probability of success and speed its growth rate. Otherwise, it will take longer to get commercial traction and you’ll have to pay for these assets, usually by hiring someone and including equity in their compensation package.
Commitment and Risk
You’ve probably heard the old saying that “a chicken is involved with breakfast, but a pig is committed.” Similarly, the founders who join the company full time and are committed to making it a success are much more valuable than founders who are going to sit on the sideline and be cheerleaders. In addition, the opportunity cost for those who join the company instead of pursuing a career is not trivial.
Who is going to do what? Who is going to go stay up at night when you can’t make tomorrow’s payroll? Where does the “buck stop”?
Hypothetical example. Assume that we have a high technology start up spinning out of a university with four members of the founding team.
- The inventor who is recognized as the technology leader in his domain.
- The “business guy” who is bringing business and industry knowledge to the company.
- The technologist who has been the inventor’s “right hand man.”
- The research team member who happened to be at the right place at the right time, but hasn’t and won’t contribute much to the technology or the company.
Next, we evaluate each of the factors on their relative importance and each of the founding team members contribution to each on a scale of 0-to-10.
Finally, we multiply each of the founder’s values by the factor’s value to calculate weighted scores. Add up the numbers for each founder, sum those totals and determine the relative percentages. Do a sanity check to see if those numbers seem to make sense, and adjust them accordingly.
Here is a template I put together in google docs with a $$ partner and added ‘capital’ row.
Founders institute with link to several other models (w/ downloadable spreadsheets)— http://fi.co/posts/6061
Venturefizz framework (w/ downloadable spreadsheet)— https://medium.com/@venturefizz/your-partner-or-your-buddy-how-to-split-and-structure-equity-between-co-founders-5b25ddd93e8
Startup Equity & Valuation links — https://medium.com/@selcuke/startup-equity-valudation-founder-pies-means-5e8ebdaa4c55
On avoiding the 50/50 cofounder model — https://medium.com/buffer-posts/avoid-the-50-50-co-founder-model-heres-why-3de2178f25a1
Intellectual, Executive, and Monetary model — https://medium.com/@merivercap/the-best-way-to-split-the-equity-pie-in-your-startup-9f9580e2961a