Splitting the Pie
How to divvy up the shares in a new company
As I’m advising a new company in setup and incorporation, the big question that comes up is how to split the shares.
In this particular scenario, there are seven founders. Most of them have worked together before at another company. They are not building a business to sell, but rather a cash cow that will pay out nice bonuses to its owners. Consider this a typical services organization.
Our brainstorming session came up with the following ways to divvy up the pie:
Even split: Everyone gets the same number of shares. The problem with this method is that not everyone is going to contribute the same — some people make two to three times more than others in salary, and presumably would feel they contribute more as well.
Split based on past performance: Adjust the shares based on what the founders’ salary has been in the past. The argument is that the contribution to the business will vary and share ownership should reflect that. The market rate of someone’s salary would be a good yardstick to what that person will contribute in the future. The problem with this assumption is that the past doesn’t always predict the future.
Dynamic split: Issue shares at the end of each year based on each founder’s contribution for that period. While in theory this approach sounds perfect, the issue is that measuring someone’s contribution is easier said than done. Without a clear way to measure the contribution, this approach is basically kicking the can down the road.
In addition to shares, there’s also the question of salaries. As I mentioned before, some founders used to make up to three times more than the others at their previous employment.
Even salaries: Until the business gets off the ground everyone gets the same, relatively low salary. It would be enough to get by.
Market salaries: Everyone gets the same salary as they made at the previous employer.
Market salary with a back pay: Everyone gets their previous salary but company may pay only the minimum amount with the rest being owed when there’s cash to pay.
Conclusion: In this particular scenario, the founders chose to split the pie evenly and adjust the difference in their contribution through their salaries. If there’s a cashflow issue during the startup, the company may owe the difference between the minimum and the market salary.
The rationale is that once everyone gets their deserved salary, the rest of the pie will get smaller and the even distribution in that case makes sense. And the even split of shares gets everyone equally motivated to work hard towards the same goal — it aligns the objectives.
The issue of splitting the pie is an interesting case of gamification. On one hand, everyone needs to be on board to to work towards the same goal of making the business successful. On the other hand, each individual founder must feel well rewarded for the individual contribution.
