The Tricky Issue of Splitting Equity
One of the more complex issues Founders face in structuring their start-up is how to split equity between Founders, Team Members and Advisors. It’s a tricky issue to navigate if you haven’t done it before, one that is easy to second guess at a later date. There are some basic concepts to grasp as you fund your start-up, getting these right is mission critical as it creates the right structure to keep all key parties properly motivated in the ebb & flow of building a start-up and fairly rewarded when you have a successful exit. Some thoughts:
Founders — the easy answer of splitting equity 50%/50% is the one thing that most every Founder I know agrees is absolutely the wrong answer. Instead, the Founders need to do the best, fairest job they can of assigning relative value to what each other bring to the table. Who had the idea? Who is creating the business plan? Who has domain experience? Who will raise the capital? Does one of the Founders have previous start-up success that makes it easier to raise capital or hire key early team members? These are just a few of the questions Founders should ask each other. I’d suggest assigning a value to each of these questions to get to a starting point of what feels like a rational and fair equity split. In my experience, navigating this discussion with your co-founder in a way that makes everyone feel positive is the first test of how well co-founders will work together. Getting this variable wrong often results in a later startup failure due to an obvious inequity.
Team Members — the goal for your first key hires is to create emotional/ financial alignment on the product and company they are building. It’s unlikely you’ll be able to use a formula for equity grants to these first employees, it’s definitely more art than science. However, a rule of thumb for those first 10–15 hires is that they will own roughly 10% of the business in aggregate. As your start-up matures, it’s incredibly important to switch from art to science when granting equity. Not doing so is very expensive and will create structural issues at a later date. I highly recommend you assign a value to the equity based on the valuation investors or potential acquirers have recently placed on your company.
Advisors — getting the right group of advisors to support your start-up is one of the most strategic tactics you can deploy in setting the tone for how your product is used in addition to leading to early adopters. Typically, a start-up allocates 1.5% — 3.0% of equity for advisors. It’s important to keep the grants small, somewhere around 1/10th of a point in the company. Grant the shares as fully vested, doing so will remove much of the friction out of the deal by shifting the conversation from “what % of the company am I getting?” to “that’s great, happy to help out.” It’s a smart deal for everyone involved. The advisors aren’t burdened with unclear expectations on what they’re supposed to do, and they get compensated no matter what happens. On your end, because the grants are properly sized, it gives you flexibility to engage more advisors than normal, advisors with various backgrounds and expertise, regardless of the degree to which they were able to commit time to your company — that’s an advantage in my experience.
Because dividing up equity at the beginning is typically more art than science, it’s one of the more challenging aspects of getting your start-up structured correctly from the outset. It’s also one of the areas I highly recommend you get experienced outside help (legal counsel, potential investors, startup advisors, other founders), as they may be able to provide experience and more importantly, an unbiased view that everyone involved can trust. Getting this right will help you get off to a great start in building your company, one in which everyone is in alignment.