Co-founders don’t always see eye-to-eye, and our best-laid plans have a habit of falling apart, so it’s important to be at your pragmatic best when it comes to apportioning equity to members of your start-up team. Here’s our guide on how to split equity among founders – it’s certainly never a straightforward path so it pays to consider all options so that you get what you want from the agreement and encourage future investors to take a chance on your business.
How much equity do founders get?
Splitting a company between its founders is the easiest thing in the world, right? It should be logical enough: one founder = 100 per cent, two = 50 per cent each, three = 33.333r per cent, four = 25 per cent each and so on.
But the reality is not always so straight forward.
There are plenty of scenarios in which you might want to divvy up company shares in favour of one or more founders, to the detriment of the others. Probably the best example is if the business has been envisaged by one individual and he or she has rounded up a founding team.
There might be two friends who call upon the services of a third party, or it’s conceivable that one founder might claim superior abilities or more contributable value than the others, so believing themselves deserving of a bigger stake.
Whatever the deal, it’s good to take a grown-up approach to splitting equity between founders; never more so than if the split is unequal.
Dividing equity between founders, investors, and employees
The last thing a team needs is a fall-out right at the start of your business’ journey. Successful start-ups require all the energy, ideas, and enthusiasm they can get, but bad blood can sour relations and act as sea anchor on growth from the get-go. So start from a position of fairness and honesty.
Your first hurdle is to agree who will be receiving equity. It’s possible that some members of the founding team – launch employees for example – will not qualify for a share in the business.
It’s a rare scenario, but businesses with backing from wealthy third parties or some other source of ready cash might well hit the ground running with a sizeable workforce. In this case, it’s unlikely everyone will have ownership.
Equity can also be used as a recruitment tool or as an incentive to long-serving staff, so the decision to give what to who is complicated.
Factors affecting the founder equity split
There are several factors that can influence how equity is split between founders. One is the level of sacrifice and risk each person is accepting to work in the business. If one founder is giving up full-time work and ploughing hours into the start-up, while another is maintaining paid employment, then the split might reflect this discrepancy.
Another obvious consideration is how much money, if any, founders are committing to the business. Clearly, more money means more equity, but this could be balanced out by a founder who does not contribute cash but is devoting time instead. Many start-up teams split 50-50 between two founders have an active manager and a passive investor.
The impetus behind the business is also important. Who had the idea, and have they already created structures that improve its chance of success? Do they have special access or contacts that will be valuable, plus how much of the business’ future success is contingent on these factors?
As you can see, what starts as a simple slicing up of a pie can become a lot more complicated. It’s why diplomacy and empathy are useful traits of fledgling entrepreneurs: you have to understand each founder’s contribution and put a value on it.
Remember too that achieving fairness, not happiness, is your goal. A research report conducted by the Harvard Business Review (HBR) summed it up nicely: “A team has succeeded at splitting the equity if all of the co-founders are equally unhappy”.
Common pitfalls when splitting equity between founders
Amid the excitement of starting a business, it’s easy to forget that friendships can crumble and people don’t always make good on commitments. Relationship breakdown between partners is common, especially if the business experiences rough patches, so founders should agree contingency plans for worst case scenarios.
What happens, for example, if three founders sign on the dotted line only for one of them to experience a life change and they are forced to back away? Worse still, what if they planned to do so all along?
The solution is to insert a clawback mechanism into the equity contract, allowing founders to retrieve equity from a business partner if certain conditions are met (or not met, as the case may be). This might feel unsavoury or mean-spirited, but you might well be grateful for it later on.
The Havard Business Review research suggests that splitting equity too early, before all the different factors have come to light, is another common trap. It concludes that teams who conduct a “lengthier and more robust dialogue” have a higher success rate than those who jump straight in.
This is particularly true in the case of family businesses because relatives often discover new (negative) traits about each other’s approach to business. How people act at home doesn’t always reflect how they approach tasks and relationships in the office, it says.
An umbrella piece of advice, covering all of the above, is to ensure you have comprehensive legal documents in place: a verified and signed founders’ agreement which you can draw on in future if the path of business-building fails to run smooth.
Top tips on sharing equity between founders
Peter Ziebelman, co-founder of Palo Alto Venture Partners and lecturer at Stanford GSB, advises co-founders to hold back a slither of equity for what he calls ‘corrections’ later on. If a founder reneges on agreements or fails to live up to their promised usefulness, you can allocate the retained equity percentage to beef up the stakes of other, more useful, team members.
If you are planning to raise equity funding later on, statistics suggest that you should give more thought to your equity allocation and make sure your calculations are reflected in your agreement. According to the HBR, investors look at equity split equally among co-founders and – often – see a company that is not serious about its strengths and weaknesses.
A well-crafted equity split that is sane, justifiable, and explainable does the opposite. It tells future investors that you are a grown-up business that gives plenty of intelligent thought to tough decisions.
The good news is you do not have to do it all at once. It is possible to create the company and its shares, then wait until a later date to allocate them to individuals. This takes some patience and restraint, but it will help the founding team figure out a genuinely fair split based on factors such as performance, skillset, and earnings.
As you can see, sharing equity between co-founders is a lot harder than it seems. Start-up teams taking a mature, reasonable, and logical approach could stand to reap many hidden rewards. Conversely, those who blithely throw equity about at the very start of their journey might just live to regret it.