You’re starting a business. You have a co-founder team. And now you’re allwondering, “How should we divide the equity between us?”
Microsoft co-founders Bill Gates and Paul Allen decided on a 64-36 split. On theother hand, Larry Page and Sergey Brin, Google’s co-founders, agreed on a 50-50 structure.
Which begs the question, what should you do?
There is no right or wrong answer; allocating your equity will depend on the team you’ve assembled, everyone’s level ofexpertise, prior business experience, and future value contributions.
Dividing up co-founder equity is one of the first difficult conversationsevery new startup founder team should have–yet most avoid it.
As a mediator and executive coach, I facilitate equity restructuring conversationsbetween startup founders and business partners under my company, CollabsHQ. I see how most teams landedon an equal equity split out of avoidance or convenience. Yet, months or even years later, they find that noteveryone contributed equally, and frustrations and anger developed.
Whether you decide on an equal split or not, having the equity conversation earlyon can save you from future stress and be beneficial for everyone on the team to understand:
- What is most important to each founder
- How a founder advocates for themselves
- And can also strengthen team ties, which I call their social capital since the foundersknow they can handle a difficult conversation together.
This article will walk you through the various components you should consider whendividing up your equity, including the what, when, who, and how, based on my experience facilitating theseconversations between startup founders.
👉 Understanding that equity is a slice of the business that is based on afounder’s value contribution
👉 It is critical that founder teams not avoid an equity conversation and insteadget candid about what everyone brings to the table
👉 Founders should consider the five factors—i.e., Idea/Intellectual Property(IP), Commitment & Risk, Responsibilities & Duties, Business/Domain Expertise, and Capital Invested–whendividing their equity
👉 A collaborative process and tool for guiding equity negotiations can serve as astarting point for the overall conversation between founders
What is an equity split?
Think of an equity split as dividing up a pie. In this case, the pie (or equitysplit) is the slice of the business each founder owns based on their value contribution.
In the above example, Founder 1 owns 13.8% more of the business than Founder 3,the lowest equity partner within this four-person team.
When the startup still hasn’t achieved product-market fit and/or has producedlittle to no revenue, founders work for what they call “sweat equity.”
Sweat equity is the value that founders put into the business, represented bythe equity shares they receive–usually in place of cash compensation or if they’re offered a lower marketrate to join the company.
Founders can also use sweat equity to attract top talent in the early days whenthe business might not be able to afford a professional’s market rate.
Founder 3 may have problems with this split, but if the founders did a good jobexplaining their rationale, he (along with everyone else) should be bought in.
When you’re having a candid conversation about someone’s value, it is as much abusiness decision as it is an emotional one. The teams that get it right understand that:
- Everyone needs to be satisfied with the outcome
- And everyone equally needs to be motivated to do their best work too.
When the founders put their egos and greedy tendencies aside, you have a greaterchance of ending with a win-win result.
When should startup foundersdivide equity?
I was working with a three-person team of an ad tech company that had been inbusiness for two years. They hired me to help them evaluate their equity split. Initially, they distributedtheir equity 33-33-33% amongst the three, with an outside advisor getting 1%.
They were scaling fast, with a follow-up post-Seed round of investment. However,as this became a real possibility, resentment amongst the founders popped up because not everyone worked equallyon the business.
Two of the founders were full-time, while the third came in part-time with thepromise that he would use his parent’s network of connections to get investment for the business.
That didn’t happen, though.
And now that more investment looked possible, the two full-time founders wanted toredo their equity split to more accurately represent everyone’s value contributions.
Why didn’t they initially do this, though?
Like most teams, they hoped for the best and avoided the tough conversation.
Research fromHarvard Business Professor Noam Wasserman found that nearly 40 percent of startup teams spend a day or lessagreeing on their equity splits.
Startup teams were three times more likely to be unhappy with a founder equitysplit that was divided equally by default.
Some rushed into it.
Others may be too optimistic about future performance.
And some teams, not knowing how to have an equity conversation, opted for a quickhandshake deal instead.
That’s why I recommend having the chat as early as possible–with intention.
I also recommend that teams ask each other thesequestions to jump-start the conversation and better understand each other’s working styles, futurecommitments, and vision for the company.
Equity negotiations can be a great starting point to build a foundation for howthe team will act, creating that mindset shift that is necessary for early-stage founders that they are, infact, founders of a business.
Who can get equity in a startup?
Equity is a startup’s currency. But, like a precious commodity, founders shouldguard, especially if they envision a successful exit.
Over time, with subsequentfundraising rounds, the founding team’s equity gets diluted, which means their ownership stake in thebusiness will decrease.
This, in turn, will affect their control over the company.
The general rule for who early-stage founders should give equity to includesthemselves, outside advisors, and any early hires.
Rule of thumb regarding equity for outside advisors: anywhere from .25 to 5%is reasonable, depending on the advisor’s level of involvement and risk tolerance. Their equity should alsobe on a vesting schedule that vests over a specific period.
Determining how much equity to give an advisor or early hire should always bebased on their value contributions and how they’ll help the startup succeed.
How do co-founders splitequity?
I had the idea so I should get more equity.
I’m the technical co-founder, so I should get more too.
I’ve been working on this for a few months now, so I should have a largershare.
I’ll be in charge of fundraising and ensuring we have money, so I should getmore.
I have heard founders say these things in the equity negotiations I havefacilitated. I advise them to consider the long-term prospects of value creation and what will incentivize eachfounder to do their best work.
Investors look poorly on equity splits that are too skewed in one founder’sdirection. For example, one founder has 80% compared to his fellow co-founder, who has 20%. Avoid such asplit. Investors will also look to the equity split to assess each founder’s motivation and how they valueeach other.
When deciding on your equity split, your north star should be: how will thisperson and what they’re bringing to the table help us tosucceed?
The founder that has prior business experience should get a bump in equity.
The technical founder who’ll code the first iteration of the backend should alsoget a bit more.
How to quantify all these factors is the bigger question that stumps mostteams.
For now, remember that value contribution is your team’s north star when thinkingabout how to divide your equity.
Factors to consider in a fairequity split
Each factor you’ll consider for a fair equity split will relate to a founder’svalue contribution.
This category includes who came up with the original idea and any contributionsanyone has made in creating specific intellectual property (IP). The person with the idea should, of course, getsome equity. But depending on the nature of the startup, the IP may be more valuable. For example, in aSaaS-based company, coding the first iteration of the backend will be more valuable than creating a businessplan and marketing deck for how to scale the eventual product. Both are valuable, but you’ll need to decide theweight each should get as a team according to your market.
Commitment & Risk
Commitment asks you to consider whether a founder is full-time versus half-time.Risk includes financial, emotional, mental, and reputational considerations that someone is giving up to enterstartup life.