One of the issues founders often run into at the very early stages of their startup, is not being sure on how to split equity among the Co-Founders. There could be hundreds of different questions which would make it even harder to make a decision. Especially if you're teaming up with our friends or family.
The subject of how to split equity among co-founders can easily become a major source of conflict in the future, especially once the startup starts getting higher-and higher valuations. That’s why how you decide to split the equity early-on, will have a lasting impact on the co-founder dynamic and the company.
These are some of the very common issues founders have when deciding how to split the equity among Co-Founders.
Many Founders make the mistake of splitting the equity based on the work done during the early days of the startup. For instance the first 12-18 months. The issue here is that it takes much longer (7-10 years) to build up a company which will have great value.
Variations in the first year should not have a great impact on equity splits in years 2-10.
As many startups tend to fail, the founders need every bit of motivation they can get to increase the chances of success. More equity does lead to more motivation, so bringing in founders with little equity will likely have a negative effect on their motivation and future chances of success.
Giving small portions of the equity to your co-founders does not really help in building a positive image either. It brings doubts as to how much the founder values his/her co-founders and whether they get small amounts of equity because they are not very good or will likely not have a great impact on your business. This is especially risky when it comes to attracting investors as the perceived quality of the team plays a major role in investment decisions for early-stage startups.
Execution takes precedence over ideas. When founders split equity unequally because of the founder initially coming up with the idea and therefore getting much more equity, this often leads to issues later as compared to startups where the founders get equity based on the product to market process and initial traction.
There are different methods to split equity between founders. There is no such thing as a perfect method as these all have their potential up-and downsides.
The question of what value everyone in the team brings is pretty common. Basing the equity split on the answer to this is question is also rather common.
What is important to determine with this method is what everyone will be bringing to the table, how they will contribute to the success of the startup and which skills matter more and why.
Individuals can provide value in different manners. For instance, by providing initial capital, expertise in a specific domain, providing growth opportunities through a new network, etc. Depending on the founding team, each of these different values will have different weights and result in different amounts of equity being given.
What is important to notice is everyone's commitment to the startup and the journey to success. What happens to everyone's equity if someone leaves or starts working less. While the commitment and enthusiasm might be very high in the early days of the startup, this might change over time as challenges occur and progress seems to stagnate.
Some founder teams divide equity based on the amount of experience each individual member brings to the table. Specifically experience in building a company.
Building a startup is very challenging. Having someone in the founder team who has prior experience in raising funds, a vast network of potential investors/partners, experience creating a minimum viable product, or scaling a product, can be extremely valuable to any startup and therefore lead to that specific founder receiving more equity.
This method might cause some frictions as first-time founders would lose out on equity compared to experienced co-founders, just because of that lack of experience.
When distributing equity, another method of assigning equity to the founders is to base the portions on who is taking the most risk. For instance, if one founder is quitting a full-time job to work on the new business while another is continuing his/her full-time job and just treats the startup as a part-time project, the former will be in a much riskier position, especially if the startup doesn't work out.
Therefore, some founders opt to reward the person who is taking on more risk, with more equity to make the situation somewhat more fair.
A slightly controversial but much more simple method is to split equity equally between everyone. This method will ensure that the motivation is there for everyone within the founders team and should lead to more cohesiveness within the team. After all, these are the people that will help you build up your company and who you will celebrate with when your startup succeeds. You will likely spend more time with them than with your family.
Team cohesion is invaluable in a startup, especially when trying to overcome setbacks and major challenges that can be considered guaranteed elements of any startup's journey to success.
Another thing to consider is that if you are not willing to give a partner an equal share, the partner might not actually be the right person for your startup which could explain why you are not willing to split the equity equally.
When you start your own company, there are bound to be some conflicts, especially so if you are working with co-founders. Equity stakes can be a major source of these conflicts and carefully deciding how to take care of these splits can save everyone a lot of headaches in the later stages of the startup.
It is up to you and your co-founders to decide which method of splitting equity is the most favourable for your startup.