In order for a startup to thrive, there are many agreements among founders that need to be forged. We’ve covered some of these arrangements with our posts on buy-sell agreements and successful business partnerships. In this blog post, we’ll cover what can often be a sensitive topic: splitting startup equity.
Discussing each founder’s worth and amount of equity she or he deserves can be tricky. But if you and your founders take the time to divvy equity in a manner that feels fair and earned to all, you’ll set yourself up for a stronger foundation of trust and greater likelihood of a successful working relationship.
Start with the Difficult Conversations
The conversations around splitting startup equity might get uncomfortable, but it is crucial that you and your partners have them as early as possible. Any confusion or resentment over equity can doom a startup’s potential for success. Ultimately, you might find that you cannot come to an equity agreement and thus cannot move forward with your startup. While disappointing, it is better to come to that realization at the beginning rather than after months or even years of hard work.
An Even Divide Is Not Always Best
You might think the fairest way to split startup equity is to simply to divide it evenly amongst founders. However, that doesn’t guarantee you’ll be happy with the results. Harvard Business School professor Noam Wasserman spent 15 years studying over 6,000 startups, and found that distress within teams nearly triples when founders choose to distribute shares equally by default. That’s because there are some founders who deserve more equity than others. These are the people who had the original idea, have crucial experience, or will take on more responsibility in the startup.
Wasserman discovered nearly 40 percent of startup teams spend a day or less negotiating equity agreements, simply agreeing to split equity with a “quick handshake.” While that might save some time and uncomfortable discussions upfront, it can breed future conflict. Take the time to think through everyone’s worth using the same metrics, and you will have a better chance of coming to an agreement that works for everyone.
Decide a Founder’s Value Based Upon These Criteria
- Leadership. The larger the leadership role a founder takes, the larger their share of equity should be. Red Rocket Ventures managing partner George Deeb recommends setting employee tiers to divide equity. For example, C-level executives get the largest share, VP level executives get less, and director/manager level staff get the least.
- Idea. Every group of founders will find its own unique method to fairly divide startup equity. However, Wasserman found that on average, founders who came up with the idea for the startup get around 10 to 15 more percentage points of equity.
- Intellectual Property. If you’re capitalizing on the technology, patents, copyrights or trademarks of any founders, these contributions should be given more weight when dividing startup equity, says New York City startups attorney Nathan Whitehouse.
- Personal Capital Investment. LinkedIn founding team member Lee Hower says you should consider giving co-founders more startup equity if they provide a personal capital investment, rather than structuring their capital as a separate investment via preferred equity or convertible note.
- Personal Time/ Work Investment. Founders working full-time on the startup deserve a share of the company that’s significantly larger than those who are not able to commit as much time, says Hower.
- Industry Expertise. Founders with crucial industry expertise, especially those who have founded successful startups in the past, are valuable and entitled to more equity, says Whitehouse.
In Case A Founder Wants to Leave Early
Before finalizing any agreements, make sure to implement market vesting terms for all of the founders’ equity. That way, if a co-founder decides to reduce her or his commitment to the company or leaves earlier than anticipated, his or her stake in the company will decrease. This helps ensure that founders will continue to add value and contribute to the company so that they’re continually and actively earning their shares.
Bo Yaghmaie, Head of New York Business & Finance Group, Cooley LLP, says the most common vesting terms are those that occur monthly or quarterly over three or four years.
Are you and your co-founders ready to set up your startup? Come to UpCounsel if you need help forming your business or creating a founders agreement.