How do you divide equity between co-founders?
Startup founders have a million and one decisions to make. Each one needs to be thought about carefully because one wrong move could end in disaster.
Some of the more difficult decisions sit within the boundaries of how to share things with one another.
For instance, when there is more than one founder (which is often the case), how do you share equity with one another in a fair and equal way?
It’s easy to say it should be a 50/50 divide but what if one person puts more capital into the business than the other? What if one pulls their weight more than the other?
Can you see where problems might arise?
One person could pour their entire being into the business and make it their sole purpose, but the other may just do the very bare minimum. In that case, should they expect an equal share of the equity pie?
You could argue that no, they don’t...
Equity splits are rarely simple things
For many startups, decisions like this can cause conflict. Money can cause major issues between people and it’s rare for someone to hold their hands up and say that receiving less of the pie is fair.
For that reason, you need to lay your cards out on the table early and commit to negotiating. Start by having honest, frank conversations about each person's role and responsibilities.
Let's say there are two of you and you both put the same amount of capital into the business. In that case, you might expect to get the same amount of equity, right?
But what if you go to the office every day and work all the hours, but the other person turns up every now and then and doesn't quit their day job?
And what if you find yourself making all the decisions but the other person just tells you that they trust your judgement? We've heard a fair few horror stories in our time!
It’s easy to promise the world when you’re caught up in the excitement of your business getting off the ground, but the business world rarely goes according to plan and these projections may be a little far off the mark.
It’s also true that not one single person establishes a business and expects it to fail - we’re all optimistic until the reality of the situation dawns.
What does each co-founder contribute?
The share of the equity pie for founders tends to be around 70% of the final amount, once you’ve assigned equity to shareholders and employees. You might choose to go in with a 50/50 split, or perhaps a 60/40 depending upon the amount of capital that has gone into it.
That's called a fixed equity split or a static equity split. But what that doesn't take into account is someone's actual contribution.
You can think about contribution in a variety of ways. For instance:
- The risk they took by getting involved
- The salary they're willing to sacrifice
- Their cash contribution to get the business off the ground
- The projects they're committed to completing
- The hours they're willing to put in
So one way to decide how much equity a person receives is to base it on their contribution and the level of risk involved.
It's called the Slicing Pie approach. We go into more detail in this article, but essentially the Slicing Pie method is a way to ensure people receive fair equity rewards.
Developed by Mike Moyer, Slicing Pie contains specific formulas to calculate how much equity to allocate. And with it, you can set clear, measurable and specific milestones for co-founders to meet before equity is released.
Download the Slicing Pie Handbook to learn more.
That way, it's a logical decision, not an emotional one - instead of someone with a crystal ball attempting to predict the future or giving the other person the benefit of the doubt that they will in fact deliver what they've promised.
It's an approach that we've baked into our flexible Agile Partnerships framework. We like to think of it like a prenup but for co-founders!
While it might seem like the easiest approach, a fixed equity split can be problematic. That doesn’t mean it’s always the wrong approach for every business. There is no ‘one size fits all’ answer here, after all.
But it can breed discontent and bitterness over time, leading to falls out that could potentially ruin the future of the business.
So slice the pie in a more dynamic way and sidestep the issue.
Book a free consultation today to see how you can design flexible equity agreements for co-founders with Vestd.