How to divide equity with co-founders
Updated: May 9, 2020
First time founders who are good friends tend to ask if a 50-50 equity split would make more sense? While, This looks good as friend gesture, often leads to practical issues in running the venture.
Lets understand why is it important, Equity split and wealth sharing have a very high emotional quotient for the founders. The equity ownership among founders is central factor. In addition, There are few areas that have a bearing on company operations immensely. Couple of very important factors are the core founding team structure and equity split among them. These factors impact in many areas such as:
Decision Making: Situations where co-founder have difference of opinion, an equal split makes it even more difficult to resolve.
Regular operations: As simple as it may sound, equal equity split brings in a baggage, Not all co founders have equal value at stake, one co founder would have started with idea, or other would have brought everyone together, some may work full time while other may have a family obligation and may be part time.
Investor appeal: Most of the investor prefer to have one co-founder, first among the equals in the group who would have the say. While he/she may not be the one to come up with the idea but should be a notch higher to ensure smooth decision making. As Kunal Bahl of Snapdeal said" No matter who is right or wrong Rohit or me, If there is a difference of opinion, we get together and come up with one decision and both go after it. It does not matter who came up with the idea or who did not. We are capable to come up with one decision.Today Kunal owns 4% and Rohit owns 3% roughly (as of 2014).
So here are the few areas to look at while deciding equity structure, Lets say we do this through a point based system . Allocate all the co-founders 100 points at the beginning of exercise by default, then use the following filters:
What role would each one of you play. Who is a visionary, or hustler, or a tech person or a strong operations guy. Allocate extra point for each co-founder who brings in little extra to the table. (Let's say we give additional 5 points for each)
Now, consider the commitment level in terms of time allocation. Who is full-time versus part time. Full time should have higher equity. Let's say you give 5 points extra for whoever is full time.
Capital infusion is paramount importance. Specially when you're starting up and founders shell in investments based on their financial ability. Has everyone put in the equal investment if not then that also be accounted for equity structure. ( 10 points extra for anyone who has put in higher investment)
Give some extra points to one who came up with the idea, also to the one who has connected the other co-founder and convinced to come onboard ( 5 points for each point )
If one of the founders is drawing salary while other is working without salary. ( 5 point for the one working without salary)
Person who is putting more and more efforts to get in touch with people and benefiting your start-up say investor connects, customers, vendors, PR should get extra points ( 5 points extra)
Add up all the points for each founder and divide the equity as per the points
Some investors also look at the extent of asymmetric split. A huge skewed or difference can also cause issues. For example the split like 80%-20% between 2 co-founders. if you're going in with the idea that one founder is more valuable or that if there is a disagreement one founder will get to unilaterally decide, the founder with less equity is likely to leave. So, make sure each co-founder is equally valued beyond the equity distribution.
If there are just two of you which is often is the case, Then 49-51, 55-45 even 60-40 should be fine to go.
Ground rules:
Don't avoid this discussion: In the beginning, good friends try to avoid this conversation thinking this may spoil the camaraderie. This may look like over engineering a simple question as founders start but the startup streets are full of stories where good friends start a venture only to fall out over differences years later. A clear arrangement with well laid out understanding within group of founders can save the enterprise years later when its large with lot more stakeholders.
Don't get hung up on every percentage: More importantly, we can learn that holding onto every percentage of equity is not the way to increase your chances of success. Instead, your approach should be fair and generous. In return, you will likely be rewarded with a loyal team of motivated employees. And a loyal, motivated team will increase the chances of your company's success, and a loyal, motivated team will increase the value of your equity