When I launched my digital media start-up in 2007, I did it with my brother. We didn’t intentionally set-up a business, it was more a hobby that turned into a business. So when it came to the question of how we split the equity, we both just assumed it would be a 50/50 split.
Of all the items that received deep cognition during those early days, how we divided the equity split received arguably the least. Yet, when we sold the business close to 10 years later, the implications of the split were pronounced.
This post isn’t about whether my brother and I split the business ownership correctly or not. But in the years since, I’ve met hundreds of founders, witnessed numerous exits, and thought a lot about this complex issue. Different teams, VCs, investors and market commentators all have different approaches to splitting equity. Some decide on an equal split, while others find that attributing different stakes to different founding team members is the correct approach to take.
Y Combinator recommends that equity should be split equally between the founders, as at the early stages, all the work is ahead of you and execution > the idea. HBR’s research found that the teams who spend longer thinking about the equity split, are more likely to have unequal portions. Their data also found that co-founders who are related to each other, are statistically more likely to skip this discussion… something I can attest to.
Gust has recently released a tool that recommends equity split amongst co-founders based on the business domain and relative skills each founder brings. I had mixed results going through it myself and wouldn’t recommend this as a sole determiner of outcomes. But the process will force good discussion amongst the team as a minimum.
Often when we meet companies who are in the process of launching, they ask for our advice, so here are some observations on how co-founders might wish to approach the thorny issue of splitting their equity amongst themselves.
What should founders be thinking about when considering equity splits?
At its core, there are two options. 1) Should we just split the equity equally; or 2) Should each founder hold unequal portions of the equity. In truth, there is no right answer. Each will depend on the circumstances, and it will only be with the benefit of hindsight that you will know if what you have done was correct. But in our experience, there are things to consider, and the longer you take to consider what option is best for you and your company, the higher the chance that you will get it right (whether that results in an equal split or otherwise). With that in mind, here are some things to consider.
Structure and outcomes: Charlie Munger is noted for observing: “Show me the incentive and I’ll show you the outcome.” In essence, the structures we use not only support our processes, but they carry a deterministic quality. Founder equity splits then not only represent how many shares each party holds, but the mix will shape certain outcomes. Consider what happens if a company is going through a rough period and one of the founders holds less than 5%. What flight risk does the structure open-up in this case? Equally, a 50/50 split means that in the early days at least, there is no dominant voice on key decisions.
Idea vs Execution: It is well known that the startup journey is hard. Again, something I can deeply attest to. There are no overnight successes and at inception, all the work is ahead of you. An idea without execution is worthless. As Y Combinator argues, giving undue preference to the co-founder whose idea it was, versus the co-founder who can productised or commercialise the idea makes little sense. Conversely, splitting the equity equally before understanding the skills, time, financial benefit and commitment each co-founder has will lead to problems further down the track. My suggestion is to think and discuss deeply the equity split considering these factors. It’s the process that matters more than the outcome.
Vesting: One must-have for all companies at inception is implementing a simple co-founder vesting schedule (or reverse vesting, as the case is often with founders who have already received their shares). Vesting sets up a structure that can deal with certain outcomes. Vesting ensures each co-founder ‘earns’ their shares in the company by remaining actively involved over a period of time, and resolves what happens if this doesn’t occur.
Mitigation: Often founders knowing who ‘wins’ a fight prevents the fight in the first place. In my situation, I ended up with more equity than my brother. Thankfully, we never voted on anything, but it was known that should there be a vote, I would win. It forced compromise and may have mitigated events playing out where the outcome was not already known.
Dealing with tough decisions: HBR’s research shows companies where founders have an equal split can have more difficulty in raising capital than those who don’t. Their research shows that for some, an equal split can be a troublesome signal about a team’s ability to negotiate with each other and deal with difficult issues up front.
I asked two founders to comment on their equity split process, with the following edited responses from them:
“As close friends, who developed the business idea together, we had always anticipated the shares would be split 50/50 and hadn’t given it much thought. However, in our conversations with Shearwater, they recommended we be factual and data-driven about how we split equity to ensure that we protected our personal relationship as we set up the company. They then passed on an article ‘The Founders Cheat Sheet’ which made us score our personal contributions. For example: who had the idea?, who raised the funds?, etc. This process meant that we objectively arrived at an equal split of equity, so we both feel confident and secure in our stakes in our business.”
“I felt it was important to understand each founders’ leverage (available capital), personal life goals and ambitions. We realised we don’t have equally weighted perceptions of value (ie. one founder was more willing to be diluted earlier than I am)
Treat equity as a sacred number – once it’s gone you won’t get it back. Don’t give equity to early stage developers.
Treat people fairly in the early rounds, it’s not worth losing good people for the sake of 1%. Similar to negotiating, sometimes it’s best to leave a little on the table
Thoughts on the process of discussion equity amongst co-founders:
– Get your cards on the table early – be honest and transparent. We went through a 50 question survey to better understand how we work, what our goals are, exit value, salary expectations etc. This helped better understand each other and get aligned to the mission.“
When this article was posted on LinkedIn, Michael Carden provided the following insights from his experience:
“Such an interesting topic. I’ve boiled all of my experience down to something like this. Make it equal. Create a reverse vesting schedule, that lasts 5 years. If a founder leaves in that period their unvested stock gets split amongst the remaining founders.
“It’s basically this. Initial ideas, and even initial momentum, is nothing in comparison to the years of hard work down the track. So if you expect equal commitment, you’d expect equal division of outcomes. If for some reason you think that one founder is somehow more valuable than others, then you either have the wrong culture for the long haul, or the wrong founding team“.
So, there’s no rule in how to split equity amongst founders. But in our experience, the longer each founder thinks about this issue, the higher the chance that they will get it right. Or less wrong as it may be. And the process of discussing the split has inherent value in setting the culture to be able to have hard discussions between founders from inception.