Founders frequently ask me to provide guidance on how their startup should split equity between co-founders. My answer is always: (1) It Depends, and (2) Quickly.
(1) IT DEPENDS
If you’ve ever hired a lawyer, you will (unfortunately) hear the phrase “it depends” several times. In this situation, the “it depends” hinges on the respective past/current and future contributions of the founders:
– The Idea
– Business Plan
– Intellectual Property
– Cash (Consider structuring this separately from the founder split.)
– Opportunity Cost (i.e., Is one founder making a larger sacrifice?)
– Industry Expertise
After taking the above items into consideration, a startup team will rarely end up with an equal split. And for what it’s worth, a startup team should rarely end up with an equal split. On the other hand, I don’t recommend the startup team create a complex methodology to come up with the solution. Save the fanciness for the code.
Rather than pushing forward with development & implementation, co-founders run the risk of spending too much time on the equity-split decision. In addition to multiple startup-wide meetings and emails about the split, the individual co-founders will spend time wrangling with the matter as well. However, it’s not going to “kill” the startup if this decision takes a bit of time.
The main reason to have this determination done very quickly is that the startup team gets to have — and conclude — its first difficult conversation. There’s no avoiding difficult conversations at a startup. Don’t start with the first one.
Regardless of how you decide to split the intial equity pie, seriously consider vesting your founders shares.
“We want to have 30% of the startup company at exit.”
-Anonymous Startup Founders
Occasionally, founders will plan out their startup’s lifespan to the point of pre-determining their final equity figure after all hires and investments have been made. Usually, a set of founders want to end up with a final equity percentage in the 25% – 51% range. I call this number founders (mentally) reserve for future issuance the “Issuance Pool.”
While an Option Pool is a key tool for a startup in order reaching the next level, creating an Issuance Pool is of no tangible benefit.
First, the Issuance Pool creates the potential hazard that founders will operate and make equity issuance decisions, whether for a developer or angel investment, as though the Issuance Pool is pre-authorized like an Option Pool. A common mistake made by founders is acting as though they own the 25% to 51% they plan on owning instead of the 100% they actually own as a group after incorporation and before any other equity issuances. Thus, there is the tendency for founders at future issuances to think “This 10% issuance leaves us with 39% left for our (planned) future issuances.”
Your startup could over-issue equity to consultants, advisors, employees, and investors simply because you believe there’s a large amount of equity left in your Issuance Pool. Alternatively, your startup could turn off new hires and investors if you attempt to under-issue equity because your Issuance Pool is running low.
Second, the Issuance Pool should not be used as a barometer of success. Is your startup any more successful because it only issued 75% of your Issuance Pool? Maybe. But the goal should be that all equity issuances work to increase the value of the startup and generate great returns– not that your equity percentage is greater than what you planned months, if not years, ago.
While the Issuance Pool doesn’t show up on your startup’s cap table, it can still be harmful to your startup. There’s nothing wrong with planning, but an Issuance Pool should be discarded quickly after incorporation.