Splitting Equity with Your Co-Founder? Here’s What You Need to Know
August 19, 2017
Splitting equity is difficult if you haven’t done it before. The tricky part being, there’s no right or wrong way to divide equity. Some startups split equity equally, others wait to get to know each other; some go through a negotiation process, and few save the decision for later just so they can launch a successful product first.
Before you settle on splitting equity 50/50, there are a few key concepts you should understand. Once you grasp the following pieces of information, you can rest assured you will have enough knowledge to keep everyone involved motivated and financially rewarded throughout your startup journey.
Do you have an established relationship and complement your co-founder(s)? If so, you’re off to a great start. But is that enough? Being able to get along is only one piece of the pie. There are a few more pieces you’d need to get together as well. Answer these three questions:
Hopefully, they have a resume or a track record of things that they have done in the past. If they do, you’ll want to vet them by interviewing others who have worked with them. If they’re a designer, does their style match what you’re looking for? If they’re a coder, are they as good as they say they are? Test out what they’ve created and make sure it’s up to par.
Now let’s say they don’t have a resume. What’s their reputation like in the community? If they have a good one, then they have some social proof working for them. If they have a bad reputation, stay away. But if they don’t have a reputation at all, then you’re going to want to do your own homework.
Give them an unrelated project to work on, one that you can get vetted, to make sure they can deliver what you’re looking for.
Or are they going from one mess to the next? Some people are extremely talented and likable, but they don’t have these things in order. You’ll want to make sure the person you’re looking to partner with is able to stay focused and on track for your project.
Some people feel obligated to say yes when you offer them a partnership, but they don’t really want to do it. You’ll be able to see if they’re just saying yes or just committing because they don’t want to hurt your feelings by seeing how responsive they are to you over the course of a month or two.
Does the person you’re planning on working with have a solid source of income? Is this the only source of income they have? If it’s the latter, there’s going to come a point where they get discouraged and want to leave for a paid project. So make sure your partner is able to take care of themselves financially.
If someone is able to get through all these barriers, you should have a good partner on your hands. But make sure to put them on a vesting schedule 一 in case your judgment was wrong. Also, if you aren’t able to attract partners, then you have to look at all these issues for yourself as well. Why?
Because your potential co-founders are looking for the same set of ethics and commitment levels from you.
What role will they play in the long-term?
It’s important that you don’t make all of your equity decisions based on the company’s current state. You’ll be working on this project for years to come ー possibly your whole life.
Ensure that your co-founder is capable of providing long-term value to the company. Just because he or she is a brilliant coder, doesn’t necessarily mean they have the leadership skills needed to run a business.
Generally speaking, you should want to work alongside a co-founder in the same situation as you, in terms of experience and commitment. Meaning, you both will follow the same learning curve and will be on the same page as you enter each new stage of your company.
Splitting equity equally is a controversial subject. Ultimately, there is no right or wrong decision, but you should fully understand both sides of the argument to make the best choice for yourself.
All of the conventional advice on equity splits is just plain wrong for two primary reasons: 1) most equity splits are based on guesses about the future in terms of company value and/or an individual’s contributions, and 2) most equity splits are “fixed” meaning that chunks of equity in pre-set percentages are doled out in advance of actual work.
This means that all traditional advice leads to the wrong answer and, because it’s wrong, it must constantly be renegotiated which is painful and will simply lead to the next wrong answer. It’s a vicious cycle.
The right way to think about equity is to think about a startup as a gamble. Profits or the proceeds of a sale are the potential payoffs to that gamble. When participants contribute to a startup and are not paid for their contributions they are essentially betting on the future of the company. The value of each person’s bet is always equal to the unpaid fair market value of his or her contribution. Each day people bet time, money, etc. The betting continues until the company reaches break even or Series A.
A person’s share of the equity, therefore, should be based on that person’s share of the bets.
Unlike traditional equity splits which are based on unknowable, future events, the Slicing Pie model (see below) is based on logical, knowable, unambiguous facts.
These are the people you are going to war with. You will spend more time with these people than you will with most family members. These are the people who will help you decide the most important questions in your company. Finally, these are the people you will celebrate with when you succeed.
Equal or close to equal equity splits among founding teams should become standard. If you aren’t willing to give your partner an equal share, then perhaps you are choosing the wrong partner.
Read more: How to Split Equity Among Co-Founders
If you work hard good things happen. You should just try to be as fair as possible for the stage of the company you’re at. And the work people have put in before and after, and treat your employees well… Be generous because those are the people who are gonna be with you until 4 am.
Watch: Kevin Systrom: The Equity Question
Vesting, in which each founder has to earn his or her equity stake by remaining involved in the startup or by achieving pre-defined milestones, is one way to achieve the dynamic approach.
Essentially, such agreements are the equivalent of a newly engaged couple grappling with adopting a pre-nuptial agreement. Setting up an agreement up front that outlines negative scenarios that might occur in the future, with corresponding actions to help avoid them, could help founders avoid headaches and increase startups’ chances of success.
Equity often dictates who makes the decisions within your company. Decide who’s in charge first, and then develop contracts that make it clear who is responsible for what aspects of the business. You can easily justify a higher equity stake if you are also responsible, as CEO, for the difficult work of growing your company.
These trusted tools objectively assess your industry, business, and co-founders, to calculate equity splits for you:
Solving the equity equation is typically the most challenging and time-consuming aspects of structuring your startup correctly. We recommend taking the information from this article and discussing your situation with industry experts: investors, successful founders, or startup advisors. These professionals will be able to leverage their experience to provide you with the unbiased insight needed to make important decisions.