Learn how to split equity in a startup fairly so everyone in your company feels connected and works together for long-term growth.
You have started a startup or are thinking of starting one with some similar-minded co-founders. Both you and your co-founders are excited and working hard to make this dream a reality. At the same time, you guys are riddled with one question “How to spit equity fairly.” so that everyone remains happy and provides as much effort as they are providing now.
It’s a no-brainer to say that startup share distribution is a challenging and equally important decision to make. This decision can have long-lasting implications for the future of your startup, and it is crucial to get it right.
The goal is to divide the equity fairly, taking into account each co-founder’s contributions, skills, and plans. But how do you determine what is fair? In this article, we will explore different types of equity split in a startup and provide a few rules that founders must follow while dividing the equity among themselves. So keep reading, and you’ll have a better idea of how to split equity in a startup that will satisfy everyone.
Understanding Startup Equity Basics in Simple Terms
When it comes to startups, the term “equity” refers to the ownership stake each founder has in the company. This can be in the form of stock options, restricted stock units, or actual shares of stock. Equity gives co-founders and early employees a financial interest in the success of the company, aligning their interests with those of the shareholders.
In most cases, the equity split is determined by the amount of money or resources each founder contributes to the business. For example, if one founder invests $100,000 in a startup and another only invests $50,000, the first founder will likely have twice as much equity as the second. But is it that simple?
No, equity can also be affected by each founder’s role in the company. For example, suppose one founder is solely responsible for developing the product, and another is responsible for marketing and sales, and both invested the same amount at the beginning. In that case, the former may have a more significant equity stake. The idea of the product itself has an essential role in equity split. The original owner of the idea usually gets a substantial portion of the equity. We will dig deeper into this topic but let me briefly tell you why equity spit is so important.
Equity can significantly impact a startup’s valuation, as it represents the portion of the company that each founder owns. Therefore, carefully considering how equity will be divided among the founders is essential. Otherwise, there could be conflict down the road over who owns what percentage of the company.
When Should Founders Split Equity?
There are different options on when co-founders decide to split the equity in a startup. Some co-founders choose how to divide the equity without disagreement; some engage in lengthy negotiations.
Some divided the equity right once, while others waited until they established their organization. Some may believe in equal distribution; some in dynamic. Every startup has its own way of sharing equity in the startup.
Anyway, one thing we all know is that the co-founders complement each other and work together to achieve a common goal, “company success.”. What’s worse than having trouble among co-founders and not being able to work together at all? Equity spitting is something that can cause such a situation.
The sooner you sign an agreement about how your equity will be divided, the less likely it is that conflict will arise later on down the road when big decisions need making and disputes over shares pop up in every instance imaginable–even ones as popular as Facebook!
It’s normal that, you are worried about dividing equity at this early stage. It can put your company in a risky situation if any of your co-founders fail to prove themselves. Don’t worry; we got you covered. A vesting schedule safeguards you and your co-founder against this risk.
If you don’t know, standard startup vesting lasts four years, with a one-year cliff. It ensures that the founders stay in the startup for at least a year. This means that a founder will fully retain all shares after four years. Now that you know you have security, you must feel relieved to move on to learn about how equity works in a startup.
The Different Ways to Split Startup Equity
There are two options for splitting equity: evenly and dynamically (unequally). Before using any of these splitting equity methods in your startup, you need complete knowledge of when to do which splits and their benefits and drawbacks.
When Should You Use Equal Splits?
When you are at the early stage of your startup, all the work is ahead of you. Finding a co-founder or co-founders allows you to divide the labor involved in getting a business off the ground in these early years. You must ensure that all the co-founders are equally committed to and invested in your company and its success. Equal equity distribution is the key to doing this perfectly – and why not? These are the people you rely on, face crises, and celebrate your success. They deserve equal or close to equal equity splits. If you are doubtful about offering your business partner an equal share of the equity, you should rethink partnering with them. If not, here are the benefits you will get if you use equal splits.
Equal Split Pros and Cons: A Quick Look
1. Encourages co-founders to make similar efforts.
Impacts decision-making negatively.
2. Keeps your co-founders motivated.
Investors don’t like equal splits.
3. Easy to execute if all parties agree.
It may create an unfair distribution of work.
4. Motivates all co-founders to work towards the success of the company.
It may create conflicts in the future.
Benefits Of Equal Splits
Encourages co-founders to make the same effort
An equal equity split will encourage all of your co-founders to put in the same effort. It will produce an excellent outcome, which will be great for your startup.
Keeps your co-founders motivated
You and your co-founder must have the same vision for the startup and equally invest in seeing it succeed. An equal equity split will help to keep your co-founders motivated to do better work.
Builds a sustainable relationship between co-founders
It doesn’t matter which co-founder has sacrificed more to this point; building a successful business takes time and effort over many years. So you can have a sustainable relationship with your co-founders by giving them an equal equity split.
Provides a way of recognition as contributors
You’re bringing someone into your firm because you recognize their worth as a contributor. They’re valuable for your startup. An equal equity split is the best way to recognize the value of your co-founders.
Helps to avoid conflict between co-founders
After the firm becomes successful, if you and your partner divide the profits equitably, it will enhance your relationship and reduce the likelihood of disagreements.
If there are benefits, there will be drawbacks; to fully understand the topic, you need to know both.
Drawbacks Of Equal Splits
Impact on decision-making negatively
An equal split indeed helps to avoid conflicts, but it’s also true that if there is any disagreement between the co-founders, the situation worsens. This can slow down your startup’s progress. To avoid this sort of impact, some choose to do an almost-even split, such as a 51-49 equity split, which gives one founder more power.
Creates bitterness between partners
Equal splits might cause issues in the long run. It’s possible that one co-founder may grow less engaged or less helpful over time. This might lead to bitterness between you and your co-founders. You and your partners can set up an agreement in advance that specifies potential negative scenarios and related activities to help avoid them.
Sometimes turns off the investors
At any point if you think about raising outside money especially venture capital for your startup, you might face difficulty because of equal splits. Experienced venture capitalists know all the co-founders don’t put in the same effort. Try to have an open discussion with your founders and venture capitalists to encourage everyone to understand each other’s points of view.
May cause unfair distribution of work
Not all your co-founders will have the same role or contribution to your startup. This can be an injustice for others, which can later create a conflict for your startup. So try to pre-define roles that work for you and your co-founders to avoid conflicts.
May create a contribution crisis
It is common for founders to exaggerate their past contributions and undervalue future contributions. This can lead to a contribution crisis for your startup. You and your co-founders need to balance both because a startup can only be successful if it’s balanced with a glorious past and an advanced future.
Till now, this was a brief overall perspective on the equal split. Let’s take a look at dynamic splits.
The other type of equity split is dynamic split. In dynamic split, you and your co-founders can determine how much equity each of you deserves based on what each of you contributes to the startup.
Why Use Dynamic Splits?
The other type of equity split is dynamic split. In a dynamic split, you and your co-founders can determine how much equity each of you deserves based on what each of you contributes to the startup. You must be thinking, if an equal split is best and fair, why on earth do we need other different types of a split? Your thinking is valid. There are several reasons why founders demand unequal equity splits.
Idea– The whole startup was my idea.
Investment– I got the investment before my co-founders joined.
Experience – I am more experienced as I started before them.
Contribution – I am contributing more than anyone and didn’t take my salary.
MVP – I launched the MVP before my co-founder joined.
These are some of the common reasons. As different startups have different issues, there are countless reasons why founders ask for dynamic split. There are also some pre-requisite if you want to dynamic equity spilt model works for your startup:
A trustworthy leader: You must have a trustworthy capable leader who will be responsible for tracking the shares and keeping equity distribution fair.
Relative value: Calculating actual value is difficult. To calculate quickly and more meaningfully, try to use a relative number provided by each founder.
Theoretical Base Value: Use TBS to start yourself; over time, it will change based on someone’s contribution.
Now that you know the reason and the per-requisite next topic to discuss is the benefits and drawbacks. Just like equal splits, dynamic split also has benefits and some drawbacks.
Benefits Of Dynamic Splits
Justice is served
Every co-founder gets based on their contribution. It just justifies the very thing you and your co-founders deserve.
Split equity, more precisely
You and your co-founders can split equity more precisely for various reasons.
Good relationship between founders
It is based on contribution, so nobody could disagree or argue. So it helps to maintain a significant relationship between you and your co-founders.
Add or subtract founders
Dynamic split changes over time, as well as additional contributions. In any case, you need to add or subtract any of your co-founders; it’s effortless in dynamic split.
You can calculate the equity in many different things and factor that makes it so flexible.
Dynamic splits always ensure fairness regardless of your and your co-founders’ contribution; those who contribute the most will get the highest reward.
Drawbacks Of Dynamic Splits
Not suitable for the long run
Dynamic equity splits always focus on the current situation. If someone is not contributing now, if he changes and starts contributing later, it will not affect his equity. Equity that feels fair right now can feel unfair later. Many experts don’t recommend dynamic equity in the long run.
Everybody wants the biggest share
In a dynamic split, there is always the most significant share that every founder dream of having. This can create bad politics between the founders.
One person is in charge of decision-making
The dynamic split gives one person the right to make decisions, but for a good business, every founder must agree.
Founders with lower equity can think they have been mistreated. They deserved more equity. It can lead to conflicts between founders.
Now you know the reason, benefits, and drawbacks of both splits. You and your co-founders can choose a method that better fits your startup. Here are some rules you can follow to avoid mistakes and split equity fairly.
How To Split Equity in a Startup Among Co-Founders
There is no step-by-step process for splitting equity. Instead, there are a few rules that founders must follow while they are dividing equity among partners in a startup.
Rule 1: Choose the correct Co-founders
Choosing the right co-founders for your startup can be the difference between success and failure. Always consider who they are as a person and what they bring to the table.
While having a strong team of passionate and talented individuals is important, it’s also essential to have a complementary skillset. For example, if you’re launching a tech startup and don’t have enough tech experience, you’ll want to ensure you have someone on your team who is experienced in coding and product development.
Likewise, if you’re starting a marketing agency, you’ll want someone on board who understands the latest marketing trends and knows how to create an effective branding strategy.
Ultimately, the goal is to have a balanced team that can cover all the essential bases and helps your startup thrive. So take your time choosing your co-founders – it could be the most important decision for your business.
Rule 2: Keep your personal feeling aside
It’s nearly impossible to have personal feelings toward someone and still treat them fairly. A founder should put his/her feelings aside and do what is right to ensure the startup’s success.
Rule 3: Avoid taking more than two co-founders
As a founder, it’s natural for you to want talented people in your team. But remember, your goal behind taking co-founders should be creating a balanced team at the beginning, not gathering talents.
Plus, the higher the number of decision-makers at the top, the messier the situation gets down the road. So, Avoiding taking more than two co-founders is wise, although it’s not a golden rule.
Rule 4: Don’t make hasty decisions
You and your co-founders should take your time to review all aspects of the equity split. Always remember – Patience is the key.
Rule 5: Always use vesting
Vesting can help safeguard you from any disastrous situation created in case any founder leave or doesn’t work out.
Rule 6: Maintain fairness and equality
While trying to split equity, ensure you aim for equality and fairness as much as possible. Otherwise, this is going to create conflicts.
Rule 7: Consider the future value of equity
Your equity value will increase day by day; you need to keep that in mind while splitting the equity.
It’s always better to be prepared beforehand — you just read some ground rules. Here are some faqs for extra help on splitting equity among startup co-founders is the next topic.
Rule 8: Document everything
Always make sure everything is written and everything is well documented. Try to make multiple copies of that document. Because in the corporate world, if it’s not written, it didn’t happen!
Splitting Equity Among Startup Co-Founders – Faqs
Is it ok if I don’t want any co-founders?
A startup has many complications. It’s not easy to manage. You can go solo if you are confident enough, but having partners can make things much easier for you.
How can I choose my co-founders?
It’s a challenging task to find the right co-founder for your startup. It’s better if you both share the same work-life balance. Also, someone you have a work history with. It’s better if he has different operational skills.
Is shaking hands and starting work a good idea?
If you and your co-founders can quickly divide your equity, it’s excellent, but make sure you have it all documented, signed, and printed in several copies with every party concerned.
Will I be facing a heavy loss if my co-founder leaves?
It depends on whether you have a vesting schedule agreement with your co-founder. If you have one, you are saved. But be careful while choosing the next co-founder.
Is it ok If I give my employee equity?
Yes, it is. You should save 10% of your shares for your loyal employees.
Splitting equity among co-founders can be a complex and emotional process. Don’t hesitate to reach out for help if you’re feeling overwhelmed. Our founding CEO is happy to chat with you about the best way to split equity fairly, or you can talk to experts for advice specific to your business. No matter what path you choose, make sure that everyone involved feels like they are being treated fairly and that the company is set up for success.
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