This blog post is about what you need to know when it comes to how the Split equity work, tips, and examples.
Equality split among co-founders is an important topic for any business owner who has had the luxury of founding a company with another partner. It’s one thing to have two people work together on a project, but when they are also splitting ownership of all assets equally, it can become complicated. How do you divide them up? What about future growth potential? This blog post will discuss some tips and tricks that may help you find your way through this process!
What Is an Equity Split?
When a startup is started, the founders and early employees take on Risky venture capital by investing their own money in order to make it succeed. In return for this risk they receive shares of equity that can be split up at different levels depending upon what role each person played during inception – from being just an employee who comes onboard later down the line allocating some tokens as part of compensation package while others become more valuable due time spent working hard building something great together!
Factors to Consider in a Fair Equity Split
Determining a proper and fair equity split among founders, investors, and employees can be daunting. Below is a list of important factors to consider with calculating the right equity split for your new company.
Two or more co-founders should share equity in a startup based on how much work they put into the company. If one person only had an idea, but didn’t do any actual development for it then he/she might deserve all of that initial ownership because their contribution was greater than others’.
A rational split between two founders who have different levels of investment would be determined by assessing each’s level and weighting attributes like early-stage input versus later stages when additional capital is raised from investors etc., as well subjectively rewarding those taking higher risks with less potential reward.
When a company is at an early stage like startup, the founders and employees deserve more equity for their time.
This makes sense because they put in lots of work before any money comes into it which can really hurt someone later on if there isn’t enough consideration given then when things do get funding heavy-duty tasks may be taken away from them.
Employees are often willing to take a lower salary than what they would normally be offered in order for the company’s value and share of ownership.
The amount of investment as a percentage of the startup’s valuation may properly be considered in equity distribution. A 50/50 split for otherwise equal co-founders, for example, might fairly be adjusted to 60/40 so that one founder has put more seed capital into their company than another – this would take into account both past contributions (how much was invested) with future ones considering what is expected from them now and going forward depending on how long you’ve been working together.
Past contribution factors to consider include, among others:
- Time spent by each person presenting the business model to potential investors.
- Each person’s individual contribution to the company’s intellectual property.
Future contribution factors to consider include, among others:
- Time to be spent on business development.
- Ability to resolve future problems based on the individual’s professional connections and experience.
- Value of opportunities lost to the individual due to his or her commitment to the startup.
In the startup world, it’s not just about coming up with ideas. The most valuable asset you can have in this business is an honest and open relationship between cofounders who are willing to give one another all of themselves so that their venture makes sense for everyone involved
The best way I’ve found as a veteran entrepreneur who has raised capital from seasoned investors alike: don’t rely on online calculators or formulas when starting out; instead, spend time talking through what each person needs going forward before anything happens at all – including any splits.
Candid conversations are a must
How much of the company’s equity should you get if I am one of its founders? A founder’s share can depend on a number of factors, like who came up with an idea and how integral they believe themselves to be in launching or developing said business. Financial contributions may also factor into this equation – what did these people invest money into coming up with in terms of future profits/losses (i.e., funding)? Industry connections might play too; just remember that not all industries have equal access points so being well-connected won’t always help as much here unless there are other options available within your industry worth exploring before settling for less than perfect circumstances.
Take a long-term view
Dividing the equity pie right now and taking a long-term approach is crucial. Sometimes founders get tied to the idea that they’re so valuable immediately, but are going to be valuable for ten years? An even distribution of value adds responsibilities over a time period.
Founder prenuptials are difficult to have but necessary for the long-term success of your company. Without planning for what could go wrong in various situations – such as somebody dying or getting fired from their job- there will always be threats that can’t wait until after launch time!
Maintaining flexibility through building an emergencies fund helps with disaster recovery and allows you to take corrective action when needed before they become serious problems.
Keep potential investors in mind
The cap table is an important document for investors to look at when deciding whether or not they want their money invested in the company. “Investors want to make sure management team has enough incentive,” says Goldberg; if someone looks at a spreadsheet and most of its values don’t belong with those running things could indicate potential problems ahead- especially since there may only be so much return on investment possible given what’s happening right now economic wise.
In order to maintain a sense of vested interest, it is important for founding members and investors alike that there be someone who makes decisions when the time comes. “If you have equal equity,” says Gandhi, “it can sometimes hard break ties.” That’s why she suggests looking into how your company will operate once underway so as not only do what’s best now but also prepare yourself in case something changes later down line.
Don’t avoid the topic
The consequences of avoiding difficult conversations about how to divide equity can be harmful. Researchers found that teams who negotiated longer were less likely to have unhappy founders, as they took time in serious conversation on the topic and didn’t just cut it short by defaulting with an uneven split like some other approaches might do instead.
Here are some of the most often cited reasons for unequal equity splits:
- I came up with the idea for the company
- I started working n months before my co-founder
- This is what we agreed to
- My co-founder took a salary for n months and I didn’t
- I started working full-time n months before my co-founder
- I am older/more experienced than my co-founder
- I brought on my co-founder after raising n thousands of dollars
- I brought on my co-founder after launching my MVP
- We need someone to tie-break in the case of founder arguments
Founders tend to make the mistake of splitting equity based on early work.
All of these lines of reasoning screw up in four fundamental ways:
- It takes 7 to 10 years to build a company of great value. Small variations in year one do not justify massively different founder equity splits in year 2-10.
- More equity = more motivation. Almost all startups fail. The more motivated the founders, the higher the chance of success. Getting a larger piece of the equity pie is worth nothing if the lack of motivation on your founding team leads to failure.
- If you don’t value your co-founders, neither will anyone else. Investors look at founder equity split as a cue on how the CEO values his/her co-founders. If you only give a co-founder 10% or 1%, others will either think they aren’t very good or aren’t going to be very impactful in your business. The quality of the team is often one of the top reasons why an investor will or won’t invest. Why communicate to investors that you have a team that you don’t highly value?
- Startups are about execution, not about ideas. Dramatically unequal founder equity splits often give undue preference to the co-founder who initially came up with the idea for the startup, as opposed to the small group founders who got the product to market and generated the initial traction.
Example of an Equity Split
The global equity firm Advent International provides this example for an equity split after the first round of funding:
- Founders: 20 to 30 percent divided among co-founders. The company contribution is rarely exactly 50/50 and the equity split should be based on a variety of factors, including those discussed above.
- Angel Investors: 20 to 30 percent.
- Venture Capital Providers: 30 to 40 percent.
- Option pool: 20 percent, which can be divided up among employees.
In order to ensure that the company’s unique nature, needs, and business strategy are reflected in its ownership percentages you should take into account what these specific elements mean for an individual’s equity share.
What Tools Can Help Navigate an Equity Split?
Many startup founders can get bogged down in details without a solid organizational platform to manage all of their equity data. Consider using an automated cap-table management tool, such as this one offered by eShares.
Equity calculators, such as those offered by Founder Solutions and Foundrs.com, can also be useful. Equity calculators take into consideration a variety of factors (ideation, time spent away from other projects, per-hour pay estimation, etc.) in calculating equity splits. Foundrs.com also offers this helpful venture capital calculator.
Is Equity the Same as Stock?
Stocks and equity are the same, as both represent the ownership in an entity (company) and are traded on the stock exchanges. Equity by definition means ownership of assets after the debt is paid off. Stock generally refers to traded equity.
What Are The Types of Stock Options Commonly Offered to Employees in an Equity Split Agreement?
The two types of stock options typically offered to employees are non-qualified and incentive. Non NQOs may be granted by companies as well, but they don’t offer any special tax treatment for recipients like ISOs do; however there’s more information available on the differences between these different kinds so it pays off carefully reviewing them all before making your decision!
Other Quick Tips to Consider
- Anyone with less than a 10% equity share should likely not be considered a co-founder, but instead, as a first employee whose compensation should be supplemented with some level of salary.
- More co-founders are not necessarily a good thing. One or two co-founders are ideal. There should probably be no more than four co-founders, however. More than that and a reassessment of individual company roles should be considered.
- Don’t let your emotions dictate your equity split decisions. Be sure to put some real-time and effort into an objective assessment of the value of each equity holder’s contribution. This is particularly true when family members are involved.
- Be realistic, but not stingy. Remember that a larger equity share usually means more incentive to help the company succeed.
- Be patient. It can take some time to assess the relative value of each individual’s contribution to the company. A simple, even equity split among co-founders, for example, maybe seen by potential investors as a sign of managerial immaturity, and may also result in personal animosity as the company moves forward.
- Consider holding back some shares from allocation at the beginning. As the company moves forward, it is likely that, due to greater than expected contributions to the company, some founders or early employees will deserve more compensation than originally allocated. Shares held back can be used to correct such compensation inequalities.