Splitting Equity Between Founders – How to Approach It.

Splitting equity between founders can make for interesting conversation.  The couple times I have done it, we made a point to address the matter purposely and methodically.  We all walked away happy. That does not mean I am an expert, but what worked for us might work for you.  Here is a step-by-step guide on how we approached dividing equity.

When Should the Discussion Happen?

We waited as long as we could for two reasons:

  1. In the early stages of problem discovery and customer development, our energy was better spent on finding perspective customers than dividing up a company that had yet to show promise.
  2. We wanted more time to understand the type of company we were building, and more time to work together to understand our strengths and weaknesses.

We never avoided the subject. We simply were in no hurry to split the equity until we absolutely had to, which was when we incorporated.

That raises the question, “when should someone incorporate?” I will share my specific thoughts on that in a later post, but for the purposes of this post, we needed to incorporate in order to close our first customer.  The Articles of Incorporation required what we state our percentage of ownership, so we had to discuss equity.  Equally, we were facing larger capital expenditures as well, so money matters were a higher priority.

Plan the Meeting Date Ahead of Time:

Splitting equity was an important discussion, so we scheduled a meeting between the two of us a week in advance.  With time to prepare, we could collect our thoughts on what we believed was equitable. Appropriately, the meeting agenda was solely focused on equity as to avoid distractions.

Meeting Preparation:

My partner and I did our own research, but our primary goal was to build a framework for what we considered an equitable split.  We both did a lot of reading on how others had approached this, and we forwarded articles to each other that we found insightful.

By and large, most articles and blogs I found were useless.  They lacked practical advise.  That said, Geekwire.com stood out by offering a formula, and I ended up using it as the basis for what I found to be an equitable split between me and my partner.

The Framework We Used:

Not everything in Geekwire’s formula made sense for our startup, so I modified it some.  I suggest reading the entire Geekwire article for a basic understanding of how it works.  My modified version is as follows:

Each founder starts with 100 shares.  For each of the following criteria a founder meets, he/she adds the corresponding shares to their pool of shares.  At the end, the percent of the total shares each founder has equates to the percentage of equity they have in the company.  Read the Geekwire article for details and examples.

One major difference between my formula and Geekwire’s is that mine assigns a fixed number of shares to each criteria instead of a percentage.  Percentages make the order of the list very important, and I did not see a reason for that.  We also added criteria as it related to our business.

Criteria Shares
Owns Intellectual Property/Already has a Product:  5-25
Experience in the Market/Industry:  5-20
Will be CEO:  5
Full-Time Commitment:  20
Raised Money Before:  20

*Important Note:  This formula does not state you should have a few hundred total shares in your company.  Rather, it is a formula to figure out the percentage of ownership.

Cash/Financing:

Cash is not included in this formula because it requires a company valuation.  It should however be included in the final equity split.  If you cannot agree on a reasonable valuation, a convertible note is an alternative idea. It was something we considered but did not use.

Sales:

Another item not in the formula is anything sales related (i.e. closing deals, sales experience, the size of one’s Rolodex, etc.).  Sales is important, but not in splitting equity.  Sales concerns future events, which are uncertain.  There is a reason that commission is earned after deals are won, not before.

If someone is demanding that sales be included in the discussion, I would envision putting defined revenue goals around it.  In all cases, avoid giving away equity without the business getting something in return.  In our startup, sales was everyone’s job so there was no reason for special consideration.

Meeting Day:

The first order of business was to share the framework we used.  I shared my formula: the modified Geekwire formula.  My partner shared his: a formula similar to Geekwire’s as well. By using the formulas, we kept the discussion centered on what was valuable to the business, and was able to keep personal feelings to a minimum.  That said, personal feelings did creep in, but they did not prevent us from being productive.

At some point, we had to say what we thought the split should be.  In our case, our numbers were far enough apart that we had a few more meetings to find agreement.

*Important Note: Some people want equity for different reasons, like ensuring they have a voice in the business.  There are ways to ensure minority shareholder rights in the Articles of Incorporation.  We took advantage of them.

Important Points to Keep in Mind:

  1. Money Matters – If one founder has considerably more money than the others, this can tilt the balance of ownership dramatically.  It is best if the founders have equal finances, but if that is not possible, you can add provisions to the Articles of Incorporation to help everyone feel at ease (e.g. board control, vesting periods, etc.).
  2. Share Proportions Matter – Certain thresholds of ownership allow for different levels of control.  In the Philippines, ≥66% ownership allows passage of anything through the board, including special resolutions. In many countries it is 75% (e.g. Hong Kong, United Kingdom).  Depending where you are, you can adjust the thresholds for passing shareholder resolutions in the Articles of Incorporation.
  3. Directors – Some countries require a minimum number of directors.  The make-up of the board typically reflects the percentage of ownership, but it can be an important area of negotiation.  This was very important to us, especially in the Philippines where there are restrictions on doing business in the Philippines as a foreigner.
  4. Vesting Period – This should be discussed along with the equity split.  A 4-year vesting period with a 1-year cliff is very common, but I have heard of longer periods.
  5. Sweat Equity – Sweat equity matters, but some countries’ laws do not recognize it.  Thus, it may not play a role in equity discussions.

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