Whenever splitting money is on the table, there will be concerns. Deciding how to distribute equity when starting a business is no exception, especially if you’re not going solo but with co-founders. The question of splitting equity amongst them is bound to come up – take it as an opportunity to have an honest discussion with all parties involved to avoid friction.
Where do you start? You have already decided about the responsibilities for yourself and the remaining founders, so everybody knows what they’re doing. Some founders may have been with the startup longer than others. There’s usually also one idea-bearer. How to split equity fairly in such cases? Should it be 50/50?
We could ask a lot of other questions that would make it even harder to make a decision, especially if you’re teaming up with your friends or family. That’s why I sat down with Tomasz Popów – a serial investor – and discussed a list of nine most common questions founders ask when it comes to splitting equity. Hopefully, by the end of this text, you will have a better idea as to how to reach a solution that will satisfy everyone.
Splitting equity amongst startup founders – 9 FAQs
Question 1: Should I give more equity to the person who delivers results?
Imagine this situation: you decide to go all-in, quit your full-time job, and allocate all your time and effort, maybe even money, into starting your dream business. You go to a local meetup for entrepreneurs, meet someone who likes your idea and is willing to cooperate with you and become a co-founder. But, they’re not going to quit their job and will work part-time. What do you do?
It’s quite simple: if one of you works more and dedicates more time and effort – they deserve more. To regulate this kind of situation you should think about signing a vesting agreement. I discuss it in more detail further below.
Question 2: Should I get more equity as a person who came up with the idea?
This one is pretty simple. Gary Vaynerchuk once said, 'Ideas are sh*t without execution', and that sums up this scenario very well. If you can’t turn your idea into reality, it has no value. For that reason, it doesn’t matter who came up with the idea – everyone involved in the execution should get their equal share.
Question 3: Should the CTO get more equity as they know how to actually build the app?
This situation is quite common nowadays. CTOs often tend to believe that they deserve more compensation because without them the product wouldn’t be brought to life. However, the app itself doesn’t guarantee success. There are a lot of apps out there. According to Statista, in March 2022, there were over 3.7 million apps in the iTunes store alone. How many of them are actually being used on a regular basis? Certainly not all of them.
If you’re not capable of selling and marketing your product – it may become nearly impossible to succeed. And for that reason, even though you may not see a huge impact of your actions in the very beginning and you might think that the CTO does a lot more, don’t fall into the trap.
Question 4: Should I just go solo and keep the equity to myself?
Even though it might work for some people, it’s recommended to find yourself one or two co-founders. Building a business is a very stressful process, not only business-wise, but also when social life comes into play. When you see your friends getting promotions in their corporate jobs, getting married, having kids and here you are spending most of your time building something you cannot be certain will work out, it might be pretty overwhelming.
If you’re not mentally prepared to handle this, the chances of you giving up grow rapidly. The first 2-3 years are crucial for the startup. And that’s when having a co-founder(s) will help.
Question 5: How should I split equity with a co-founder with the same background?
‘What if another co-founder and I both have sales backgrounds? How should we split?’
Don’t. Don’t split and don’t become co-founders. Your founding team should consist of people with different competencies and skill sets.
Question 6: Does more equity equal more motivation? If yes, should we split equity 50/50?
Yes, it is true that more equity means more motivation, especially if you and your co-founder(s) work full-time on your startup. For that reason, it’s much better to split equity equally. It doesn’t have to be 50/50, it might be 42 and 58, but you should split at least on a similar level.
Question 7: What should I do if my co-founder leaves?
After you’ve decided how to split equity in your startup, it’s very important to plan ahead for any future changes in commitments. What if after a few months of hard work suddenly your co-founder decides he doesn’t want to work on the project any more and quits? He leaves, and yet he still has a 42% stake in your startup. What are you going to do in a situation like this?
Don’t worry, there’s a solution. It’s called ‘vesting’. Vesting is a type of contract, in our case between co-founder(s), which regulates how the split occurs. It’ll be easier to explain using a brief example.
Vesting example
Let’s imagine a situation when both you and your co-founder want to feel secure, that you will work on your startup and no one will leave the other one to deal with it, while keeping their shares. You sign a 24-months vesting which states that you won’t get any shares during the first 6 months. If you successfully go through this period, you’ll get your first 6% of the company. From that point on, you will each get an additional percentage every month until the vesting period ends, let’s say 2% per month.
That’s vesting in a nutshell. Of course, the conditions can vary, but the idea stays the same. If you want to be on the safer side, prepare a vesting contract that stipulates receiving the 6% not after 6 months, but at the end of a 24-month period.
Question 8: How many shares should I give to investors?
First and foremost, remember to not look for one big round of funding and give a vast amount of shares to a single investor or a VC. It’s better to have 3 smaller rounds and give smaller parts of the company to different people.
When looking for a seed round, don’t give away more than 20% of the company, try to go for a 15% as a perfect deal. And if you’re a B2B SaaS startup, start looking for investment only after you’ve reached 100k ARR (Annual Run Rate).
Question 9: Should I consider giving loyal employees any part of the company?
When it comes to employees, make sure you have around 10% of the company shares reserved for the key ones. And I don’t mean your secretary but people who did bring a lot of value into the company. It’s not necessarily the very first employee of yours, but if they did a lot for the business to prosper then, of course, it’s a good idea to give them a small percentage of company shares. As I mentioned earlier, it is a great way to motivate an employee, since the person’s share value will grow only if the company grows.
Splitting equity amongst co-founders fairly
Here’s a TL;DR summary of the most important rules you should stick to when splitting equity amongst co-founders:
- Rule 1: Aim to split as equally and fairly as possible;
- Rule 2: Don’t take on more than 2 co-founders;
- Rule 3: Your co-founders should complement your competencies, not copy them;
- Rule 4: Use vesting. Always;
- Rule 5: Keep 10% of the company for the most important employees;
- Rule 6: Don’t start looking for funding too early (if you’re a B2B SaaS, start only after your ARR (Annual Run Rate) reaches 100k);
- Rule 7: It’s better to get 3 smaller funding rounds rather than 1 big one; and
- Rule 8: When looking for a seed round, don’t give away more than 20% of the company, aim for 15% as a perfect deal.
I hope this article helped you get more clarity when it comes to reaching a fair deal while splitting equity with co-founders. You may find some of my advice controversial, but it’s all oriented at splitting as fairly as possible, which should always be the case in any business.
