Startups: How to Split Equity Between Co-Founders

As a rule, startups have got from 1 founder to up to 4 co-founders, and the question of how to split up equity becomes more and more actual as the number of co-funders increases. The best practice is not to register a legal entity from the start to save money on the office. Before your startup begins to make money, it’s a good idea to observe what contribution every team member makes and plans to make in the future after it takes off.

The contribution may be of a different character — working hours, roles in the startup, money put into the growth, a deck of skills, complexity of tasks fulfilled, previous experience, useful contacts, sales, etc. And there 2 types of approaches to dividing the equity — dynamic and static. Both have pros and cons and will much depend on the agreed terms between the members.

The vivid example of a dynamic methodology is Slicing Pie by Mike Moyer. It is ideal for bootstrapped startups (with no venture capital or outside investments) on the early stage. Under the equity, the author means the profit the startup generates or will generate. The best about it is that it takes into account the contribution of each participant not only in the beginning but over time. One more advantage is, according to the author, that it’s the only model that guarantees that every founder, investor, partner, and an employee gets exactly what they deserve…no more and no less! There 2 visible cons. First, it’s a bit difficult to explain the slicing pie model to a lawyer. The second visible con is that you can’t use it with the angels or VC investors as they make a pre-money valuation and get a fixed share according to their investment, which doesn’t correlate with the dynamic methodology of the Slicing Pie.

One more option is to use online startup equity calculators. It’s easy to find them on the net. They also count the contribution of each member, and the more extended the questionnaire is, the fairer the result will be. It’s a good idea to fill in the form together with your team not only to split the equity but also to note unaccounted responsibilities. The con is that with time the contribution of co-founders may change, but the shares will remain the same. This approach is familiar to lawyers and investors. After a pre-money valuation and issue of new shares, the shares of co-founders decreases (now we won’t speak about the preference shares).

A very similar approach is to divide the entity in negotiations determining the value of the contribution of each co-founder without the pre-made online questionnaire. This way is simple and agile but leaves the space for inaccuracy in the distribution of the shares. The thing is that the amount of equity is motivation and, it’s essential not to offend anyone.

Proportionally between roles is one more viable option. The idea is to split between such buckets as co-founders, team, advisors, and investors. As suggested by Dan Martell, the division is better to be the following:
Founders — 60% for all co-founders
Team — 10% for all team members
Advisors — 1% max for each advisor and up to 5% for all
Investors — 25%
The author states that by his experience, it’s a good way to split equity in your startup.

There’s also a possibility for the one who wasn’t at the origins of the startup to join it in the later stages. This is getting shares for the completion of some milestones. The person is obliged to fulfill the agreed work and show certain results to be granted common stock. The exercise price is usually the fair market value of the shares on the date of grant. The options may be exercised before the agreed terms from the date of grant. This approach doesn’t guarantee a chair in Board, as a rule. Sometimes partners and consultants may work for the shares. But it also happens that co-funders also distribute the entity in this way.

Conclusions

There’s no one-fits-all answer to the question “how to split equity fairly between co-founders”, but there are several viable approaches. Experienced founders say that it’s a rare case when the equity division satisfies everyone, and it requires analysis, communication skills, and trust.
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Originally published at https://xbsoftware.com/blog/split-equity-in-a-startup/