Building a startup collectively entails a lot of decision making. Product decisions, Marketing and Financial decisions become paramount. Founders often plan on taking their ideas forward.
Hence Startup assets and business prerequisites often take a backseat. Thus the founding team’s structure is not deliberated. This practice often gets problematic when the organization undergoes an overhaul.
Equity Split is one such important decision. If not deliberated adequately, it often poses a problem when the assets are re allocated and ownerships are revised.
A Harvard business Review Article rightly points out that a team has succeeded at splitting the equity when none of the founders are happy.
So in this article we will explore the right method to split Equity. Moreover we will also highlight why a 50-50 equity split is a bad idea.
When Paul Allen and Bill Gates sat to split the asset, they didn’t go for a 50-50 split. Rather as mentioned in Bill Gates autobiography the process was based on logic.
Paul Allen settled for 36%- 40% since Bill Gates had done more work in the initial phase.
When google filed an IPO (Initial Public Offering), they each had a close to equal (which was 15%). Later it was speculated that it went on to be a 49-51 split between Larry page and Sergey Brin.
Oracle had 3 stakeholders and the initial split was 60/20/20. Since Larry Ellison was the founder it was rationally decided that he should keep the lion’s share.
Steve Jobs, Steve Wozniak and Ron Wayne settled for a 45/45/10 split. Since ron wayne played a role a little later and was instrumental in handling the administration and logo design.
The common thread in all the examples here is that we don’t see a 50/50 split. Although it sounds the most convenient way, it’s far from a rational approach.
Equity split decisions take time mainly because numerous factors into account. While some founders dive into it from the start, some take time to build rapport to understand the right approach.
There are various situations which should be taken into consideration before deciding the split. Some key considerations are elucidated below :-
It is a very perilous affair to rely on goodwill. Especially if the co founders have just met. Hence the first mistake is to ponder about equity split in the initial phases where the trust building is still in process.
It’s a long term commitment which could steer your corporate strategy. That said, hiring a co-founder you have just met is also a decision one should reconsider seriously.
The examples stated in the previous sections of the article, it is not wise to go for a 50-50 split. Firstly equal stakes will entail difficulty in decision making. Often the founders could be at loggerheads and coming to a conclusion would be tough.
In a situation where co-founders have equal stakes, business decisions are not easy to take without landing in a deadlock. Bottomline – Equity split should depend largely on value creation.
Differences of opinion can crop up any time. Sometimes co founders decide to part ways over differences in roadmaps they wish to take.
Hence vesting restrictions is essential to make sure that the person doesn’t keep his equity stakes by serving for a short time. A restricted stock purchase agreement is the right way to ensure this.
Make sure you have a minimum cap on the year of service your co-founder needs to fulfill.
Founders must adhere to the laws and comply with the documentation needs. Equity split is a key decision that entrepreneurs must take in order to achieve their goals.
They can resort to wealth maximization and be rich or decide to take controls early and be the king. A Harvard Business review article explores the decision tradeoff and the bottom-line is in the Matrix below :-
Value addition refers to the amount of conscious efforts to build and work towards managing and growing it. Always look out for two things.
Entrepreneurs believe the one who ideated is the king. However you must meticulously plan and gauge who contributed effectively to bring the idea on paper to fruition by jumping into the market.
After gauging your Business Idea Feasibility, it is essential to gauge market readiness. After this step, the execution is a mammoth task. So always make sure the co-founders have had an equitable contribution historically.
The key questions that you must always ask here are the following :-
Bottom line is Most of the equity splits consists of a major chunk of deliberations and a minor chunk of execution. Most companies offer services to calculate equity based on negotiations coupled by their Equity calculator algorithm built by experts.
Firstly the co-founders discuss and fill out a questionnaire to assess the involvement and role in scaling the business.
Secondly, Based on their responses the algorithm factors in all the necessary elements and calculates a rough estimation of the split. Thirdly, the co-founders deliberate upon the output and settle for the final split after few rounds of discussions.
Over the course of the life cycle of the start-up the contributions and role of the co-founders undergo continuous overhaul. One of them might have had little to contribute during the inception who now plays a bigger role in driving the business.
Hence it is sometimes unfair to have a fixed equity split structure. Thus Dynamic Equity Split Model helps the co-founders to continuously assess their role and contribution.
The main idea is to take into account the monthly (or periodic) contribution of the co-founders and recalculate shares continuously.
The best way to assess this is to monitor the effort, involvement time and thought that co-founders put into their start-up. This is known as Sweat Equity.
Under the dynamic equity split model, each cofounder has the chance to continuously earn shares. Hence this model opens doors for motivated teamwork and continuous revision of roles and responsibilities.
It also paves way for a fare negotiation backed by evidence and objective analysis of contribution.
The following are the essential areas where you can benefit as a co-founder-
However the downsides are important as well. The following are the areas which the co-founders should take into account before resorting to a dynamic model.
You can also use our Venture Capital Pre Screening Assessments to evaluate your business. This will also help you in getting funding for your business in just 5 steps.
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