How to Split Founder Equity: The Ultimate Guide
As a startup founder, one of the most difficult decisions you’ll have to make is how to split founder equity among the owners. There are many factors to consider, and it’s not always easy to come up with a fair solution that everyone is happy with.
If you’re wondering how to split founder equity, we’ve got you covered.
Joe Beninato co-founded four startups during his career. Every time the inevitable question of how do you arrange an equity split was raised, the conversation and the outcome were different.
In some startups, he retained the majority of ownership. Others had split equity with co-founders.
Beninato says, “I’ve seen it done in many different ways and I would argue that there is no consistent one-size-fits-all way to do it.”
Carta has collected data on over 20,000 companies and found that there is a lot of variability in equity splittings. Equal division among cofounders may seem the most natural and easiest arrangement. However, most founding teams choose to use a different structure.
It is crucial to determine the best allocation for your startup. There is no single way to do this. What should you remember? Here are some tips from experts and founders on how to do it.
How to split founder equity
There are many online calculators and suggested formulas that can be used to give co-founders data to get started. However, seasoned entrepreneurs, as well as VCs, insist that these tools should only be used as a starting point. It is far more important for co-founders and investors to have honest conversations early on so that they can reach a mutually beneficial split.
Carta data shows that 37% of startups are started by two-founder teams. Single-founder companies account for 24% and three-founder businesses account for 23%.
According to Carta data, while a 50/50 split may seem the easiest option for a two-person team of founders, only 32% of two-founder companies settle for an equal equity split.
Peter Walker, head for insights at Carta, says that “the majority of founding teams, no matter how large, don’t split things equally.” “It seems that there is one person who takes up more of the cap table.
It can be more difficult to determine how to split equity in companies with more than three co-founders. It is important to have open conversations about the value each co-founder brings, according to Michael Goldberg, Executive Director of the Veale Institute for Entrepreneurship, Case Western Reserve University.
“Is a technical cofounder more valuable than a business founder? It’s possible that this is true.”
Start the conversation as early as possible
There are many factors that can influence the share of equity each founder receives. These factors include who was the original founder, who is the CEO, and who is most involved in the coding.
It also depends on how important each founder is to the business’ development and launch. Depending on the situation, financial contributions and industry connections may also be important.
Another way to look at a founder’s worth is to imagine how a startup’s prospects of success would change if the founder left.
Guillaume Cohen-Skalli and Marina Tarasova are co-founders of Paloma Health. This online medical practice focuses on hypothyroidism. The discussion quickly grew beyond individual contributions and included personal situations and risks when they started to talk about equity.
Tarasova recalls thinking, “This is going to be a test of how the partnership might go. We had a very dispassionate discussion focused on what each of us can bring. I was leaving a stable job that paid a decent wage so it had to be worth it.”
While Tarasova had the industry experience, it was Cohen-Skalli who had the original idea and had done market validation before Tarasova joined. He was also a former founder and would assume the role of CEO. After weighing all these factors, they agreed to a split which gave Cohen-Skalli more equity but still met Tarasova’s needs. Tarasova says that the conversations around equity can have a significant impact on how your relationship will develop.
Take a long-term approach
It doesn’t matter how you split the equity pie right away, a long-term perspective is key. Sometimes founders are entangled in the idea of “I’m so valuable now.” But will they be valuable over the next ten years?
Shruti Gandhi, general partner and founder engineer of Array Ventures, wonders, “Is there an even distribution in value and responsibilities over the next decade?
It is crucial to have a long-term view and to build in a contingency plan should things not go as expected.
“Many founders don’t want the awkward conversation I call the founder prenup. You need to consider all the possible disaster scenarios: someone leaving, somebody dying, somebody being fired,” says Beninato.
Chris Wentz, the founder of EveryKey, believes that vesting is the most important aspect of the co-founder relationship. He recommends a four-year vesting schedule with a one or two-year cliff to help founders stay longer.
Keep potential investors in your mind
Goldberg says that a startup’s cap table can be a valuable indicator for potential investors.
“Investors want the management team to be properly incented. If a majority of the shares are not owned by the people running the business, it could be a red flag. Is there enough upside to management, especially if they were brought in?”
Investors want to know who makes the decisions. Gandhi says that if you have equal equity, it can sometimes be difficult to break ties. “There must be someone who calls all the shots.”
How to split founder equity? Give everyone an equal ability to contribute, making sure that the final equity decision you come up with makes everyone feel valued for what they are bringing to the table. Even if that means you have to give up a percentage point or two to get everyone there, it will be worth it in the end.