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V2 of the Founder Equity Split Template
A new version based on risk reduction.
At a recent early-stage workshop I ran I asked how many people divided their equity equally. Everyone raised their hands. How much time did they spend deciding? Under an hour.
This is typical.
Whenever I meet founders I find myself wishing I could have met them earlier, especially when they were deciding how to divide ownership.
Previously, I shared A Template for Founder Equity Splits which recommended you use time or milestones (or both) to divide equity fairly.
Now I want to go one step earlier and talk about how to approach the conversation about each co-founder’s contributions and how that should impact their equity.
Equity does not need to be divided equally to be fair, though it can be. I’ll end with a new, better version of my equity split template (V2). I’m not afraid to iterate!
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Simple or not so simple?
A company with three founders divides their shares equally. It could be one each or 10,000 shares each, it doesn’t matter.
What’s the thinking behind that seemingly fair split?
When it comes to the fairness of how future money is split, it comes down to this:
“If I’m getting less than you there’d better be a damned good reason for it.”
It’s human nature to think of fairness in relative terms.
But as a mindset I would challenge the assumption that if three people start a company they should also benefit equally. We’ll dive into the details later.
When you own a share you also own the right to vote, so control is a consideration when splitting equity.
Of course there’s precious little to control at the beginning of the company. But talk to founders and they’ll tell you they’re always worried about that time in the future when they have to “give up control”.
I’m not saying control should be freely given away. But all those times you’ve fought for 51% ownership has probably not gained you much.
Splitting by Risk
If compensation and control are not the most useful ways to think about splitting equity, there is one area that has a huge impact: risk.
The most valuable contribution each founder can make to the company is to reduce its risk and accelerate its growth. Those are the same thing in early startups: less risk = more opportunity to growth; faster growth = lower risk.
Startups fail. A lot. So anything a founder can do to significantly reduce risk may be a matter of life or death (for the company).
I think this is a good way to evaluate each person’s contributions.
Some of those contributions could be:
Up-front capital or the ability to not draw a salary for a period of time. Cash is extremely valuable at the beginning when capital is scarce. But it should not be overvalued. The “ramen phase” may only be 10-20% of the life of the company.
You shouldn’t assume that each founder’s idea of “full time” is the same. Every person has a different lifestyle, family and health situation. Discuss expectations up front. With shares that are awarded or vest over time it’s fairly easy to adjust if people are no longer contributing the same amount.
How much would a company be de-risked if one founder had deep connections in your industry? A lot. Bringing that network, and maintaining it, should be considered as valuable as cash and time, or more.
An extensive network is an example of an unfair advantage a co-founder could bring to the table. Others could be IP, an existing client or subscriber base, or a strong reputation.
I’ve purposefully excluded skills, eg coding, as something you should consider. Those are difficult to measure and table stakes. If someone has world-class skill at something that’s an unfair advantage.
Another way to divide equity is by each person achieving some important milestones:
Raising future financing rounds is a huge task that ensures a company’s survival and growth. Being responsible for delivering financing is a good milestone to unlock or vest equity. Yes it’s a team effort but it’s usually led by one person and also objectively measurable.
Eg, for a finance person it makes more sense to give equity based on delivering funding milestone vs compensating them for the salary they could have been earning somewhere.
Especially for B2B startups, closing initial sales is game-changing. Those that don’t achieve initial sales end up exiting the game. Early sales validate, or correct, the product direction, bring in cash, and instills confidence.
Sales of early, buggy products are also very difficult to achieve, which is why a founder who can deliver it should be rewarded with a generous amount of equity.
Demand creation, for both B2B and B2C companies, is similar to sales: difficult to do but clears away a lot of risk when it’s done. It’s also measurable making it a good basis to reward with equity.
This is not as straightforward as it seems. Most companies will pivot which means whatever product is built will be discarded. That doesn’t mean leading product or engineering is not important. But many startups have cap tables with past engineers or CTOs who built one thing but couldn’t pivot and evolve.
Being able to build somewhat reduces risk. But being able to adapt and change significantly reduces product, and therefore company, risk. You should split equity accordingly.
Eg, for a CTO you could grant equity when certain product metrics are achieved, rather than when features are delivered.
The new template
Here’s the new Founder Equity Split Template incorporating the above concepts:
There are two sections: Contributions and Milestones.
These are both up-front contributions like money, and expressions of future commitments, like time. It’s up to you to define what each means, including the category of “unfair advantages.”
Applying weights to each category allows your co-founding team to be aligned on what things are most valuable.
In my example, founders end up with an uneven split because some founders are contributing more of the things that are valuable. Eg, Founder 1 is contributing 50% of the up-front capital.
You should adapt the values and weights to your team and your startup.
Note: you can start with the assumption that all contributions are equal and all categories are equally weighted. That just means the process is now writing down what would be required of each founder to make that true. Either way works.
I had milestones in the old template but I found one limitation: it assumes that everyone’s milestones are in synch, and often they are not. I removed the concept of time-based phases and replaced with individual milestones.
This means it’s possible for founders to earn equity at different times, and even that someone might not achieve all 3 potential milestones.
Again, you need to think through the actual milestones and their weights. You could also take the approach that all milestones are equally weighted.
The important thing is having a clear and fair record of what each founder is promising to do.
Even with milestones you might still have time-based vesting.
Putting it together
In the new template I’ve weighted Contributions and Milestones equally. The result is that each founder ends up with a similar, but not identical, equity split. Even if the numbers end up being very similar to an equal split, this future-looking template retains its fairness even if a founder leaves or doesn’t deliver on a milestone.
This template is a statement about what the founders think is important and what is expected of each individual. That sounds like a good founding document to have.
It’s incredibly difficult to address unfair equity splits later, once a company has been operating. Even bringing up the elephant in the room can put the company in jeopardy.
Founding teams should slow down and take the time to work through this template. It’s not about punishing people or having a crystal ball. It’s about making sure the principle of fairness is true for the long-term in an environment where many, many things are unpredictable.
Control considerations are even less important when you consider this: in The Founder’s Dilemmas, Noam Wasserman concludes that founders who kept control ended up with equity 52% less valuable than those who gave up control (p 338).