I get this question fairly often from new startup teams. Often the teams consist of founders that were classmates, colleagues at a prior job, etc. The question is:
Should we divide the equity in our startup equally?
The short answer to this is: No.
The longer answer is of course, slightly more interesting.
Here are some of the reasons I get for founders wanting to do this. I will assume there are two founders, but all points apply equally well to three or more founders.
Why Founders Argue For Equal Equity
- It’s Simple: It avoids the need to have complicated discussions and negotiations. In my opinion, there are definitely complexities and debates you should avoid in the early days of a startup. This is not one of them. The initial equity allocation is an important factor in the future success (and sanity) of the company. The issue should not be skirted.
- We’re All Equal: This is kind of the philosophical argument. The premise is that all of the founders are equally qualified, will equally contribute, etc. So, the argument goes, we should divide the equity equally. I’ll argue that this is rarely ever the right answer. Deeper inspection will reveal that one or more founders are deserving of more early equity than others. The founders all have different (even if similar) experiences, different opportunity costs, different relevance for the new startup, etc. It’s hard to convince me that it just so happens that two people came together and that they just so happen to have identical value to the new startup. Even if you were born as twins, not separated at birth and lived identical lives, chances are, you’re not “equal” in this given context.
- There’s No Right Answer, So Might As Well Divide Equally: This one is starting to get at the heart of the real issue. The thinking here is, in the absence of sufficient data to justify otherwise, it’s easier and better just to divide equally and get started building/running the company. This is a very tempting argument, but also not a good one. I think it’s possible to pick a couple of “dominant variables” to use as an objective benchmark.
- We Want Equal “Skin In The Game”: This argument proposes that to ensure all parties have an equal vested interest in the successful outcome, they should have an equal number of shares. I think this is a weak argument. The reason is that “skin in the game” is a situational measure (not an absolute one). How people perceive risk, and how that impacts their behavior (in terms of incentives) varies from person to person and situation to situation.
- The Debate Over Equity Will Kill The Company: This is a troubling argument (but I’ve heard it a few times). The thinking here is that trying to figure out the “right” answer is filled with too much emotion and anxiety and rather than kill the startup before it even really gets started, it’s better to just push past this and create something of value. I’m troubled by this argument when I hear it, because it is usually a sign of trouble to come. If you can’t talk about hard issues (like equity distribution), amongst the founders right now – how will you have the other hard conversations later? Startups are replete with difficult and often emotional decisions. Trying to ignore the early issues in the hopes that “things will get better later” is asking for trouble.
Of course, the obvious question is, if you shouldn’t divide it equally, how should you divide it? I don’t have a magical formula for this, but will give you some points that might influence your thinking so you can objectively “triangulate” to an answer:
1. Is there pre-existing IP and/or effort? (i.e. did one founder actually start the company before the others joined)?
2. Fair market value vs. actual compensation for all founders. So, if one founder makes a larger sacrifice (in terms of cash comp.) this might raise her equity stake.
3. Focus of the company: Is the company technology, marketing or sales focused? If so, this might impact which founders will presumably bring the most value.
4. Cash investment: by a founder: This should be treated separately from the equity allocation (and the founder in this case is also an investor).
5. Degree of commitment: Is one founder keeping their day job for a little while? If so, it might warrant lower equity.
Note that this article does not cover the also interesting topic of why you don’t want to divide equity equally (yes, there are downsides). Purpose of this article is to make the case that thought and effort should be put into this and you shouldn’t just “revert to the default”.
Summary of My Point: The issue of equity allocation amongst the founders is just one in a series of difficult decisions that need to be made with a minimal of data and objective criteria. I’d advise getting outside help (legal counsel, potential investors, startup advisors) etc. as they may be able to provide experience and more importantly, an unbiased view that the entire team can trust. But, the answer is almost always never “split it equally”.