One of the most important and many times overlooked areas in starting up a new venture is how to split the initial equity within founders of the company. Many times, founders who have been friends for a long time simply assume that they would be able to “figure it out” as they go along; other times, they are just afraid to bring or discuss the matter, leaving it for a later stage. Many a times its decided to split the equity evenly.
The failure to make an informed decision, or sign a co-founder agreement, can result in disastrous consequences for the founders, the start-up, and in fact their relationship with each other.
There are essentially two fundamental “rules” on this issue:
Rule No 1. It is always good to build strong boundaries at an early stage, in the form of formal agreement, on how the initial equity capital will be split. Failure to reach an agreement early could result in false expectations on behalf of one or more of the founders. It could also create significant legal issues for the start-up, many times with bad consequences. If the founders are not able to reach some sort of agreement at an early stage, the likelihood that they will reach such agreement once the venture is fully off the ground is even lower. Of course, many times the founders don’t have all the information needed to make a fully informed decision; even in those cases, it’s important to get to some sort of agreement, possibly based on some assumptions and realistic milestones. And, if everything goes well among the founders, they can always re-evaluate their arrangements. The key is to have had a full discussion on this important issue on this matter so as to have each party’s commitment towards the venture.
Rule No 2: Equity split needs to be fair, but fair doesn’t mean equal. It could depend upon financial contribution or each founder’s time devoted towards building the business. The initial equity should be based on a realistic assessment of each founder’s potential contributions. It is very unlikely that 2 persons will bring in exactly the same amount of time, value and money into the company. This issue becomes even more important when there are more than two founders and they all decide to divide the equity equally. Initiating a full discussion on this issue will also lead them to an agreement on different roles like CEO, CTO, CFO, etc. The reverse is also true – if founders can agree on their respective roles then that would help them get to the equity split; for example, allocate some extra for one leading as the CEO, and then CTO and so on and so forth.
To summarize, get the equity sorted out early, and get to that decision based on realistic expectations and understanding on what each one is bringing in and the role for each founder in the venture.