When it comes to slicing the pie of equity among a start-up’s founders, the initial reaction is often to give each founder an equal split. In fact, Harvard professor Noah Wasserman’s research found that these sorts of 50/50 splits take place nearly, well, 50% of the time when multiple founders are dividing equity. The problem is that these even divisions are almost never correct in rewarding the different founders in proportion to their past and expected future contributions to the company. In considering these contributions, many factors come into play, from conceiving the initial idea to fundraising to building the actual product.
Frank Demmler at Carnegie Mellon even developed a matrix that considers and weighs the contribution from each founder to the business in the following areas:
• Business Plan
• Domain Expertise
• Commitment and Risk
Depending on the type of business one is starting, these factors may carry more or less importance, or you may want to replace them altogether. Other considerations when dividing equity include the ease of managing the company, the existing relationships between the founders, and the timing and value of their exits from the business, given expected dilution. In other words, will one founder hold a majority of equity (and control), allowing the business to make decisions despite potential disagreements? Can you trust that the other founders will adjust the equity split if it becomes clear that such an adjustment is merited? Will the split give each founder an acceptable exit if the company takes its expected trajectory?
When I started a company with two other co-founders whom I’ve known for years, we went through this process and later settled on a rough formula that accounted for each founder’s expected contributions in his work, fundraising—the provision of personal investment or the ability to raise money from outside investors—and network for recruiting employees and partners. In short, we wanted to determine some assessment of how much responsibility each founder would bear for the success of the business.
In our case, one founder had been paying for many of our initial start-up costs, including our office space, and invested his personal savings in the company. We valued those contributions by taking, as our company’s total valuation, the opportunity cost of the commitment we were all making. These approaches gave us a good starting point, but the ultimate decision on how to split things up came after good, old negotiation among us. We didn’t strictly follow any of the models, although no two founders own the same percentage of the company, and our split will inevitably be proven incorrect over time. But we can all sleep comfortably with our decision, and that’s worth something.
— Ricky Opaterny