Is it time for “the talk” with your co-founders? Every startup reaches this point - that time for talking about ownership and splits of equity and shares - and ideally they should reach it early in the piece.
It’s easy to think an equal split is the best idea, but many experts actually warn against the practice. Research shows the percentage of founders who say they are unhappy with their equity split increases by 2.5x as the startup matures, which is why many co-founders wait to get to know each other before going through the process. Others, though, do it straightaway.
Working with your startup accountant, you should thoroughly go through the options to decide what works for your unique business.
Is splitting 50/50 fair?
Y Combinator’s Michael Seibel advocates for an even split of equity between co-founders. Writing in the company’s blog, he says: “These are the people you are going to war with. You will spend more time with these people than you will with most family members. These are the people who will help you decide the most important questions in your company. Finally, these are the people you will celebrate with when you succeed.”
Seibel argues that while the startup may be one person’s idea, a startup is about execution, not just the idea itself. That idea must be taken through planning and build phase, then taken to the market and sold to customers.
He also argues that more equity equals more motivation - that a 50/50 split will help ensure your founding team has the motivation to make things work, and to not be one of those failed startups.
Unbalanced splits may be a better option
Yet many venture capitalists and startup experts disagree with Seibel, saying an equal split is a signal to investors that your CEO is either weak, or that the founding team can’t make difficult decisions. The decision over company ownership is one of the tough early decisions a leadership team must make - with or without the help of their startup accountant - and how it’s resolved will be closely investigated by investors.
While an even split may appear the fairest arrangement, it can lead to deadlock when tough decisions need to be made. To rapidly grow a startup requires very different contributions and commitments, and experts say those levels should be reflected in the equity split. Avoiding this decision, and opting for an equal split, can even be the source of legal fees later in the company’s life once the level of contributions become clear and co-founders demand their fair share.
Think of it this way: if you give someone equity but they don’t pull their weight, it will breed resentment. Likewise, if someone has given up their job to work full-time in the startup while everyone else keeps their day job (and salary), they will feel like they’re doing all the work and not being rewarded.
You may also want to keep a certain percentage of equity for future employees as an incentive. Your startup accountant can advise here, and this should factor into the equity split decision, too.
Just remember that 10% is the minimum equity required to be considered a co-founder. Anything below that will put you in the range of first or early employee; if this happens, ensure you take a salary.
Questions to ask before you decide your equity split
Working through these questions should help you arrive at a fair split for your startup.
Who is behind the idea?
If your idea is truly unique and patentable, then the person who came up with the idea should be rewarded. If it’s not unique, then consider the next questions carefully.
How much money and time is everyone devoting?
Has one of your co-founders fronted all the capital? Has someone given up their day job to dedicate themselves to the startup? If someone is deferring compensation rather than taking a salary, they should be rewarded more than the others.
What value does each person bring to the venture?
Ask yourself how much harder it would be to start the company if you didn’t have each person on board. This will help you evaluate their worth.
Will the deal make the company stronger?
If the people with equity will help you meet your growth targets, then go for it.
What feels right?
At the end of the day, it’s your company. A startup accountant and other experts can advise what looks best on paper, but it needs to feel right and equitable to those signing the papers.
Get a startup accountant to help
To make sure any equity split agreement is legal and official, you’ll need the help of an expert. Your startup accountant can walk you through all of the options above and help you and your co-founders and investors to decide what will work best for your specific needs - because all startups are different, and all equity splits reflect the unique spirit of the startup they’re attached to.
If you don’t yet have an accountant to help with your business finances, now is the time to compare accountants with PROfiltr and find the right one for you. Your accountant can help with so much more than the equity split - you’ll need vesting schedules next! Get your free quotes and kickstart your business today.