Small Business Legal Tips on How to Split Founders’ Equity

A common question startup co-founders often ask is this: How should we split the equity among ourselves? This is an excellent and extremely difficult question.


A common question would-be startup co-founders often ask is this: How should we split the equity among ourselves? This is an excellent and extremely difficult question; and one that I cannot answer for them.

Ultimately, it is a heavy decision that co-founders are going to have to make. This is the cause of trepidation for most startups because the question itself raises many uncomfortable questions. This is why too many founders take the path of least resistance and decide to split the founders equity equally. In reality, however, not all founders contribute equally, so an equal split isn’t really fair. Some founders come out better than they deserve, while others come out worse.

Even though I can’t decide on behalf of founders, I can suggest some key factors they should consider in deciding how to split the founders equity.

 

  • One factor is to look at what the founders actually contribute to the startup. If a founder contributes cash or intellectual property, that might warrant a greater share of the equity.
  • Another factor is whether a particular founder came up with the idea behind the startup. That might also warrant a greater share, although you can argue that it shouldn’t count for much. After all, ideas are easy, it is the execution upon that idea that makes a startup truly successful.
  • You can also look at whether a founder is working full-time or part-time. If two of the founders have quit their day jobs and are devoting all their efforts to the startup, while a third founder is just moonlighting, then the full-timers should probably get a greater share.
  • Another aspect of this is to evaluate whether a particular founder put in more time pre-incorporation than the other founders. If so, that founder should get a greater share.
  • Looking forward, the founders should evaluate whether one founder will have greater responsibility than the others. For example, maybe one founder will be acting as CFO and the main interface with potential investors? That might warrant a greater share, but is that more important than developing the actual product? It’s a tough call.
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In all likelihood, several of these factors will be at play at the same time, which will require some delicate balancing. One method is to assign a value to each factor, and look at the total for each founder. Of course, the assigned values are pretty much arbitrary, so it is really just the illusion of accuracy. Who is to say that contributing cash is an 8 and working full-time is a 6?

While this analysis will be difficult, and possibly contentious, it can also be quite revealing. It is better to find out upfront how each founder values the contributions of the other founders. They will probably find out later, most likely in a time of stress, when the stakes of a disgruntled founder leaving will be much higher. So, while the discussion may be painful, it is necessary.

 

Paul Spitz is an entrepreneur and business attorney, based in Cincinnati, Ohio. Paul’s practice, the Law Office of Paul H. Spitz, is focused on providing transactional business law services to startups, entrepreneurs and small businesses. Paul started and ran two businesses before opening his law practice in 2013. Paul has a law degree from Boston University, and an MBA from Indiana University.

 

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