STARTUPS: A COMPELLING ARGUMENT TO SPLIT EQUITY EQUALLY, OR NEAR EQUALLY, AMONG CO-FOUNDERS
A question that co-founders often ask is how to split the equity of a startup based on their respective contributions of the co-founders, whether it be running operations, generating revenue, creating technology, handling admin/legal/finances, making an investment, or in combination of two or more.
STARTUPS ARE ABOUT EXECUTION RATHER THAN IDEASAt the formation of a startup, there is no company. Therefore, at the outset is the perfect time for all founding members to be equal just as the U.S. Constitution states that "All men are created equal." I am therefore an advocate of the notion that, among founding members, they should have an equal, or close to equal, equity split for the precise reason that there is no company. Just because one might argue that there should be an unequal equity split due to one of the founders coming up with the idea, investing time in the business plan, being more experienced than the other, making a greater initial cash contribution than the others, working many hours developing interest, etc., etc., etc., the early work means nothing because all of the work is ahead of all of them. As for the initial funding, this initial contribution is matched by the talent and heavy lifting of the other co-founders to develop this new company's MVP, launch, and gain traction. So, I would not give significantly more equity, if at all, to the investors. Moreover, as attributed to JFK, the saying, "A rising tide lifts all the boats." certainly can be applied to co-founders working together for the success of a startup. The upshot is that startups are about execution rather than ideas.
EACH CO-FOUNDER MUST BE AN INTEGRAL LINK TO THE STARTUP'S SUCCESSThe time needed to build a company of great value is 5 to 7 years, and perhaps more. During this time, each of the founding team members will need to be motivated with a chunk of equity to make the startup successful. Be aware that should the startup need to attract other investors, the prospective investors will look at the equity split as a cue on how each of the co-founders are valued. A small equity share signals that a co-founder is not highly valued. And know that investors will look at the quality of the team as a reason to invest or not.
WAYS TO REWARD AND RECOGNIZE OTHER THAN EQUITY GRANTSGranting equity is only one means of reward and recognition. Consider shares of common stock versus preferred stock, voting shares versus non-voting shares, incentive stock options (ISO) versus non-qualified stock options (NSO), and other financial incentives such as salary, bonuses, and benefits to be granted commensurate with the startup's growth and success. So, for example, if a co-founder is responsible for marketing and sales, and generates the revenue for the startup, this co-founder can be given commissions or a bonus for this accomplishment. It is also possible to award this co-founder with ISOs. But the key idea here is that each co-founder starts out as equals.
EMPLOY VESTING AND A CLIFF TO ANY GRANTS OF EQUITYAny grants of stock, stock options, ISOs, NSOs, restricted stock to founders, key employees, and others should be subject to vesting and a cliff, usually using a standard linear 4-year vesting period and a 1-year cliff to exercise options over time and possibly instituting a company buyback policy on departures by use of a 409A valuation of the equity. As a final word, it is essential for co-founders to consult with a corporate lawyer and tax accountant who are experienced with startups well before the plans for a startup come to fruition.