When founding a new venture, it can be tempting to simply shake on splitting the equity and responsibilities evenly with your team members and then get started. In practice, however, it may be better to delay assigning at least a portion of the founders’ shares until the business has made some headway and the value of each co-founder’s contribution has been demonstrated.
There are two basic approaches to distributing founders’ equity: equal splits and dynamic splits.
In an equal split, each founder gets the same amount of equity on the same terms. Michael Seibel, of the startup incubator Ycombinator, strongly recommends equal splits because they preserve a spirit of fairness and avoid a common source of disharmony among founding teams.
“Dramatically unequal founder equity splits often give undue preference to the co-founder who initially came up with the idea for the startup,” Seibel writes, “as opposed to the small group founders who got the product to market and generated the initial traction.”
In a dynamic split, equity is distributed according to the work each founder does and its value for building the business. This process can be highly nuanced or fairly simplistic, depending on the attention applied to it, but the basic premise is that certain activities in building the business are critical to success, and the founder who achieves them should be compensated with additional equity.
So, for instance, securing funding, building the initial product, landing early customers and other milestones in the business could each have a bundle of stock shares attached to them. This approach helps founders avoid feeling as if they’re doing all the work while others receive equal shares of equity for lower levels of contribution.
Carta, a software company that helps businesses manage their equity, offers a tool that lets you experiment with ways of assigning equity as you go through the process of defining splits. Founders can sign up for a free Founders Studio account to try it out.
Whichever type of equity split you use, you will want to draft a founders’ prenup, a document that outlines the terms and conditions of the founders’ relationship to the company and provides mechanisms to remove founders who do not live up to the agreement.
Scott Kupor, of Andreessen Horowitz, one of the premier venture capital firms in Silicon Valley, puts it this way: “Yes, breaking up is hard to do — whether in love or in business. But, at least in business, there are some things founders can do proactively to lessen the pain. Think of it as a common sense prenup to protect your company.”