After you’ve found a co-founder for your startup, one of the most important decisions to make next is how to split equity with them.
When you’re deciding how to split equity with your co-founder, the right thing to do is sit down together and have an honest, open conversation about how/why to divide your company’s equity one way or another.
There are two ways to split equity: equally and dynamically (unequally). Before having a conversation with your partner about splitting equity, understand when to do these types of splits and their benefits and drawbacks.
When To Split Founder Equity?
Startup co-founders have many important decisions to make when they start working together, but splitting equity is something you shouldn’t overlook in your company’s early days.
In fact, how you will be splitting equity is something that should be included in your written and signed founders’ agreement so there are no issues or conflicts regarding equity down the road. This contract is something that you and your co-founder should put together and sign soon after you commit to working together on a startup project.
Now, you may be hesitant to agree on how to split equity so early because there’s always the chance that one founder could walk away from the company without earning their share of the equity. Having something called a vesting schedule protects you and your co-founder against this.
A vesting schedule means that each co-founder gets a certain percentage of their equity at regular intervals, and you usually don’t get the first shares until at least a year into working together.
For example, a four-year vesting schedule would mean that you and your co-founder each get 25% of your due equity every year after the first year until you have received all of it after four years.
Your vesting schedule is something else that should be written into your founders’ agreement.
How To Split Founder Equity?
When To Do Equal Splits
The answer to “when should you split equity evenly with a co-founder?” is simple: almost always. Why? Because dividing equity equally helps ensure that all co-founders are equally committed to and invested in your company and its success — and that’s precisely why you want a co-founder.
The whole reasoning behind finding one or more co-founders is that you have someone to split the heavy lifting with when you’re getting your company off the ground during its first few years, so all of you should be rewarded equally for your hard work when it all pays off.
If you aren’t willing or are hesitant to give your business partner an equal share of equity, perhaps you should reconsider working with them in the first place.
Trust and confidence in one another are essential to a successful co-founder partnership. Dividing equity evenly is a sign that you both trust one another and are confident that you will each put in the same amount of effort to make your company succeed.
While there may be some cases in which it makes sense to split equity dynamically or unevenly, startup expert and CEO of Y Combinator Michael Seibel cautions against unequal splits because they assign more value to one founder over the other, which can hurt productivity and lead to future conflicts.
Benefits of Equal Splits
The biggest benefit of an equal equity split is that it incentivizes all of a company’s founders to work just as hard and deliver equal results.
Even if one founder has put more time, work, and money into your company up to this point, the reality is that there are still years of hard work ahead of you.
No matter what stage your company is in, you want both you and your co-founder to be equally motivated to keep building it together. So, you should each look forward to getting the same share of equity to help maintain equal motivation.
Think about it this way: say you’re the person who came up with the idea for your company, and you bring a co-founder on board later on to help build a technical product that you can’t build yourself. Or, maybe you found a co-founder who complements your skills in other ways, such as someone who knows the ins and outs of fundraising or customer acquisition.
Either way, you’re bringing a partner into your business because you value their abilities and knowledge. You need them to make your company succeed just as much as you need your own skills and knowledge.
Well, if you give your co-founder a lesser share of equity just because you’ve been working on the project longer, you’re essentially saying you don’t value them equally, which isn’t (or at least shouldn’t be) the case.
If your co-founder feels undervalued, they are less likely to put in the same amount of work as you, and they are more likely to walk away from the company before achieving success. In other words, having less equity is like having one foot in the door and one foot out, instead of being all in with the company.
Ultimately, splitting equity evenly with your partner will strengthen your relationship and help avoid hard feelings and conflicts as your business grows and becomes profitable.
Drawbacks of Equal Splits
One drawback of an equal equity split is that it can impact decision-making and lead to stalemates if the partners don’t agree on something. This is mainly true for two-partner, 50-50 equity splits.
With a 50-50 equity split, you and your partner must completely agree on important decisions about your company before they can pass. If you disagree on something, you can hit a roadblock that slows down your startup’s progress.
This is one reason why some founders choose to do an almost-even split, such as a 51-49 equity split. That way, one founder (known as the controlling partner) has the majority voting power regarding important business decisions.
Another drawback of even equity splits is that they don’t always feel fair if one co-founder is contributing significantly more time and resources than the others. While you should ideally be dividing the work evenly among co-founders, there are some cases where you might bring on one or more co-founders to fill smaller, more specific roles.
For example, you might find a technical co-founder who can only work part-time to build your product and bring on another part-time co-founder to help you with marketing and business strategy. These types of arrangements are known as the “junior co-founder model.”
Although it might make sense to give “junior co-founders” smaller equity shares of 5, 10, 15, or 20 percent each, it’s still worth considering an even split because their contributions could (and hopefully will) increase in the future.
When To (And When Not To) Do Dynamic Splits
Although dividing equity equally is considered to be the best route to go in most founders’ agreements, there are some cases in which you and your partner might agree that it makes more sense to split equity unevenly. These splits are known as dynamic equity splits or are sometimes called transactional splits.
One of the biggest reasons co-founders often decide to split equity unevenly is that one person came up with the idea for the company. Startup experts tend to agree that this is not a good reason to do a dynamic split.
This is because ideas are not worth anything without execution. If you need a co-founder to turn your business idea into a reality and make it a success, they are just as valuable as you, so you shouldn’t get any more equity than them just for coming up with the original idea.
Other not-so-good reasons that co-founders sometimes divide equity unequally include:
- One co-founder has been working longer than the other.
- One co-founder is older/more experienced.
- One co-founder has invested more/raised more funding.
- A co-founder was brought on board after a prototype or MVP already existed.
These reasons for splitting equity dynamically tend to assign unfair value to the co-founder who started working on the project first and thus undervalue the co-founder who got involved later on.
Considering the fact that it takes up to 10 years to build a high-value company, there should be plenty of time for all co-founders involved to contribute equally as you develop your startup. So, things like who came up with the idea, who has been working longer, who has more experience, and who has put more money into the startup so far shouldn’t be big factors in your decision about how to split equity fairly.
Now, let’s take a look at a couple of scenarios when it might make sense to do a dynamic split with your partner.
The first scenario is if you want to have a controlling partner with a slightly higher percentage of shares to make voting on business decisions easier and more agile. Many people disagree about whether or not this is the way to go, but splitting equity something along the lines of 51-49 is an option when you want there to be a clearly defined business leader.
Another reason to give one co-founder a slight majority of equity is so that they will still control the majority of the company if the other partner decides to sell their share of the company in the future. In this case, usually, the company’s original founder would get the majority share.
You may also decide to split equity dynamically if one partner will clearly be doing more work than the other.
For example, if you are working full time on the project and your co-founder is dividing their time between another job and your startup, it might make sense for you to get a majority of the shares. In this example, something like a 60-40 split could work. Although if this is the case, you might want to reconsider your co-founder, since you should ideally be dividing the workload evenly.
Every company and co-founder’s relationship is unique, so the most important thing to do when deciding how to split equity fairly in a dynamic split is to sit down and discuss all your thoughts and feelings openly to come to an agreement that satisfies everyone.
Benefits of Dynamic Splits
The greatest benefit of using a dynamic split model for sharing equity is that it allows you to split equity more precisely for various reasons.
Whether you want to divide equity dynamically to avoid decision-making stalemates or to compensate one founder for doing more work, you can calculate dynamic splits in different ways to make all parties happy and avoid disputes.
Another benefit of dynamic splits is that they are very flexible. They allow you to factor in many different things in order to calculate the equity percentages, and thus are sometimes favored when there are more than two co-founders with very different roles and responsibilities.
Drawbacks of Dynamic Splits
The main drawback of a dynamic equity split is that it only takes the current situation into account. So, although it may be the most precise way to split equity right now, it might not always be so.
For instance, if your partner is currently unable to work as many hours as you on the project, this doesn’t mean they won’t be working as much or even more than you at some point in the future as things change.
So, if you split equity unequally now because it seems fair, it might seem unfair later on. This is why founders and startup experts generally agree that an equal split is the best option — with good, equally committed co-founders, the work tends to even out over the long run.
There is also a valid argument that giving one controlling partner a slightly higher stake in your company in order to make decision making easier is actually not a good idea.
Some business experts argue that, rather than giving one person the power to majority vote on business decisions, it’s important for all founders to agree on major decisions to proceed. Opting for an equal equity split instead of a dynamic split helps ensure that no decisions are made without all founders onboard.
A good way to look at the difference between a dynamic equity split vs an equal equity split is that dynamic splits often feel right in the short term because of their precision, but even splits usually make more sense and are more fair over the long term.
Should the CEO Receive More?
In most startups, the CEO should receive the same equity as all the other co-founders, since an even split is generally considered the best way to split equity among co-founders.
However, if you are going to split equity dynamically, the CEO may or may not be the person who should receive the largest share.
If you are the original founder of the company, it’s most common for you to be the CEO and to receive a larger portion of equity than your co-founders, since you’re naturally going to be the most dedicated to the company from the beginning.
However, you could also be the original founder of your startup, but hold a title other than CEO. For example, you might be the technical founder who is building your product, and you partner with a non-technical co-founder to help you pitch your product to investors and work on other sides of the business.
In this example, you might choose to take the title of CTO and make your co-founder the CEO, since they will be the one pitching to investors. But, you might also get more equity than them to remain the controlling partner at your company.
At the end of the day, titles like CEO/CTO are just that — titles. You and your co-founder will be working closely on day-to-day business activities and there is bound to be some overlap in your duties and tasks, which is another reason why 50-50 splits are highly recommended.
If you do decide to go with a dynamic split for you and your business partners, make sure that the difference is not huge, no matter who the CEO is and who is getting more equity.
For instance, if you are splitting equity between three partners, something like a 40-30-30 split is pretty standard.
Which Documents Should You Sign?
As we touched on earlier, all the agreements you and your co-founders make regarding equity and vesting should be written down in legal terms in a co-founders’ agreement that all parties sign.
To ensure that this contract is correctly written and legally binding, it’s best to have a business lawyer compose it or at least look over it and provide feedback after you put it together.
Keep in mind that as your company progresses and you acquire investors and hire employees, there will be more people who are entitled to shares of equity, so business documents will have to be updated.
As the financial aspects of your business get more complex and equities need to be recalculated, you should always have a startup lawyer helping you out with everything.