Splitting equity is a difficult and sensitive decision that co-founders have to make when starting a business. The result of this decision can lead to a stronger relationship where each co-founder knows where they stand—or it can turn into a complete nightmare.
There isn’t one universal rule on how equity should be split, but we have some tips to help you avoid common mistakes.
Tips to avoid common mistakes when splitting equity:
- Avoid rash decisions
Shaking hands quickly without having a serious dialogue about personal expectations and contributions might be easier in the short-term, but will probably create conflicts in the long-term.
By doing this, you will probably make some bold assumptions about how your co-founders work, their skills, past experience, expectations and their level of commitment to the project. Patience is key, and you and your co-founders should spend time listening to concerns, asking questions and reviewing all aspects of the equity split.
Having a deep and honest conversation will not only help you get a fair share allocation in a transparent way, but also to understand one another and what you are most looking to get out of the venture.
- Avoid mixing personal feelings
Sometimes co-founders are friends, family or old colleagues and you think you already know them very well. However, working under the stress that accompanies the startup journey, you will discover new sides of people. Make sure to have the same conversation you would have had if you had met your co-founder just a moment ago.
In addition, shares have to be allocated based on the added value of each co-founder. This means that although it might cause some disagreement or even hurt somebody’s feelings, you have to avoid mixing emotions when making the equity split decision.
- Avoid a 50/50 equity split
There are some exceptions to this rule, but splitting shares equally between two founders is usually a bad idea. This is commonly known as the 50/50 co-founder model and it can lead to a number of issues, including “deadlock” situations where decisions can’t be made and business progress is stalled. It can also create issues for securing investors, as some investors view it as a negative signal about the team’s ability to negotiate internally and deal with difficult issues.
- Don’t forget about rights and share vesting
Founders often get so caught up in the amount of equity each person should receive that they forget to consider the other issues surrounding equity, like share rights and vesting.
Apart from the number of shares each founder will get, be sure to discuss what rights come with each person’s shares (i.e. whether they will be the same “class” of shares). Should each founder have equal voting rights? Should each founder have equal rights to dividends? These are questions that also need to be addressed in the equity split conversation.
It’s also important to consider when the shares and their rights get distributed (i.e. when the shares will “vest”). A vesting scheme enables you to distribute equity rights over time, rather than all at once. In a new business, it may not be prudent to give each founder their full equity rights up front. For example, you may want to spend some time working with your co-founder(s) before giving equity away, or you may want to leverage the company equity to incentivise the founders to stay with the company for a certain period of time. The initial equity split conversation may be your only opportunity to take advantage of putting vesting in place.
- Don’t make the decision in a vacuum
Splitting equity can be complex so we recommend taking advantage of all the tools and resources available to help you with this task. Seeking different strategies and recommendations will allow you to see your equity split from new perspectives, and to truly consider all of the possible factors for how to make a fair decision.
We’re totally biased, but our personal favorite tool is Spliquity, Linkilaw’s startup equity calculator. Spliquity is an automated, unbiased tech tool to calculate equity splits between co-founders. Based on the experiences of thousands of startups, it weighs all of the various factors that you should consider during your equity split discussion. It then provides a transparent breakdown of your results, allowing co-founders to compare results and start an honest dialogue.
Following these tips will help you avoid common pitfalls in reaching a fair equity split. If you want a lawyer’s input, you can also book a call with our legal team to discuss your equity split or answer any other legal questions you have.