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Ask the question, “How should founders split startup equity?” and you will most likely receive a hand-wavy answer. Some offer blanket statements like, “The programmer should get at least 30%.” Others offer calculators or other arbitrary measures. These answers have never satisfied me. Before I offer a more rigorous approach, I’d like to play Devil’s Advocate for a moment and ask whether rigorous founder splits are even necessary. Here are three scenarios that cover the spectrum of possible outcomes:
- The company fails and is worth nothing.
- The company becomes successful as a going concern but its stock does not command a premium on any market, private or public.
- The company is successfully sold in part or in total for a premium in the market.
The first scenario is clearly moot. The second leaves the founder without an “exit.” As a going concern, however, the company will provide salary, perks, and other recognition that can compensate the founder beyond what a partial or total sale would. In this case, founder’s equity doesn’t really matter.
The third scenario is what entrepreneurs hope for. Imagine the startup is sold at a significant premium to its value as a going concern. The difference between 20% and 45% founder’s equity has huge dollar value difference, but probably little or no difference in terms of their new-found quality of life. They’re a successful entrepreneur with vastly more money and cachet for their next project. In some blowout exits, founders become rich even with just a sliver of starting equity.
Such a focus on dollar outcomes could tempt you to argue that equity splits are a “champagne problem,” that the only scenario in which they obtain significance is one in which the founders are so successful they don’t really matter. But you’d be wrong to argue so. Equity splits actually matter crucially in two spheres of a startup’s early business, without which any speculation of an exit would be in vain.
The first sphere is in founder relationships. Founders must be able to talk candidly about their relative strengths and weaknesses, their relative contributions, and their mutual and perhaps uneven commitments to one another. These difficult conversations cannot be glossed over, or else down the road, when more serious matters of success and failure are at hand, there will be no professional basis for frank and searching problem solving.
The second sphere is in that embryonic stage where no one is getting paid for their work. Everyone must be counted on to lift their share of the weight. Shares must be allocated with foresight of individual founder availability, skills, and financial resources. Otherwise a situation may be created in which the most able have a diminished incentive to work hard, on account of the least able receiving an apparently unfair percentage of equity.
It’s imperative that startups start out on the right foot by discussing candidly and concretely how much each founder is bringing to the table and signing up to contribute.
If you’re sold that equity splits matter, let me know in the comments below. If you want me to take it to the next level and offer a rigorous method for how founders split startup equity, let me know that, too.