Equity: Slicing up the Pie

The other day a friend of mine and I were talking about start-ups. Part of the discussion was how the founders split up equity in the very beginning. Having started two companies, I’ve made a few mistakes in this area. So, I thought I’d share. It’s not as simple as it seems and can cause serious pain down the road if it’s not handled right in the beginning.

I think there are 3 elements to consider when dividing up equity between the founders; investment, the idea, and commitment.

Investment is easy and many entrepreneurs stop there. They divide up the company by the amount each person put in. Let’s say you put in 70k and your partner puts in 30k, then you would split the business 70/30. This sounds good but there is more to it.

Imagine if you’re partner was the one with the idea and he called you to help bring it to reality. The idea is worth something. I’ve always believed that. It’s the IP. I think the idea, the IP, is worth at least 10-15% in the beginning. Overtime, things will change, it will morph and you may end up doing something entirely different, but the original idea is what started the whole thing. It has value and should be part of the formula. So now the equity ration should be more like 55/45.

This is the moment most founders settle on equity and start their glorious road to taking over the world. The problem is their is one more critical element; commitment.

Commitment is hard to measure and very hard to determine up front. Imagine if you’re partner was ready to quit his job and make this a fulltime gig. He was making trips to see potential customers 2 times a week. He was calling VC’s everyday and he was coding 14 hours a day. This was his full time job. You on the other hand were keeping your day job until the gig had more traction. You were working hard, but doing it at night and on weekends. You weren’t available for most of the customer meetings and were difficult to schedule for VC meetings. You needed more time to get your tasks completed and develop code, because you had other commitments beyond the new business. The commitment level is NOT equal in this scenario and if not addressed up front will create big problems down the road.

There is no formula for commitment. It’s difficult to say; I’m quitting my job to make this happen and you’re not so I get 20% extra equity. However, the conversation around commitment has to be had. Commitment up front has value. It needs to be considered. In the scenario above, I would say it’s worth at least another 10-15% . Now the equity ratio is 30/70.

30/70 is a big shift from the 70/30 that most founders and entrepreneurs would have started from. But it’s more equitable.

No matter what you settle on, both sides HAVE to feel it is fair; fair based on dollars invested, the IP (who had the idea) and the commitment level. Not taking all this into consideration can cause big problems down the road and take the focus away from what is most important . . . getting the business off the ground.