How to divide equity among founders in a startup company

by Daniel Batten on March 8, 2010

Getting this right is getting the genetic information for the company right. Its like deciding how much DNA will come from each one of the parents. It creates undercurrents forever more when it is done wrong, and a solid base when got right.

By the time startups are picked up by incubators, its too late – they have already been created with either strong or weak DNA. This is as important as the parentage of a child.

Here are some examples of it going wrong:

1. Two founders divide the company 50/50. The founders then reach an impasse they cannot resolve. Their is no tie-breaker and the company dies a slow and painful death.

2. Four founders split a company 25/25/25/25/. One goes on to make almost no contribution. One contributes for a year then leaves. One contributes for four years then leaves. One contributes 1/2-1 day a week off and on for five years then moves on from his executive role. The one who did the four years eventually could no longer justify the inequity and went on to pursue other projects.

There are many many other cases I see every day. I recently stopped one founder who had build up IP over 8 years and invested 6-figures personally from gifting half the company to 2 people who had neither that founder’s indispensability, nor time/financial history with the company.

So how do you split up a company fairly ? There are some subtleties, so if you are serious about building a company that will stand the test of time, you must seek outside neutral advise (from an entrepreneur, not a lawyer). But here are the basics to get you started.

There are 3 main variables to consider when splitting a company. Over time, I’ve developed a metric that takes into consideration these three thing, which I’ve used several times in mediating founder negotiations. And this metric came out of me getting it drastically wrong – and almost killing my first major company as a result.

1. Time. Who has spent time on the company? Who will spend time on the company? If it is not the same – then the valuation should not be the same. Too many times, people get their egos in the way and think that uneven-equity means “I am not valued equally as a person”. My suggestion is that if a person has this sort of ego, and cannot objectively see that equity is a reflection of a combination of value and contribution, not just value, then they are not someone you should be starting a business with.

What you want to do is to build in the possibility that people may not contribute equally in the future too. For example, I advise companies to withhold equity, and apportion it over a 3 year period. Over those 3 years, each founder works an agreed number of hours. If they leave or “get busy” before the 3 years is up – then their equity is pro-rated to what they work. This safeguards against the all-too-common theme of founders walking without earning their piece of the pie.

By the way, by time I mean “unpaid hours”. If you were paid for them, then thats an employee relationship which doesn’t count for equity – unless it was significantly below a market rate you could demonstrably have otherwise commanded, in which case count the difference between your market rate and what you got.

2. Indispensibility: is there someone in the business that the business cannot do without? If so, then their input is more vital to the business. For example, in one company – there was one savvy business person with years of experience in the field, and a person 20 years more junior with a couple of years experience and little/no business acumen. Again, that founder was just about to gift far too much equity to, simply because of “relief to have the helping hand”. We sorted out a fair arrangement, substantially weighted to the senior founder, that suited both people, and the company is strongly structured as a result.

3. Money. Has anyone put in money? If so, this counts! If it is under $10,000, it doesn’t count much, but thereafter it becomes quite significant – particularly if one person has contributed and the other has not. This is because it represents real risk-taking and sacrifice of other opportunities that needs to be recognized.

Let me give an example.

Company A

Founder1 – indispensible. Contributed 6000 unpaid hours. Contributed $50,000 cash.

Founder2 – not indispensible. Contributed 2000 unpaid hours. Contributed $0 cash.

End result: 80/20 split. Both parties happy (My recommendation was 87.5/12.5 but they mutually agreed on the 80/20 – which worked too).

Company B

Founder1: 4,000 unpaid hours. $40,000 cash input. Indispensible (creator of IP)

Founder2: Skilled software developer. 100 hours. No cash input. But likely to contribute for the next three years onwards

End result: 95/5% split at day one, with opportunity for Founder 2 to increase this to 15% based on 3 years full-time work for the company at significantly below market rate.

In reality, even allocating 5% at day 1 for so little input is too generous, but it shows good faith, without being stupidly cavalier with equity that can no more be re-configured than the DNA of a child post-conception.

Company C:

Founder1: Product expert with unique combination of field-expertise and business skills. 100o unpaid hours, plus creator of the vision.

Founder2: Brought in after 6 months as CEO. Very experienced, with strong commercial track record. 200 unpaid hours.

Both parties crucial to business success. Recommended 60/40 split, or 49.5/49.5 split if Founder 2 evened up hours/money imbalance with one-time cash investment. The remaining tie-breaking percentage to be allocated to a neutral external director (tie-breaker). Both parties to “earn equity” over a 3-year period to safeguard against under/over-contribution.

So there you have it. How to avoid heartache in 3 easy steps. The hard bit of course is keeping the emotion off the table and acting like grown-ups during negotiations. For this reason – unless its obvious and both parties are equitable in all three areas, get a neutral facilitator to help you negotiate the agreement. Honestly, you will save guilt on the part of the over-equitized and resentment on the part of the under-equitized by doing this right first time.

Speak your mind, speak it well, then get on with growing the business.

{ 27 comments… read them below or add one }

Pete March 9, 2010 at 3:47 pm

Fantastic article Daniel and timely. Thank you.

Daniel Batten March 10, 2010 at 11:09 am

no probs Pete. How are things? Let me know if you want to talk anything over.

Levik February 4, 2011 at 7:31 pm

Like the examples at the end. How about this one:
Founder 1: Connections and rights to IP. Most hours. $0.
Founder 2: Business acumen, some experience $10,000. Some hours.
Investor: Brings in $50,000 and some business connections. 0 hours.

Daniel Batten February 10, 2011 at 1:44 pm

Tough to say on this information alone. Depends on the agreed value of the company for starters (which is highly subjective) and how developed the idea is and how difficult it would be to get the connections/ develop the IP – are we talking a million dollar startup with a product that is ready to go and has undergone market validation?

Levik February 10, 2011 at 1:51 pm

It’s an already developed product/service in a growing market, ready to roll-out. Loans weren’t available so we looked to investors. It’s essentially a franchise, valued at up to $1 million / year / location.

DividingItUp February 18, 2011 at 6:46 am

Here’s a fun/challenging one for you if you’re bored:

Founder 1: Too many hours to count, probably 3000+, decent at programming, most motivated.

Founder 2: Highly skilled backend programmer, ~1000 hours, great at advising on technical matters.

Founder 3: Highly skilled frontend programmer, < 10 hours, just came on the project but seems quite promising. Founder 4: Graphic and logo creator, marketing, video creation, ~50 hours, ideas. Founder 5: Moderately skilled frontend programmer, marketing, video creation, ~100 hours, business (?), best speaker of the group, ideas. Thanks!

Daniel Batten April 8, 2011 at 10:58 am

Hi Levak,

In this case – the money was small – but when was it invested? – presumably a long time before the company was worth $1M. Say it was early stage – then the company may only have been worth 1/10 what it is at the point the investor came in.

And what % of hours is most? – 75% of the hours?

Assuming so – I’d say
10% to founder B for the money
15% to founder A for the IP
then consider criticality to the business going forward – founder B is more important because they have business acumen. Founder A becomes progressively less important unless (like Gates or Jobs or Page) they also have business smarts and want to use them. So assuming that Founder A doesn’t have the business brains –
25% to founder B for importance to business going forward
10% to founder A.

That leaves the 40% of hours. Split it 30/10 in favor of founder A who has the most sweat equity – that’s only fair.

That gives founder A a total of 55%, founder B 45%.

that’s pre-valuation.

Then the investor comes in and they get 5% if you agree the company is worth $1M. So that leaves you with (roughly – no calculator handy … 52.5%, 42.5% and 5%)

Daniel Batten April 8, 2011 at 11:11 am

Founder 1: Too many hours to count, probably 3000+, decent at programming, most motivated.
Founder 2: Highly skilled backend programmer, ~1000 hours, great at advising on technical matters.
Founder 3: Highly skilled frontend programmer, < 10 hours, just came on the project but seems quite promising. Founder 4: Graphic and logo creator, marketing, video creation, ~50 hours, ideas. Founder 5: Moderately skilled frontend programmer, marketing, video creation, ~100 hours, business (?), best speaker of the group, ideas. OK - so no-one contributed $ - so that keeps it simpler. Divide based on hours and criticality to the business going forward. It depends what your company is, and how advanced it is, and how many hours you'll be doing before its worth anything really. For example, founder 5 may have done only 100 hrs. But how many more hours will they have done before you get investment? That's the figure that matters. Anticipate this if you can. Otherwise the ones that haven't done many hrs, but may do a lot more before the investment comes in are disadvantaged. Putting that issue to one side and assuming you are ready for investment now though ... 60% based on hours spent. 40% on ongoing importance to the business going forward. That's business skills increasingly and product design skills decreasingly. So in my blunt view: founder A gets 48% for their sweat equity + 10% ongoing importance. (more for motivation and product knowledge than their programming skill) = 58% Founder B gets 16% + 5% = 21% Founder C gets 0% + 2% (2%) Founder D gets 1% + 5% = 6% but only if they have genuine marketing skills (logo and graphic design is not critical unless its a graphic design product) Founder E: 2% + 11% = 13% - speaking skills (if they can genuinely influence) means s/he's been the sales person and the person doing the pitch. Critical stuff. Give them options too as well as equity if they end up being the CEO.

Harry April 18, 2011 at 9:28 am

Hi Daniel,

Great post for those of us that are merely starting out. I am also in the verge of splitting my company with a potential business partner and the dividing of share really is giving quite some headache.

Situation is follows:

I am the creator, started the project a year ago with serious investment of hours and probably 10k$ invested money mainly for freelance work, e.g. programming, content production etc…

The other person could delivery valuable content, contacts and skills to the project because he is quite an authority in this industry but has not invested anything yet.

I have the feeling that I sort of “need” him to succeed and for the company to grow, however I want to keep somehow my weight in making decisions for that company.

Another variable is that there might be potencial partners yet to come, e.g. skilled programmer to do all the tech stuff that we both don´t know much about.

What could my offer be for him?

Thanks in advance for your help.

Harry April 18, 2011 at 9:45 am

What I have come up with till now is something like:

Reserving 20% por potential partners granting me 50% and to him 30%. If no additional partner is found then this 20% is divided equally so we´d end up 40/60. Would that be too generous?

Daniel Batten April 18, 2011 at 11:25 am

Hi Harry,
Very common scenario. How many hours have you done – and how many has the other person done? If your strength is the product-creation, as opposed to the business side/ attracting investment and /or early cashflow etc – then you are right, you’ll absolutely need others in this area. As you go, the product side becomes less important and the business side (how you get it to market, business model, sales generation strategies, partnerships etc) become more important.

Also – how near to being market-ready is the product? – and what do you both think the company is worth?

10K counts – because you put that in at a time when the company wasn’t worth much (more than 10K put in today, after there is some sort of product – because the company will be worth more as the concept is de-risked more and more).

Based on the information – general thinking would be: 80% to you for the creation of the product, its IP, your unpaid hours, and your 10K investment. 20% to the other person, if they really are critical to the growth of the business.

To get around the fact that their input will become more and more important – you could make 20% of the company an options scheme, and give this person and others a certain number of options per year in return for work done.

Bear in mind you’ll dilute and lose your “majority shareholding” the minute you go down an investment route also (if you do) – if not in the first round, then one of the rounds.

Also – make sure that you have similar values to the other person – not just complementary skills. (There’s a section on how to do this this in my book. ) If you don’t then you are setting yourself up for trouble and heartache and probably a split down the track. You’ll see this person more than you see your spouse! That matters.

Hope that helps
Daniel

Daniel Batten April 18, 2011 at 11:27 am

you are not far off – but make that additional 20% an option pool, which defaults back to you according to your shareholding percentage if you dont use it. That way you don’t give away 20% for nothing. A potential 40% for someone who is yet to make a financial or sweat-contribution is too much.

Harry April 18, 2011 at 8:37 pm

Hi Daniel,

Thank you very much for your input, it´s really helpful getting other people´s advice on things you have never done before and obviously one is afraid of making mistakes.

Regarding my company: it is an online platform which sells mainly videocontent. It is up and running and sales are slowly pouring in but it´s still a long journey towards profitability or break even. So it is difficult to estimate the value of the company.

The product is market ready and is going to be more compelling to the customer when adding more content as always and he could add a bunch of that content, I guess.

Probably I could do it the following way, including your advice:

Being “generous” by giving him 30% – for one I am “afraid” he might turn me down ’cause he could do a competing product and adding him to the team could boost the company foward.

Giving 50% to me and leaving the 20% as an option share for, yeah, for who? To make it more attractive I could say if he invests money and time he himself could earn peaces of that cake on the long run, say, a year or so…

In preceding conversation he already said he would be interested in equal shares so I think it might even be difficult to convince him to accept that 30% with the option of more. But I think this is the max. I´d be willing to give away.

Not easy, also, In terms of negotiation psychology I should probably offer less to have more margin…but I think on the other hand that “less” might just sound ridiculous in his eyes…

Well, thanks again for the advice and this great blog post.

Suleiman April 26, 2011 at 5:02 am

Hi Daniel,

hopefully you can help me out with this question
a friend of mine owns a company, and he is trying to open an other branch, he asked me to work with him and possibly take control over the branch. I will be investing 50% of the start up cost and be able to put few hours of work everyday. I am not sure how to divide the equity. once the company starts functioning. I am the one who is doing all the work. the only contribution he is making are 1. creating the logo and all other legal paperwork. 2. 50 % of the start up cost

Thanks in advance

Daniel Batten April 26, 2011 at 11:31 am

This is an interesting one

Even tho you are doing all the day to day operational work – your friend has invested a presumably huge amount of time to generate a business that it is now possible to open a new branch of, and create new opportunities for people a a result? In this case it’s a lot more than logo and paperwork – it’s a whole brand reputation. Not to mention the associated learnings s/he made first time around which are lessons you don’t now need to make the hard way. That de-risks it significantly for you.

It depends a lot on how much actual money 50% is as a set up cost, relative to value of the existing business.

But based on limited info my opinion/ gut feel is 40% to founder for brand and Intellectual Property and past time (sweat equity) invested into the company. 25% to each of you for the financial investment and 10% for your time. I would say more for your time if you are doing a lot of unpaid hours (you haven’t said if you are) so again I’m making an assumption. But if you are getting a salary/wage – then you are already being compensated for hours so the equity-for-hours is only for the extra unpaid hours you do to set up a new branch.

Hope that helps.
Daniel

Daniel Batten April 27, 2011 at 11:03 pm

50/50 is almost never a good idea. I know a friend who built a company that stalled because there was no “tiebreaker” when they reached an impasse. Also – 50/50 – unless both have contributed equal hours, money and business criticality is going to be based on ego – not common sense. What I mean is that it’s the result of someone thinking “I’m worth as much as you …. You aren’t getting more than me. ” not mature thinking and no basis to build a company. Put egos to one side – if it’s not possible now, it never will be – and work on a neutral dispassionate assessment of relative contribution and potential for future contribution. Trust your intuitions and don’t kid yourself you are being generous if really all you are doing is taking a hit personally to avoid a conflict. You will only be sewing the seeds for Ill-contentment down the track because you’ve caved in and not placed high importance on a well-designed, well-thought-out equity structure

Good luck!
Daniel

LA February 29, 2012 at 10:20 am

Hi Daniel.

Help!
Idea phase, in process of securing financing.
Should I hire a management team or make them co-founders?
I would be the CEO of course and they would be VP of Sales & Marketing and VP of Finance&Accounting. I would take care of operations and human resources myself, being that this is a startup.

In case you say co-founder:

Founder 1: 2000 hours, secured financing, business plan,ideas, and vision

then later decided to bring in help…
Founder 2: 1000 hours, sales, got customers, help market, market strategy

Founder 3: 800 hours, finance, accounting, finance strategy

Daniel Batten March 8, 2012 at 11:35 am

Think very carefully before weaving anyone into the fabric of your organization. Once they are their – they are hard to unstitch if they aren’t the right material. Do you need them in the short term or long term.

Think about whether they have complimentary skills and compatible values.

Be honest with yourself.

It’ll save a lot of heartache down the track.

Beerboy October 29, 2012 at 11:24 pm

Brother: hospitality: (full time $3K invested 40%)
His friend : chef. ( full time $5K invested 40%)
Me: investor $10,000 ( no hours ) 10%
Chef’s friend: investor $10,000 ( no hours ) 10%

Started restaurant / bar… Potential to develop into more beachside bar…/ restaurant… Doing well 5 months, haven’t had financial update? Should we all sit down to discuss?

Now brother & I starting up a brewery, to sell at our restaurant and distribute locally, I’m sole investor of capital $6,000.
How should we split shares and 50/50 or ?

Plus brother owes me $4,000 from a failed land sale…
Your help would be greatly appreciated …

Daniel Batten November 21, 2012 at 10:10 am

never split 50/50. There is no tie-breaker in the event of a disagreement. I’ve seen a company trainwrecked by doing a 50/50 split, and another one rescued because they had a tie-breaker.

Eduardo Sarabia December 17, 2012 at 8:21 am

Hi Daniel.

After a year of developing our company. We’ve decided to split the shares officially.
Both partners are founders and indispensible.

Partner A: equal amount of hours. future CEO. 90% of financing.

Partner B: equal amount of hours. Creative, image, etc. 10% of financing.

I should mention the company highly depends on its image. It’s what sets us aside from our competitors.
also in january we will have our first paid half time employee, which we plan to offer shares if he works out after some time.

Looking forward to some good advice.

Daniel Batten January 15, 2013 at 9:08 pm

What’s your gut-feel. Let me know what your thinking is in terms of equity split – and I’ll comment on it.

Mark Fab February 7, 2013 at 3:07 pm

Hi Daniel,

Here is our dilemma

Partner 1: No formal business background. His idea, not patented and cannot be patented. Put in around 400 hours of work and maybe $500 into the business for R & D prior to partners coming into the business. Needs investors as well as the investors to be a part of the business (production, sales, distribution, etc). Will not be putting any more money into the business. Has the opportunity for $5K if he wins a competition

Partner 2: Investing $12.5K or more, accounting and finance background and as said above will be working in production, sales, distribution, etc. in the future as well as helping with startup

Partner 3: Investion $12.5K or more as well, business administration and sales and marketing background. Has committed all his time now to this business and will be the same in the future.

This is the dilemma, Partner 1 wants a 50/25/25 split, where as 2 and 3 would like equal 33/33/33 or at the least 40/30/30.

A’s arguments is that the idea and the work done prior to the partnership is equal to the worth of $25.

B and C’s argument is that the each of their money as well as their present and future work with the business is worth equal to the idea.

Looking forward to your advice.

Thanks

Newbie February 12, 2013 at 12:02 pm

Hi Daniel. Great article and extremely helpful as I am now trying to decide this for my startup. Would love your thoughts here…

Founder 1: 500 hours invested, developed business idea and plan, 100% time commitment to the company and has an indispensable skill necessary to the product plus 12 years of marketing experience, CEO of company

Founder 2: 25 hours invested, will oversee the development of the product (6 months) and ongoing business strategy and marketing consultation. 17 years experience in field and strong reputation to attract investors – will contribute approx 20% of their time

Founder 3: 15 hours invested, will oversee finances and business operations. Has experience setting up 2 successful businesses and will contribute 60% of his time to the startup and growth of this company.

I am planning on holding back a 20% options pool and require vesting over a 4 year period. Any seed money contributed by founders will be done on a loan basis – not in exchange for equity. Based on your article and other support I have read here is my best attempt at an equity split.

Founder 1: 50%
Founder 2: 8%
Founder 3: 22%
Options: 20%

What are your thoughts?
Thanks,
T

Bee February 15, 2014 at 1:59 am

hi Daniel , I need your quick professional advice on splitting equity in my startup ( medical device invention ) , im the founder for it with all the innovative features and ideas and will be pitching for investors from my extensive social background and help out with the research and market fitting , my partner is a cofounder (engineer) who will make the device into sketches , and manufacture the design and such . what is the percentage of split here ? thank you .

Sylvia March 8, 2014 at 12:07 pm

Hi Daniel, I thought your metric is quite right. I am starting a new clothing design company with other 3 partners. We design and sell clothes here in US but do production in China. Based on funding/contribution facts, I think it should be 40%-25%-25%-10%. Do you mind to offer your advise?

Me: Business idea initiator, Founder and sole operation controller of the company in US, funding 16%.

Partner A: Business idea initiator, funding 29%, located in China, very little production support.

Partner B: Funding 29%, located in China, very little production support.

Partner C: Funding 6%, located in China, fully responsible for managing all production and sampling.

Greg May 11, 2015 at 2:14 pm

Hi Daniel,

I am at a loss on trying to figure out equity in a start up baseball facility. Currently I have my own business that i have had for the past 7 years. I have 240 clients and a great following. Currently I have an indoor batting cage and do strictly private lessons, a travel team and summer camp. I have been thinking of opening a full indoor facility and am thinking of bringing in 2 investors.

I am going to be investing 40k and have done the business plan, research, location and will be 100% the one running and working at the facility.

I have another person I am negotiating with to come in because he has clientele and with his networks bring revenue to the company. He did none of the research, leg work, or anything in this start-up. He just came about recently and will not be investing money. He will be working at the facility but cannot put in the hours I will due to seeing his son out of state 3 days a week. He is strictly a quality instructor and great networker.

I am also talk to 2 investors. Each investor will be investing 100k and some business expertise on operations etc, but no man hours.

How much equity should I give to each investor and how much to my partner who has no investment and limited availability but a lot of networks that can bring revenue.

Thank you!

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