Splitting up the Pie: Considerations for setting initial equity ownership among founders

How much should each founder get?

So you and a few others have decided to take the leap and found a new start-up – congrats!!  Now you just need to decide how to divvy up the equity ownership.  Easy, right?

If you default to splitting it up equally among the founders, you maybe making a huge mistake, one with a long-term impact on your working relationship and therefore the success of your business.

All too often we see founding teams decide to divide the pie up evenly when they start.  When we ask them why, they often admit they did not want to create a conflict and decided it would be easier to share equally.  While there are certainly examples of successful companies where this is exactly how they handled it, we would respectfully suggest you take a different approach.

Instead of sharing ownership equally, agree this is a critical part of the decision in founding the company, then sit down to discuss it in detail.  Let each person represent their personal opinion on how the pie (aka company) should be split and their reasoning for this. In the situation described above, if the person taking the CEO reins is expected to keep that role long-term, it is logical to expect they would own a larger share of the business, just as a VP Marketing would be expected to own a smaller piece.  Yes, every situation is unique in some ways, but usually not so unique that you can justify an equal equity split between the CEO and VP Marketing, even if they are both founders.

So, how to deal with the conflict this can create and ensure you have a good working relationship from the start? We always have the same reply – if you are not comfortable disagreeing with your co-founders and dealing with the conflicts that a topic of this much importance, you should reconsider starting a company with this team.  Odds are you will work together for a number of years and during that time you will run into countless situations where you do not agree on the best course of action, or are unhappy with one of your co-founders for some reason.  What better time than right now to figure out if your team will be able to work through these situations together and come out the other side stronger for it?

For companies that have taken our advice and had the “hard” discussion on equity up front we have without fail heard positive results from the process (note:  this does not mean all the companies succeeded in the end).  Invariably the equity splits are not equal but each of the participants comes away comfortable with their ownership and the reasoning behind it.

Below is a framework you might consider using for this discussion.  There are a few simple steps that require you to pull together a little bit of data (or ask us and we’ll see if we can give you what you need), and will require you to think about each of the individual founders, their role and long-term expected contributions.

Step One: Determine equity ownership for each person if they were not a founder

Figure out what an employee being hired into each of the respective founder roles would likely receive in terms of equity ownership.  We recommend you think about this as a company that just closed a Series A financing round, and all these positions are being filled on the same day.

For the sake of this example, lets assume the middle of the range for a CEO hired in this situation would be a grant equal to seven percent, a CTO would receive three percent and a VP Marketing two percent.  As shown in the sheet below, you have a ratio of  7% – 3% – 2%, or applied to a one hundred point scale (as in 100% of the company equity), 58.33% – 25.00% – 16.67%

Step Two: Make situational specific adjustments

Start with the 7% – 3% – 2% ratio and adjust as you think appropriate.  There are a number of reasons you might adjust someone up or down, and you should think about these possible factors and then sit down to discuss them and agree on which are relevant and applicable.  Possible factors to consider might include the prior experience of each founder including in the role they will be taking at the company, each person’s respective time and financial commitment to the concept before the founding of the business, and each person’s specific domain experience in the sector the business will be focused.  For this example we’ll include the following factors:

(1)  The CEO is a first time CEO, and while the founders think he/she is capable of filling the role over the long-term, this is not a certainty.  If this person was hired into the role they’d get a lower equity grant to reflect this inexperience.  In this case the founders agree it would be closer to 5.5% instead of 7%.

(2)  The CTO is an experienced VP Engineering and is planning to fill a dual role for the first 12 months and then recruit a VP Engineering into the business.  Given this dual role, but accounting for the 12 months they will hold it, the founders agree this person would get an extra 1% grant if they were hired in to fill these roles soon after a Series A closed.

(3)  The VP, Marketing has good experience in this role and has some of the key contacts needed to launch the business.  This person also played an important role in bringing the three founders together in the first place.  The founders agree that these factors warrant a bump of 1.5% to 3.5%.

Making these changes you now have equity ownerships of 5.5% – 4.0% – 3.5%.  Again, applying this to a 100% scale, the resulting equity ownership would be (rounded to the nearest full percentage point) 42.31% – 30.77% – 26.92%.

We recommend rounding the final results so you can start with a cleaner cap table.  In this case the equity would round to 42%, 31% and 27%.

Step Three: Apply the Sniff Test

So you’ve gone through the process and come up with the following equity ownership for the three founders:

CEO – 42%

CTO – 31%

VP Marketing – 27%

Now think about it for a little while and get back together to review.  Do these splits feel right?  Does anyone feel slighted?  Did you make the correct adjustments?  If you need to tweak more, go for it, but if each of the three founders can look each other in the eye at this point and say they feel good about the outcome and are ready to get rolling, then congrats, you’ve cleared an important milestone.

We recommend that after this process is complete, the founder who ends up with the most equity take his/her co-founders out to a nice dinner to say thanks.  If you don’t do this, and the business is a screaming success down the road, it is only fair that you will buy them each a sports car (or similarly priced trinket) when the company has a liquidity event.

Note:  We have been asked how to account for things like the option pool and seed investments in setting founder equity.  Our advice is to deal with these things AFTER setting the founders equity as above.  The option pool should be added on after the fact so that it impacts each of the founders equally in terms of pro rata dilution.  Seed financing should be handled the same way, unless it was raised prior to setting these amounts (in which case you should read some of our posts about working with the right attorneys, as this is a suboptimal sequence in terms of things like pricing founders shares and your personal taxes.

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19 Responses to Splitting up the Pie: Considerations for setting initial equity ownership among founders

  1. Interesting Post says:

    Thanks for posting this – great way to think about this issue!!

    • CapGenius says:

      Thanks for the comments “Interesting Post”. Glad you enjoyed it and hope you will find more as we keep adding to the library of content.

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  10. So glad to have read this. As a first time founder, I’ve been wondering how to split things up appropriately. Thanks!

    • CapGenius says:

      Thanks Casey – very glad to hear that our post was helpful. Make sure you read our post on Founder Vesting (Repurchase Rights) as well prior to forming the business and selling the founders stock – http://capgenius.com/2011/04/24/foundervesting/

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  13. Hutch Morton says:

    Thanks for this great post. Definitely a more sane and rational approach than equating ideas to shares. I have been involved in multiple startups but this is the first that I have started. (note use of “started” not “founded”…)

    in my case I am the one who came up with the idea for my new business. I reached out to a friend to share the idea with and to see if he had feedback and potentially get involved. He has since then started contributing to the idea and fleshing out ideas and strategies with me. We have been slowly working on product and strategy vision for the past 2 months, and we are now getting figuring out what it will cost to build it. (it’s an online marketplace, so tech heavy, but not really innovative tech.)

    A few questions:

    1. I would like for him to be a co-founder in the company, but believe that my equity should far outweigh his, since it was my idea that I brought him in on, and the domain expertise is primarily mine. He recently successfully sold his solar company startup so he has some fund-raising, operations, and CEO experience. In your proposed method, you basically don’t ascribe any value for the original idea. Is that because you are assuming that all 3 founders were equally responsible for the idea germination/incubation to get it to the point where this equity discussion becomes relevant, or is it because you don’t think that the “idea” is worth more? What about experience?

    2. Neither of us are engineers, and I am worried that simply outsourcing the development of the beta/launch product will give us a shiny object but limit our ability to update on the fly. Would you advise bringing on a “technical founder” at this stage? If yes, how does that decision then apply to the above question about the value of the business idea?

    Curious to hear what you think.

    Thanks for any feedback/wisdom you are willing to impart!

    -h

    • CapGenius says:

      Thanks for the comment and questions.

      One #1 – In our example we treated the VP Marketing as the person who pulled it all together and had the domain experience. This included an assumption that this person came up with the idea as well. These factors, and the VP Marketing pulling the people together resulted in a bump from 1.5% to 3.5% in our example. That said, it is only an example and the sniff test is key. If you feel you should own significantly more equity then you should adjust accordingly. Our view is that this is an important conversation to have with your co-founder, and hopefully they will agree that given it is your idea and you pulled him in, combined with what you bring to the table going forward, you should have more equity.

      That said, depending on how much collaboration he has been involved with in the two months since you approached him with the idea, you might find he feels more like an “equal” in terms of helping get the idea to this point, so you may find he has a different view. One thing to consider is how much, if at all, the idea has changed since you first discussed it with him. If the idea is basically the same with more “flesh on the bones” you should ascribe more initial equity ownership to the idea. If the initial idea has shifted in some significant way since you two started to collaborate, then you might consider applying less weight to the initial idea.

      Our recommendation would be to use the process to set the equity for the two of you where you feel it should be (sniff test adjustments included), and walk him through your thought process.

      This is the start of answer #2 (we’ll answer the second half of that question first), as you should agree on the equity split between the two of you before you start looking for the Technical co-founder (note – make sure you talk with your company legal counsel about price paid per share for the third founder if they come in much later than the two of you form the actual entity as you may want them to pay a slightly higher price to avoid any cheap stock tax issues). You should agree to proportionately reduce your equity to accommodate the technical co-founder if you find one in the near term.

      For instance, if you agree that to start you will own 60% and your current co-founder 40%, and then agree to bring in a technical co-founder who will own 20%, you should take this dilution equally, meaning you would drop to 48%, your co-founder 32% and the technical co-founder 20%. Note you could end up with a situation where the newly added co-founder holds more than one of the two of you so make sure you understand the impact of dilution before setting their equity level.

      Note: This is different than the process of setting equity ownership for all three of you at once. If you think you can get the technical co-founder in soon you might want to do this all at once, but given your view you should hold more than your current co-founder, you may be better off getting that resolved prior to bringing a third person into the mix.

      Now, the answer to the first part of #2: Yes, if you can find the right person. Outsourcing the entire development process means that the people doing the development work have no long-term incentive to make sure their efforts really pay off, and have no incentive to set things up so that you can easily migrate to internal developers (or other outsourcers). You may want to consider looking to hire someone who could fill the VP Product role and has an engineering background. This person can serve as the interface between your ideas and the development process, and should be able to get much of the initial development framework as well as development schedule in place. Given your company’s area of focus this is an important role, and it is very hard to find qualified people who are available. Given that, be prepared to give away a good deal of equity to get a good co-founder in this role. This is usually not a role where you can go bargain shopping, and if you do, you may well regret it down the road as you deal with a complete code re-write, etc.

      Hopefully these answers help – good luck getting your start-up off the ground!!

  14. Jonathon Chilcott says:

    Regarding a Technical Co-Founder, a 6-person company had formed 2 years prior with 3 co-founders: a CEO/CFO (temporary dual role), VP of Marketing, and a VP of Engineering. The stock / equity was 51% between the CEO and VP Mrktg, and 5% for the VP of Engineering had replaced the original technical co-founder a year into their project for various reasons. But the ratio of business-side to technical equity was 10 to 1 (by shares), which seemed to me, at the time, unfair to the technical side, as only 5 people in the world could do what he did. Seeing this helped me understand why myself and another engineer, fresh out of graduate school were each offered just under 1%. Fast forward to hiring a CFO, filling the Board, going IPO, and a 7:1 split, our 2-year post-founder technical folk each paid $3 a share. The fourth technical person hired 2 years later (4 years after founding) paid $4/share. As a stockholder, I went to board meetings and having left before the IPO, chose to buy 50% of what was vested, and hold until a good time.

    My question is two-fold:
    1) In splitting equity, the CEO and VP of Marketing wanted to retain a controlling interest together, especially with private funding (no VC’s), so is 51% reasonable, as with control? Just enough…
    2) The VP of Engineering, a Technical Co-Founder who more than made up for the original one, did things no single person should be able to do, all of them multiple engineering featsof world-class, state of the art caliber. Was he treated fairly? Even if he was “OK with it”, in his mind, I felt for him – 20-30%, adjusted per your example as people were to be brought on board, would have been far better, as a percentage of total outstanding shares given the breakdown prior to IPO. How is the balance of “feeling right while looking in the eye” and “fair business practice” done?

    Lastly, looking at it as entering the ground floor what % should a Technical co-founder have if there’s no funding but the idea is the CEO’s (non-technical but solid track record), and implementation is the other founder (who may lead one or more platforms)? The people and roles will undoubtedly grow after receiving funding? This is not an uncommon situation today.

    Thoughts, suggestions, releance despite no Series A funding in today’s IPO economy?

    Thank you for sharing you experience and wisdom.

  15. jay says:

    Hi there
    Such a helpful post!!! Made my thinking process much easier. But I have a bit of a mixed scenario.and.money is involved ans thought I’d put this for your thoughts.

    New startup requiring $150k.

    I am the founder, my idea, my expertise and all research and background work is being done by me. So far no one has come into the picture to assist.

    Money being pumped in is as follows

    1) myself – $35k
    2) mr b – $25k – brings some expertise along with his wife who will put in hours as required
    3) mr c,d & e – $10k each – each of them are willing to contribute in anyway they can and be involved wherever possible. They are all working elsewhere and will.contribute after hours, taking leave etc. Also their wives will help when required ie: answering customer calls, filling online admin stuff etc.
    4) we do need a bit more money

    With the above, what word be an ideal breakup of equity and how do I go about leaving some for any future investors as well?

    • CapGenius says:

      Jay: Thanks for your question – we have been away from this blog for WAY too long so will try to make up for that.

      Also – all of the numbers below are meant to be used as an example, not as the numbers you should use in this specific case. That said, we tried to infer some things from your message in an effort to get these closer to where we might suggest you focus (if we inferred correctly as outlined below).

      Our recommendation would be that you separate the financial capital being invested from the human capital. Lets start first with the human capital.

      Given your description it sounds like you will be doing the lions share of the work. If this is correct and others are contributing time but not fully committed (this assumes you are making the new startup your full-time gig), then you should start with the vast majority of the ownership of the business. To the extent it is not clear how much time others will contribute you might want to consider giving them equity later on instead of now, or giving them a small amount now and increasing this for the people who actually put in the time and energy. You’d hate to give away equity and then find out they are not doing the work for it, so either way you should set this equity up to vest over time. Recommendation is that all of this be common stock and/or stock options if you are going to have them. If not, look for our post on vesting and the difference between stock and options in this regard.

      It is hard to know how the time commitment will be split going forward based on your message, so we cannot give much guidance on exact numbers here – check out our “Splitting up the Pie” post for founders and try to work off of that if you can. Set the ownership across these people (including yourself), as well as equity you want to reserve for future use (give to people later on) on a 100% scale, so that when you add all of this up, you get to 100% ownership. Then move on to below….

      Now lets more to the investment (financial capital) side of things. This is intentionally covered second because you should figure out how to split the equity for the human capital first, and then the ownership for investment dollars should be handled after that.

      First r- everyone’s money at this stage should be treated equally. While you are committing more time and energy, and are getting more equity (per above) for doing this, your $35,000 is no different from someone else’s $35,000 that comes in at the same time.
      Second – It is not clear how much money you will need in total (including later on) – for the purposes of this reply we will assume the $150,000 is all you expect to ever need for you business, or at least all you will need for a long time
      Third – Without knowing what you business does or what the potential outcome would be, it is hard to provide input on a valuation range to consider. If this is a small business (long-term value of less than say $4 million) the approach is very different from a situation where you credibly believe this can be worth more than say $50 million in five years (note: If the latter, you should revisit the capital needs as it is HIGHLY unlikely you can get an outcome like this on $150k – it has happened, but winning the lottery may be a safer play). For the purpose of this response we will assume you are building a company that has the potential to be worth $5 million if you do a good job building it over the years, but that this $5 million level would be the upside outcome and not one you should “bet” on.

      With that groundwork in place. We would recommend you think about the $150,000 in capital as “seed money” meaning that it is a highly risky investment and the people investing should get a massive payday if you succeed. We will not set the value for you but for arguments sake lets say you sell 35% of your company for the $150,000 investment (note – this assumes a range of outcomes as outlined above). The ownership would look like this:

      Equity for “Human Capital” = 65%
      Equity for “Financial Capital” = 35%

      Simply take the 100% Human Capital ownership you came up with above, and multiply each of these by 65%, or .65. For the 35% going to “Financial Capital”, this is split among the $150,000 in capital needed. For instance, your $35,000 investment is equal to 23.3333% of the total capital, so you would get 23.333% x 35% ownership of the entity for your “Financial Capital” piece, or 8.1667%.

      Hope it helps and GOOD LUCK!!!!

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