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Dynamic Equity Splits

While many founders tend to divide equity evenly in order to avoid a difficult conversation at that moment, this has the opposite effect and leads to problems later down the line. Serial entrepreneur and investor Chris Dixon finds that “people tend to overvalue past contributions and undervalue future contributions.  Remember that an equity grant is typically for the next 4 years of work (hence 4 years of vesting).”

By taking an early decision on a static equity split, you risk incorrectly estimating founders’ potential contributions and commitment to the startup. Also, getting a fixed, high equity stake early can weaken a founder’s incentive to contribute. This can result in tension between founders and threaten the startup’s stability.  A dynamic equity split, on the other hand, should be based on certain key criteria such as past and future contributions, opportunity costs, and founder motivations. It should also be adjustable depending on changes in circumstances.

For example, the co-founders of ZipCar, Robin Chase and Antje Danielson, agreed to a 50-50 equity split early on. Robin contributed significantly to the startup’s growth. But Antje never became as involved with the startup and even retained her full-time job. Eventually Antje left the startup while remaining a key shareholder, leading to huge problems in the early stages.

Further Reading

Foundational Stuff

Harvard Business School professor Noam Wasserman points out that “The First Deal” is not as easy as it might initially seem, since it involves assessing the relative value of each founder’s contributions. In his book, Wasserman shows how 73% of the startups split equity within a month of founding. Given that very little is clear about the company’s future at this stage, deciding on something as important as equity split might be a bit premature; Wasserman advises waiting for a few months so that the cofounders can have “a chance to learn whose skills and connections will contribute the most to the startup, how those contributions change as the startup’s strategy and business model change, how well each founder gets along with the others, how committed each founder is to the startup, and more.”

Don’t go halfsies

The decision to split equity 50-50, while simple and painless, might cause huge problems later. Key criteria to consider for equity splits are – 1) past contributions – offering a higher stake if a cofounder has had the idea or offers seed funding, 2) opportunity costs – offering higher stakes to those fully employed, 3) future contributions – considering specific founding experiences and the amount of time the cofounder is willing to commit and 4) decide on stakes keeping in mind the core motivation (wealth or control) of the cofounders as well as preferences such as lifestyle flexibility or title.

- First, ask yourself who a cofounder is and assess the value of each cofounder based on his or her contribution as well as the market

- Ideas are hugely important.

- Have your own grunt fund and leveraging sweat equity – the more someone puts into the company, the more he or she can claim back.

- What about capital? There are two ways a cofounder can contribute financially.

- You might consider giving a premium stake to those cofounders who defer salary.

-The funding that a cofounder is providing to the company could be simply considered a loan with interest with later adjustment for equity, or it could be directly calculated as part of the given cofounder’s share, based on an estimate of the company’s worth.

Aren’t We All Equal?

Critics like Joel Spolsky have a completely different take on the issue of equity splits. They feel that calculating a complicated split is not worth the trouble and all founders deserve an equal share. He still feels that this equal share should only go to those who work full-time on the startup, but does not feel that having the idea should mean a premium. Also, on the issue of investments by co-founders, he proposes an IOU with interest, not equity in exchange.

There are, however, enough horror stories from entrepreneurs who get the initial split wrong to make a budding entrepreneur seriously consider Wasserman’s, as opposed to Spolsky’s, advice. At Updown, an early equity split that poorly estimated founder contributions led to great strife when another founder wanted to renegotiate 6 months later. Smartix lost an immensely talented initial hire because they had not agreed upon a sensible, contribution-based equity structure. Aim for a structure similar to that of Oakham, where early founders divided equity according to their initial contributions, but incorporated a buyback clause should one of them “cease to perform” in the future.

Referenced Texts

Amod, Sheraan. “How to Divide Equity Among Partners in a Startup.” Sheraan Amod Blog. N.p., n.d. Web. 13 Jan. 2014.

Deeb, George. “How to Calculate Equity Split Between Founders in Startups.” AlleyWatch RSS. N.p., 13 Jan. 2014. Web. 13 Jan. 2014.

Dixon, Chris. “Dividing Equity between Founders.” Chris Dixon RSS. N.p., n.d. Web. 13 Jan. 2014.

Dixon, Chris. “Dividing Equity between Founders.” Chris Dixon RSS. N.p., n.d. Web. 13 Jan. 2014.

Hellmann, Thomas F., and Noam Wasserman. “The First Deal: The Division of Founder Equity in New Ventures.” National Bureau of Economic Research (2011): n. pag. Web.

Moyer, Mike. “How to Split Startup Equity.” Startup Plays. N.p., n.d. Web. 13 Jan. 2014.

Shapiro, Dan. “The Only Wrong Answer Is 50/50: Calculating the Co-founder Equity Split.” GeekWire. N.p., n.d. Web. 13 Jan. 2014.

Tenner, Daniel. “Joel Spolsky’s Method for Splitting Shares in a Startup.” Swombat. N.p., n.d. Web. 13 Jan. 2014.

Wasserman, Noam. The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup. Princeton, NJ: Princeton UP, 2012. Print.

Wasserman, Noam. ““Founders’ Dilemmas” Course: “Building the (Founding) Team” Case Studies.” Noam Wasserman. N.p., n.d. Web. 13 Jan. 2014.

Whitehouse, Nathan. “How To Split Equity Among Founders.” Forbes. Forbes Magazine, 22 May 2013. Web. 13 Jan. 2014.

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