When setting up a business with two or more partners, one of the most important issues that arises is how to split equity percentages among them—and make no mistake, this is something you should consider carefully. Get the agreement down in writing.
Obviously, everyone would like to maximize their equity in a new enterprise, but dividing it 50/50 or otherwise equally may not be the best option for a variety of reasons, not the least of which is that not all founders have put in or will dedicate the same amount of capital, work, or sacrifice.
What follows are 7 factors to consider when determining founder equity percentages, though notably, no single factor should prevail. Instead, these factors should all be taken together when forming your final decision.
Whose idea was the enterprise? Often, even the idea of a business is a collaborative effort, but if one or two partners started the whole project moving with the kernel of an idea, this could weigh in favor of greater equity percentages.
- Intellectual Property
Did a partner develop the technology at the core of the business? Does a partner already own critical copyrights, trademarks, or patents? If yes, that partner may be entitled to, even expecting, a greater equity percentage than other partners.
Who put up the cash? Every startup needs capital investments, and you may choose to reward contributors with greater equity percentages based on their pro rata contributions. Another option, though, is to issue preferred equity or convertible debt, which is a loan taken on by the business from an investor with an option to be converted to equity at a later, specified time.
Who is taking a salary and for how much? If someone chooses to take no salary or a lower salary, that may warrant a higher equity percentage.
Who has taken on the most intensive roles? Usually a CEO or CTO position, for example, weighs in favor of a higher equity percentage. From there, you might consider breaking down roles into levels that consider a position’s responsibilities and distribute equity percentages based on that delineation.
- Sweat Equity
Who is putting in the most effort and will continue to do so? Related to this, who is risking the most by taking on this pursuit? For example, if one partner is quitting a full-time position to assume a role at the new enterprise, you may wish to reward that “opportunity cost” with a greater equity percentage.
Does anyone bring in a significant amount of industry experience that will contribute greatly to the business? A greater equity percentage may be appropriate. Related to experience is the idea of “connections.” For instance, one partner may have a great network of industrial, advisory or investment resources; and these people could bring a lot to the table.
Other Considerations in Determining Founder Equity Percentages
While working through the factors to decide equity percentages, you should have two overarching goals: fairness and setting up your enterprise for long-term success. Although you may have competing personal feelings—especially if family and/or close friends are involved—it’s important to keep discussions as professional as possible and keep emotions out of the discussion.
Remember, too, that you don’t need to assign all shares at once. You can hold some shares back to correct for any later discrepancies in individual commitment. In any event, consider making all shares subject to vesting restrictions to protect the business from a founder’s sudden departure while still retaining a large chunk of the enterprise.
Last but certainly not least: don’t rush your decision. Taking the time now to analyze all aspects of assigning founder equity percentages could potentially save you and your business from problems among partners later.