You have the idea. The founding team is in place. It’s time to execute, but first you have to make a critical calculation: the equity split. But how do you make a fair calculation of who owns what piece of equity, and why is it so important to get this right at the outset? Below, we’ll share four necessities that you must consider when you calculate your startup’s equity split.
1. Don’t — for the love of all that is holy — divide by N
We know it’s tempting to simply divide by the number of co-founders in your startup when you have a gajillion other things you need to do for your business and you want to avoid conflict and time-intensive discussions.
But please please please promise us that you won’t divide your company’s equity by the number of its co-founders. This is the most common mistake that entrepreneurs make when they split equity, and it’s the one that damages them, their co-founders, and their companies down the line.
By dividing and riding off into the sunset, you’re inviting in tension and internecine conflict. All it takes is one team member to think they do or contribute more work, skills, or money than the others for tension to begin brewing. It leads to resentment, corrodes everyone’s work, and can tear your company apart.
So please, for the life of us, don’t reduce one of your company’s most important calculations to “just divide it by three on your iPhone.” Use an equity calculator to determine a fair split.
Dividing by N is so egregious because it avoids all of the difficult (yet essential) conversations that co-founders need to have before they start a company together. For instance, is everyone actually aligned on their goals and vision for the business? You’re definitely not ready to split equity if you’re still at odds about the company’s mission and value proposition.
Also, you need to determine as a team what each team member will be contributing, and how the team will weight each contribution. (There’s an entire section on how to weigh skills, cash, etc. in this course). When you’ve made your calculations, ask each member to verify that they agree that the numbers are fair. Equity calculations are no good if one of your co-founders thinks your company is inherently unequal. You never want a co-founder saying six months later that they deserve more. Get buy-in from day one.
3. An idea is just that — an idea
Most experienced VCs and founders know that the idea is the easy part (~1%). The other 99% is the execution. The reality of equity splits is, however, that some founders feel attached to their ideas. They spent months and years fleshing them out and they want their hard work and idea to be worth something in an equity split. Unfortunately, most ideas, unless they provide serious advantages, like a patented product or a secret algorithm, are worth very little in an equity calculation. When it comes time to run the numbers, don’t give the idea more than a token value if the team isn’t sure whether it provides a distinct advantage.
4. Consider Risk
There’s a lot more risk that goes into starting a business other than money. Entrepreneurs need to quantify this in their equity calculation (more on how to do that here). To quantify risk, founders need to examine who’s working part-time and who’s working full-time, what each founder would be doing if they weren’t starting the business (i.e. opportunity cost), and when each founder is taking on the risk (does one founder have a family and a mortgage while the other is single and only needs to pay rent?) These variables may seem immaterial to splitting equity, but they aren’t, and need to be quantified and inputted into an equity equation [learn how to do that here].
Interested in learning how to make your own equity split calculation? Sign up for this course