One of the earliest challenges startup founders often face is how to distribute equity. Generally, the choices are to either simply go for an equal equity divide or opt for a weighted split, however there is no definitive right way to proceed. Often it may depends on factors like the level of commitment, expertise or business experience etc of the parties involved.<\/p>\n\n\n\n
Ultimately it is a crucial discussion that needs to take place and here we\u2019ll discuss the pros and cons of these approaches, offer industry professionals\u2019 views and highlight common best practices for you to consider when deciding on equity allocation.<\/p>\n\n\n
As the name suggests, this approach enables each co-founder to get the same number of shares in the company, e.g. a 50-50 split among two founders, etc. It is a common approach among startups and is usually adopted when each founder will be considered to contribute equally to the company\u2019s growth.<\/p>\n\n\n\n
PROS: CONS:<\/strong> <\/p>\n\n\n Alternatively, founders could be assigned shares based on factors like commitment, risk levels, domain knowledge, how much funding each founder brings and previous business experience, etc.<\/p>\n\n\n\n For example, it is not unusual to have one or more founders devote all of their time to the project at the early stage, while others might still have a full-time job elsewhere. In this scenario it is clear there are two different levels of commitment and risk in this and therefore it might be reasonable to suggest this be reflected in the equity split.<\/p>\n\n\n\n PROS:<\/strong> CONS:<\/strong> While you\u2019re still pondering which approach you should opt for, remember there\u2019s no universal right or wrong answer and what investors generally want to see is clear reasoning and transparency about how your team came up with the split chosen.<\/p>\n\n\n\n However, there are some best practices you can follow when allocating a founder\u2019s equity split:<\/p>\n\n\n Your co-founders are the people you are going on this journey with, so you should be open to discussing equity allocation with them. Encourage everyone to bring up their arguments and bring any concerns to the table in order to reach a fair decision. No one should feel their voice hasn\u2019t been heard.<\/p>\n\n\n Whether your team lands on an even divide or other split, the founder\u2019s equity should be subject to vesting, which means a waiting process to receive ownership of an asset. The common practice in startups is to have four years of vesting with a one-year \u2018cliff\u2019.<\/p>\n\n\n\n This means that if a founder leaves within one year, they will get nothing no matter how much they own on paper. Should they leave after one year, they can walk away with 25% of the shares and the remainder (i.e. unvested shares) can be repurchased by the company. In addition to promoting long-term commitment to the business, this approach can serve to prevent any of the founders from leaving completely with a large chunk of the business.<\/p>\n\n\n\n Remember potential investors will also take notice of your vesting schedule.<\/p>\n\n\n As discussed, every business is unique and your considerations may be more complex to quantify. Speak to an industry professional to get this matter sorted as early as possible, as they will be able to look at your individual circumstances.<\/p>\n\n\n All the agreements you and your co-founders make regarding equity and vesting should be written down in legal terms and signed by all parties. It\u2019s often best to have a lawyer compose the documents in case of any disagreements or queries arising at a later stage. Once this is done don\u2019t forget to update your cap table<\/a> to reflect details of who has ownership in your company and how much they each own.<\/p>\n\n\n\n The cap table should always represent the current equity ownership in a company and provide potential investors with a snapshot of the financial situation of the business.<\/p>\n\n\n Our cap table management software is free for up to 40 stakeholders.<\/p>\n\n\n\n At J.P. Morgan Workplace Solutions we work with companies from around the world every day, from the seed stage to IPO and beyond, to help them bring their equity compensation and reward strategies to life. Our tech and service-based offering was created to empower founders and employees to easily navigate their workplace incentives with confidence.<\/p>\n\n\n\n Get in touch to speak to one of our customer success managers.<\/p>\n\n\n
<\/strong>\u2013 An easy, quick solution
\u2013 Can strengthen the relationship between co-founders
\u2013 Encourages all co-founders to be equally committed to and invested in your company<\/p>\n\n\n\n
\u2013 May lead to deadlocks in decision-making<\/p>\n\n\n\nWeighted split<\/h2>\n \n\n\n
\u2013 Achieves a fair equity allocation treatment by quantifying each founder\u2019s input based on time, commitment, etc.<\/p>\n\n\n\n
\u2013 Can get tricky when assigning a tangible value to each factor
\u2013 Contributions by each founder may change in the future
<\/strong><\/p>\n\n\n There\u2019s no magic formula \u2013 The \u201cright\u201d split is highly circumstantial<\/h2>\n \n\n\n
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1. Start an honest, transparent conversation early on<\/h2>\n \n\n\n
2. Set up a vesting schedule<\/h2>\n \n\n\n
3. Consult finance and legal consultants<\/h2>\n \n\n\n
4. Document the splits and update your cap table<\/h2>\n \n\n\n
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