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Startup University: Equality is rarely the right answer for founder equity

Making the decision to take the entrepreneurial leap is one of the more difficult, and oftentimes exciting, decisions that someone makes in his or her career. The old adage that there is safety in numbers certainly applies, particularly when talking about emerging technology companies. Two, three, or four similarly minded individuals with complementary skills band together in an attempt to take an idea and transform it into a thriving business.

Among the first questions to be decided among the founders is the equity split. Time and time again, a group of founders will reach out to me to advise them on forming their new venture and, when I pose the question of equity splits, the most common initial answer, particularly from first-time founders, is an equal split among the group.

To be frank, splitting the equity equally among is rarely the right answer. It may seem like a fair outcome at the surface, but when one peels back the onion just one more layer, the problems associated with an equal split become pretty obvious.

It shouldn’t really matter much who initially came up with the idea. Ideas are a dime a dozen. Ideas alone may lead to small friends and family investments. But ideas alone never convince a venture capitalist to stroke a check—never. The “idea man” should not necessarily be the one with the lion’s share of the equity.

Over the last dozen-plus years I’ve spent representing Silicon Valley startups, I’ve seen literally 50 or 60 ideas that seemed like surefire home runs, only to have the company either fail to execute and ultimately shut the doors. Thus, a successful startup is all about execution. Founders should be thinking contributions to date, as well as contributions in the foreseeable future, when divvying up the pie.

Several questions help sort through that issue.

Is the company technology driven? If so, who is primarily responsible for coding or otherwise developing the technology?

Are any of the founders contributing cash to fund the startup costs? If so, how much?

What is the timetable for founders contributing full time to the business? Will everyone be full time from Day One, even if that means not receiving any form of compensation, other than equity, for their early work? Will one or more founders be holding a side job, whether full time or part time, until the company receives some milestone level of funding?

Who will serve as the CEO? Does he or she have a deep network of contacts for potential investors and, in relevant instances, customers or strategic partners? Is this person a first-time CEO?

Have any of the founders previously formed a startup that was subsequently financed by venture capitalists? Have any of the founders been part of a successful exit?

Those are just a few of the questions that help drive the analysis of the appropriate equity split. It is theoretically possible for two or more individuals to contribute equally to the early success of a company, but it is highly improbable. As mentioned, the equity split should reflect the anticipated contribution of each founder.

Coming up with an agreed upon equity split can lead to some very difficult, possibly even contentious, conversations for first-time entrepreneurs. It is typically a much easier conversation for serial entrepreneurs. Travelling across that early bumpy road, as difficult as it may seem at the time, is time and energy well spent.

It is very difficult to build a successful business in a purely democratic executive situation. When later disagreements happen over strategic decisions, those who are contributing the most to the success of the business should be the ones driving those decisions. Similarly, if the company is fortunate enough to experience an exit down the road, those early equity splits will have a significant impact on relative amounts of cash that each founder will pull off the table, and that is when the notion of rewarding actual contribution, not just the fact that someone was a co-founder, really comes to light.

© 2021 Dinsmore & Shohl LLP. All rights reserved.National Law Review, Volume II, Number 57
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