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A question on splitting equity among founders
My friend, Lisa Ann Thomson, a local writer and author sent me this question:
Hello! I have a quick question (or maybe a very complicated question) for all the entrepreneurial types I know:
How do you divide equity and ownership amongst founders of a company?
More specifically, I have a friend (seriously, it’s a friend, it’s not me….) who is involved in the very beginning of a start up. There are three of them. One had the idea and development of the product. My friend is doing the business plan, initial sales contacts/meetings, and developing partnerships. I don’t know what the third person is doing.
Is there a formula or are there resources to which you can point me to guide in the division of ownership and equity? Your insight is appreciated.
I responded along the lines of money and time put into the business, who had the idea, who will be the CEO, and the issues regarding future dilution.
What are your thoughts? Please sound off in the comments.
Thanks.
Ideas aren’t worth much. There are lots of idea people around who have never done anything.
Time, money and execution is what matters.
Nothing is worse than dead equity - basically someone who just sits on a pile (10%-50%) of equity and does not contribute in the slightest. Unless all three partners are very active in the company equity should be distributing on a cash contribution and work time basis. An idea guy should have no more than 5% tops. Development of course (it doesn’t specify if it is technical programming development or just developing the concept which is generally questionable) is another matter and falls under the time investment. If you have a programmer doing all the programming that is a different story. Also it depends on who is getting paid and who isn’t.
A do-nothing partner who owns a chunk of the business kills the business. For everyone else it kills your motivation and drive to succeed.
Regardless of how the friends setup the business, they should build in buyout provisions and performance ratings in any type of legal document outlining the relationship. By doing so, they can better manage expectations and have an out that would result in less bad feelings (not no bad feelings - that will happen regardless).
Just my feelings -
Left by Mark Newman on 04/08/2008Ideas mean nothing without execution.
Left by Russell Page on 04/08/2008Well, my answer is not a direct answer to your question, but something related that you should also consider. Once you determine who owns how much equity, and you start your company happily rolling along things may be fine for a few years. But generally within about 3 years the company will have outgrown one of the founders. This can be a really tough time for a company to deal with. Often times the other founders wait too long to take any action, and the person can become dead weight, or even worse a demoralizing factor on the company. So a suggestion I would throw out is that part of the equity division exercise needs to be a frank discussion about what to do when this time comes. There should be a formula built early on that allows partners to buy out, and quite frankly “push out” a partner when they are no longer adding value. Otherwise this stage can be the death, or the painful split of a company.
Left by Steve Spencer on 04/15/2008