You’re starting a new company. Congratulations! Before preparing for your product launch or talking to customers, however, you need to agree upon the allocation and terms for the equity, or ownership, of the company among you and your co-founders.
This is one of the toughest decisions you’ll have as a founder, but it’s also one of the most important to get right from the get-go. Even minor differences in equity can mean a lot down the road, so starting off with everyone on the same page (and feeling good about the agreement) will prevent big issues from coming up in the future. So, how should you get started?
Dividing the Pie
As with most things, there are philosophical differences in the approach to founder equity. One camp believes that founder equity should never be evenly split because it can result in stalemates, which can kill a company fast. The other camp believes that fairness should prevail and if an even split seems fair, then it’s appropriate.
While there’s no formula or one-size-fits-all approach, there are a number of factors that are generally taken into consideration:
No matter how you divide the founder equity, those shares should be subject to vesting restrictions, so that until the shares are “vested,” the founder does not fully own them. This is important because it prevents a co-founder from leaving after only a few months, and yet retaining a huge part of the company. The last thing you (or an investor) will want is for someone to hold a lot of equity and no longer be contributing to your success.
Under a typical vesting schedule for employees, shares vest over a four-year period, with 25% vesting at the end of the first year (called a “one-year cliff”), which ensures employees stay around for a year before owning any of the company. The remaining shares vest thereafter on a monthly or quarterly basis.
For founders, some shares are typically vested up front (in our experience, 20% to 25%, though it can go as high as 33.3%) [Editor's note: This is one perspective. As with all numbers surrounding equity, multiple perspectives exist, and you should read more than one source when making an important decision.]. Founders also often have provisions that accelerate vesting in the event of a change of control (i.e., an acquisition) or a termination without cause.
When founders launch a start-up, they own the entire thing. But, it's inevitable that your shares will be diluted as the company grows in order to attract employees and investors, and there are very few examples of successful founders owning 100% of their companies at the time of a sale or IPO.
When you raise Series A funding, you’ll issue additional shares of stock that will go to your investors, and you can expect those investors to take anywhere from 25% to 50% of the company. In later funding rounds, they may take a smaller percentage, though depending on the terms you negotiate, it can still be as much as in your Series A. Each time, your shares will be diluted accordingly.
You’ll also need to leave a pot of equity for future employees, particularly early-stage ones. In general, when you’re setting up equity at the beginning, it’s a good idea to leave between 10% to 20% in the pie for employees. If you plan on raising funding at some point, your investors will require you to have this—and if it’s already in place, you won’t have to dilute your shares further to make room for it.
Every situation is different, and there’s no right answer for splitting founder equity. But when it’s all said and done, each co-founder should feel good about the equity divide. If the agreed-upon split causes you angst, it’s probably not right. Raise your concerns and iron out the details up front—it will only get harder to ask for a bigger piece of the pie as your company becomes successful and the equity increases in value, and it’s well worth it to have these conversations finalized early on. Good luck!