Equity split: how to start
It is YOUR business that you are building. It is YOUR decision how you allocate the equity. It is one of the MOST IMPORTANT decisions that you will ever make - and one that very much influences if you are going to succeed. But you are not quite sure where to start. There are so many ‘how to guides’, proven formulas, calculators and so much well-meant advice out there. You can breathe out. It will all get simpler from here - here is the first question you need to answer:
What do you believe is the right thing to do?
a) One for all and all for one - I want to have the equity between founders split equally
OR
b) Equity should be proportionate to … what the cofounders bring to the table?
Once you answer for yourself this question, it is relatively easy to choose which equity allocation methodology is the right one for you - and your team.
So let's take it step by step.
EQUAL EQUITY SPLIT
If your answer was a) one for all and all for one - this will lead you down the equal equity split - dividing the amount of available equity equally between the number of founders. This works well if the founders believe it is the right fit for them (and don't mind if they contribute differently - for example full time vs part time, different capital contributions, different level of experience etc) OR their contributions are roughly similar. If you do choose the equal equity split make sure to document well the reasons why you did it and explain it (to your potential investors). Equal equity splits sometimes are a flag - if the choice was driven by the team wanting to avoid the difficult equity conversation and took this option as an easy way out.
Personally, I am not a big fan of equal splits. That said - there are successful companies out there for which it worked out very well.
UNEQUAL PROPORTIONATE EQUITY SPLITS
If you believe the equity is a reward - and should be proportionate to... something, then of course the next important question is, to what? Typically the most logical and fair answer is - to the founders’ contributions to the success of the business.
That is all sounding very well, but, how do you measure that?
There are different ways. One of the simplest and most transparent methodologies out there is the dynamic equity split based on the slicing pie.
Dynamic equity split assigns a monetary value to different types of founders’ contributions, it includes a risk factor (cash availability) and if applied fully, it also allows you to adjust the equity based on the real (not expected) contributions. You can read more about it here.
Personally, I believe that this type of equity split reflects more accurately founders’ inner expectations (for fairness) and if set correctly, they can achieve positive motivational and team spirit impact.
The key is to make sure that this type of equity split has some element of future proofing - that is, being able to adjust the shares based on the actuals (versus expected). Again, slicing pie is the most suitable candidate here, as it allocates the shares dynamically until the cap table is stable enough to be fixed, or the company is de-risked and the founders are being paid. In case of fixed unequal equity splits consider a combination of time and performance based vesting.
Remember that there is no one size fits all solution. The best way to go about it is:
Choose what fits you and your team,
Take your time to do it right
Remember that equity is the most valuable asset in your business and it is finite.