When we talk about splitting founder equity, there are 2 aspects to cover off:

1.  deciding on the initial split

2.  implementation – agreeing commitments and deciding on the ‘what ifs’ (e.g. what if one of us leaves?).

In this resource, we set out the criteria to consider when splitting equity, and some step by step instructions on implementing your chosen equity split.

 

 

Summary

Deciding on the initial split?

If it feels like a 50/50 then go with your instincts. If not, then consider all the variables (see below) and go with something which feels fair in the long term.

Implementation – agreeing commitments and deciding on the ‘what ifs’?

Complete the share issue or transfer administration and then enter into a Co-founder Agreement together to agree what you will both be doing for the Company on an ongoing basis, and to agree on key decisions in advance – e.g. What if someone leaves? What if someone wants to go part-time?

Guidance available in the Encyclawpedia. Visit the Contracts tab to create your Co-founder Agreement.

 

 

Detail

Part 1 – The Initial Split

Our belief is that there isn’t an exact formula for this – you may instinctively have a guide for what feels right, or you may need to consider all the variables to come up with something that seem fair. Best case scenario? Everyone wants an equal split, and to go into battle together – but that isn’t always the case.

One thing we know is that the ‘right’ or ‘wrong’ of it tends to be linked to emotion (which is why there is no exact formula). You’ll be right if all parties are content and satisfied that what you have chosen is FAIR. You’ll be wrong if one party feels the split is UNFAIR and the business and team suffers as a result, often fatally.

Either way, it’s worth running through the key areas relevant to splitting equity so that you can make a pro-active decision which feels right and fair for all:

1.  the start – when did the business start? Is one individual ‘hiring in’ another co-founder? If so, why are they doing that? Is it because they need to hire in a skill, or is it because they want a true partner by their side for the journey? If it’s a skill, it’s likely a lower percentage (although also see point 6 – The Long Term). If it’s a true partnership, it’s likely nearer 50%;

 2.  the progress – where is the business up to and what has been done so far? The further the business is along and the closer it is to its goals (e.g. an exit), then a new co-founder’s equity is likely to be lower to reflect that. Equally, if everything is starting from scratch, 50-50 seems like a reasonable starting point subject to the other factors;

3.  the day to day – who is going to be working full-time in the day to day operation? Who is going to be advising on ‘strategy’ once a month? Advice on strategy is valuable, but it isn’t as valuable as someone implementing, adapting and developing it;

4.  the skills – what is each person comparatively bringing to the table that is most applicable to this business? This isn’t a question of who is ‘better’ (that’s how arguments start). This is about assessing whether one particular skill-set is particularly relevant to the particular business. Are you providing a service which one potential co-founder is the expert in? Are you a business needing scale? If so, then being able to market at scale and open the right doors will be more valuable than if the business was only focussed on a small number of key customers;

 5.  the track record – who is bringing what to the table? Especially if you don’t know each other personally, you need to know the other person is who they say they are. Do your due diligence. If they’re a potential CTO for example, you can’t just presume they know what they’re talking about;

6.  the commitment – let’s face it – creating a successful startup is really hard. If someone wants to be a co-founder, this means that they need to be ready to commit and give their all to it. If they’re not available to do that, are they available to give their all to it for specific periods? If one person is full time, but the other(s) can’t quit their job yet because of financial constraints, then this should typically have an impact. Think of it as higher risk/higher reward. You can always implement milestones to kick in later to change the split in case someone wants to quit their job and become a co-founder but can’t quite do it yet;

 7.  the long term – most importantly, think in the context of the next 5 years. If someone wants to help for 6 months and then go travelling for 12 and then see how they feel, they probably aren’t a suitable co-founder – perhaps they are more suitable for another form of contribution if so (e.g. a consultant in exchange for fees or equity). Equally, ensure that your co-founder is capable of providing long-term value as a head of the business. You might need a coder on day 1, but on day 600, do you want that coder to be at the head of the business alongside you?

 8.  the contributions – when we talk about equity, we all have the long-term sale in mind. From a financial perspective, what is each individual contributing, both in terms of money, time and expertise?

9.  the bottom line – make sure you get on with them (enough). People succeed when they are enjoying what they do. Don’t let a turbulent co-founder relationship make you wish you never started in the first place.

If these co-founder considerations set a high bar, it’s because they are supposed to. It’s a big decision so take the time to give it full consideration.

 

Part 2 – Implementation – agreeing commitments and deciding on the ‘what ifs’

Once you have made the decision, here’s a step by step guide to implementing it properly:

1.  you agree the split;

2.  issue or transfer shares – 3 options depending on your situation:

a)  not yet registered: you register the company with the agreed split;
b) registered but no value yet in company: transfer the relevant shares using a Share Transfer Form;
c) registered and company has value: issue new shares via an SH01, ensuring you avoid a common pitfall;

3.  enter into a written Co-Founder Agreement to confirm all the details of the share split, future commitments to the company, and importantly, a founder vesting schedule for your shares. This means that if someone leaves in future, then it’s possible that their shares can be returned to the Company. In practice, this is about outlining negative scenarios that might occur in the future, with corresponding actions to help avoid them.

 

 

The Contract You Need

You can enter an agreement between co-founders called a Co-Founder Agreement. With Legal Sidekick, you can choose to create one with vesting, and one without vesting.

You can create customized versions of both using Legal Sidekick, which if you would like, our legal team can review and sign off on for you.

Consider using Founder Vesting

Using Founder Vesting means each founder has to earn his or her share in the Company by remaining involved or achieving pre-agreed milestones over a pre-agreed minimum time period. For example, if two founders agree a 50-50 split, they might agree that they effectively earn 12.5% each in each of the first 4 years. Therefore, if one leaves after two years, they have 25%, rather than 50%.

Legal Sidekick offers a ‘reverse vesting’ Co-Founder Agreement. This means that all shares are issued up front and can be ‘clawed back’ later if applicable.

 

A downloadable version of this guide is available below.

 

Get in touch to info@legalsidekick.com if you have questions or need help.

 

This Step by Step Guide was written by Legal Sidekick. Legal Sidekick is the legal platform for startups. We offer automated contracts and loads of startup legal resources and guides. For co-founder and other legal queries, contact us if you need help.

 

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