How to split equity among co-founders and business partners.
“Let’s keep it simple,” said Merrily to her partner, Anson.
“I agree,” Anson replied, “let’s just split the deal 50/50. After all, we share the same vision and we’ll be able to work out issues as a team.”
“It’s a deal!” She said as she stuck out her hand which he took and shook enthusiastically.
And they lived happily ever after…or did they?
So many smart, educated, passionate founders start their company with a “simple” split and a handshake. Their intentions are good, but this could easily be the decision that leads to the demise of their business.
Founders are nothing if not optimistic. They look to a bright future where their visions are realized and their company reaches profitability in a way that matches the story in their heads. Optimism is important, even essential, but things never unfold quite the way people think. When things change, the simple equity split can have devastating consequences.
What if the company needs money? If Merrily puts money in, but Anson can’t afford to should he still get half the equity?
What if Merrily decides she wants to quit? Does Anson still have to give her half the future profits?
What if Merrily, the marketing person, wants to hire Norvin to help? Anson, the tech guy, doesn’t get extra help. Does Norvin’s share come from her half or from both of them?
What if Merrily slacks off on the job? Can Anson fire her?
What if Merrily wants to fire Anson and hire Norvin in his place? Can she give Anson’s share to Norvin?
What if Anson wants to take a vacation, does that mean Merrily has to take one too so it stays fair?
There are countless what if’s that face a startup and any one of them could derail an otherwise productive relationship and kill your chances of success.
Traditional time-based vesting programs can help, but they, too, are fraught with a plethora of what if’s that leave founders wishing there was a better way.
There is a better way.
Think of a partnership as a game of Blackjack. You and a partner decide to play together and, like Merrily and Anson, decide to split the winnings 50/50. You each bet $1 on the same hand of cards. The dealer deals two Aces. This, if you know how to play Blackjack, is a new betting opportunity. If you split the Aces and double-down on your bet, you can win more money. You and your partner decide to go for it, but your partner is broke so you bet $2 more. Now you’ve bet $3 and your partner has only bet $1.
Does 50/50 still seem fair?
Probably not. You deserve 75% of the winnings because you placed 75% of the bets. Startups are the same thing. When someone contributes to a startup they are, in effect, betting on the future winnings (profit) of that startup. The value of their bet is equal to the fair market value of their contribution.
So, a person’s % share of the equity should be based on that person’s % share of the bets. This way you can always be sure that each person has exactly the equity they deserve.
In a startup, people bet time, money, ideas, relationships, equipment, supplies, facilities and anything else the company needs to reach break-even. After break-even, the company is covering its own costs so no more bets are required. The company is now winning and you and your partners can split the profits according to the bets you placed before break-even.
This model, also known as the Slicing Pie model, is the only way to ensure a fair split in a startup company. It easily accommodates any kind of change that a company might encounter, it will even tell you the right buyout price if someone quits or gets fired for any reason.
Poorly-executed equity splits can kill your startup. Implementing a model, like Slicing Pie, that accommodates unforeseen changes along the way will allow your team to focus on success and not on each other.