Something interesting happens between the time an idea is developed and it becomes extremely profitable. Typically, everyone who had a role in the process — no matter how small or large — begins to jockey for position and to fight for a piece of the company. In other words, everyone wants some equity, regardless of the amount of work they’ve put in. As a member of the founding team, you should take responsibility for splitting equity in a way that’s fair to all contributing parties, while simultaneously positioning your startup for long-term success.
The problem with splitting equity, however, is that there’s never a “clean cut.” Any time you have more than a couple of people involved, disagreements will erupt over what value people bring to the table, which parties were there from the beginning, etc., etc. But by keeping several guidelines in mind, you can ensure the process is grounded in fairness. Here are six tips:
1. Take advantage of tools and resources.
While there’s something to be said for taking a very hands-on approach to splitting equity, don’t confuse your desire to play a role in the decisions with a need to manually control the entire process. In other words, take advantage of automated cap-table management tools likeeShares, which can save time and streamline the process. There are so many sophisticated tools and resources available that you’d be foolish to use only an Excel spreadsheet.
2. Place an emphasis on sweat equity.
While capital contributions are great (and they can be rewarded by the company issuing convertible debt or preferred stock), what you really want to reward is sweat equity. Equity should almost always be allocated based on who has put in the most work and will continue to do so in the future. If you’re unsure of the latter part of the equation, look at the career intentions of the founding partners.
If one person intends to quit his or her current job to work full-time with the new business, that change will entail much more risk than that of the founding partner who is only willing to work part-time until things take off. As successful entrepreneur Ryan Himmel has pointed out, equity splits should reward a combination of the highest-valued contribution and the largest undertaking of risk.
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