Splitting Equity amongst co-founders (odd situation)

I learned a great rule of thumb from Doug Richard (one of the UK's most visible Angel investors).

First: split the business 50% between those providing cash and those doing the work.

Then: split those 50% pieces according to the cash splits and hours.

The nice thing about this is that it doesn't try and put more value on one founder's time vs another's.

Tim made an excellent point about compensating Founder 1 with a bonus rather than giving him more equity in the company. That might be the best way to keep everyone from feeling cheated, as Jarie pointed out.

Another twist on that same concept is to split the profits unevenly for some time period, while keeping the ownership equal. For example:

Split up the remaining 1/3 of the company evenly so all three founders own 1/3 of the 1/3. Then split the profits for the first two years unevenly, so that Founder 1 gets 4x the amount of profits relative to you and Founder 2.

Of course the two year time frame is up to you guys to decide...it can be one year or it can be five years. And the amount of profits each founder gets is also up to you guys to decide. Maybe you want to give Founder 1 10x the profits or maybe just 2x the profits. You have a lot of flexibility with this method, and it allows everyone to feel good about the split.

I know this can be done with an LLC, but I'm not familiar with any of the other business structures. Although I don't see a reason why this can't be done.

What's the amount of hours that each of the founder has put, and is willing to put into the startup from now on? The ones 100% committed should get more equity than the ones keeping a day job and working part time.

The biggest danger flag for me is having the founders only own 1/3 of the company. They basically have no incentive or rights to anything going on in the company - but, that is not what you asked.

I would argue for an equal split. As someone said - he is trying to justify a huge slice because of doing something that was his job. It is not useful to have the other two founders (#2 and #3) own so little - they are just going to walk away from the company. I know I would not work as hard if I owned that little.

But, again, you guys are splitting up only 1/3 of the whole pie.

Perhaps you can work out an arrangement for a bonus for finding the investor - rather than uneven equity.

Good luck. You are in a tricky negotiation. The investment may not have saved you all - it may actually cause a problem...

Question: What would you do? Am I overreacting to his 4x negotiation? Is 2x for him fair or should they be closer to equal?

If the situation is truly as you've laid it out above, then you're definitely not overreacting. Splitting the equity in thirds will give the company the best footing. If you or the other founder feel shorted, it will certainly affect the company going forward.

I understand that in your case, an even split may be a best case scenario, but one you should aim for in negotiations. Or, if you agree somewhat with the CEO's assessment of his own importance, offer him a higher share, like a 4:3:3 split. But for x:y:z, try at least to hold to the following: x < y + z

I would suggest you hire a CPA with accreditation in business valuation. He or She will give you the best estimate of what each founder's basis is.

There is no easy answer, as in any negotiation, it's best to handle on a case-by-case basis.

His initial offer is part of the negotiation. You should definitely counter his offer, obviously, there are a lot of variables in play here.

Try to come up with a solution that is workable for each of you.

You are essentially dividing up founders equity and since you have 3 founders that are all essentially equal, you should divide the remaining third of founders equity equally between the three of you.

The CEO's argument is not that good since that's his job to raise money. I would fight for an equal split because it will take all three of you to make that equity worth something.