Equity distribution amongst startup co-founders

My last answer was replied in a bit of a rush without really thinking through all the possibilities completely. Apologies for that.

When I look at equity splits there are three things that you really want to look at in my opinion when discussing this subject.

1. Money to be invested
2. Time to be invested
3. Experience that each partner brings

There are a couple of things that have been mentioned in the question above. So I am going to work with the information and adjust this answer as more information is shared.

Assumptions:

1. All partners agree that the money component in the total business has a total weight-age of 40%.
2. All partners agree that the time component has a total weight-age of 40%.
3. All partners agree that the experience has a total weight-age of 20%.

Depending on the type of business and the requirements these can be adjusted. For example businesses which are highly capital intensive will have a far greater money component weight-age than those which provide service based consulting etc.

Given this model:

1. Money to be invested $300k by partners #1 & #2.
2. Time commitment #3 & #4 are full time. While #2 will be putting in 30% of this time.
3. Experience between partners #2 #3 #4 is equal.

Plugging these into our weight-ages:

• Partner 1: Money (20%) Time (0%) Experience (0%) = Total Equity 20%
• Partner 2: Money (20%) Time (6%) Experience (6%) = Total Equity 32%
• Partner 3: Money (0%) Time (18%) Experience (6%) = Total Equity 24%
• Partner 4: Money (0%) Time (18%) Experience (6%) = Total Equity 24%

I have rounded up the percentages.

This model can now be used and adapted to specific requirements of your startup. If you think experience is a key component you can increase the weight-age and decrease it in other factors.

The key is to really start talking about what everyone brings to the table and how they are being compensated for it.

I wrote on the subject of equity splits in detail on my blog for those who want to read about the things I discussed here in detail.

When comparing apples and oranges (time and work vs money) you are going to have to fudge a bit.

You need to have a lower limit on the equity share otherwise people will not want to be involved any longer. The other numbers I see in answers here are insulting to me.

Investors generally don't want to take a majority share - and in this case you also want the founders to have a reason to be engaged. Giving 5% share to anyone is ridiculous. They'll just quit the venture and you'll be left with two "money" guys and no one to do the work.

It may be best to structure the money as a loan - and perhaps not dump all the money into it initially.

If the two 100% guys are foregoing significant salary then that has to be factored as investment as well. (in my opinion)

I would probably start off with roughly 25% stake each and then negotiate with everyone as to how best to split it if those are unreasonable.

If you get too much below 20% each then you are going to have serious issues with resentment and loss of interest.

Each person needs to be able to communicate his position and justify it.

Again, what I would do is start with 25% then move up or down maybe 5% from there. Any more than that and you have to wonder if it is really worth it for them to stay in.

You could try to take a mathematical approach to it. Determine some kind of valuation for the stock like you'd have to do for an investor. Then the $150k investments become pretty easy to convert to equity. Determine the value (or cost) of the time people are putting in. For example, if the typical salary for your #2 would be $100k, then 30% of his time is worth $30k/yr. I'd probably throw some multipliers on some of that due to the risk involved. How easily replaceable everyone is should also be a factor - if the idea would be doa without #4, then his value is higher.

But I really don't know if that's going to get you a split that everyone can agree on. There are so many factors involved - maybe #3 is working full-time but not really accomplishing anything and #2 is actually delivering more value in his 30% time. But it's important that you figure this out now and include vesting so if someone walks, they don't take a big chunk of the company with them.

Here is how you want to think about this:

#3 sounds like the CEO

#4 is the CTO

#1 and #2 are angel investors.

Angel investors, in such an early round, could get anywhere from 10% to 40% of the company. Since the amounts are significant, I'd say 20% minimum. Or you could go and sign a convertible note, so the exact percentage is left undefined (a future round, with larger funding would decide on the valuation)

The CEO should probably get more than the CTO. It could be as low as 50/50 for CEO/CTO, or 75/25. Surely nothing below 25%.

Combine the two and you get something like:

45% for #3 25% for #4 15% for #1 15% for #2

Adjust based on how senior the CEO and CTOs are, how much money will be needed down the road, etc.

You know what they say talks.

The money guys should get the largest slice of the pie. $300K is not pocket change and, without the money, the idea would be dead in the water. There are a bajillion ideas out there and money doesn't need that idea. It's the other way around.

Assuming that guys #3 and #4 are taking a salary from the $300K, here's how I'd estimate the break-down to be:

1. 44%
2. 46%
3. 5%
4. 5%

This way, #1 can't control unless #3 and #4 are onboard, but #2 (who is making some descisions) can control with either #3 or #4 backing him. If #3 and #4 don't draw a salary, then maybe go with a 41/43/8/8 split.

Remember, the idea itself is worthless and the sweat equity is great and all... but money is that much greater.

You also need a strategy if one of you decides to leave or if things work out differently (they usually do). It is going to be a lot less painful if you work that out now...

I would recommend talking to a lawyer - a lot of times, an attorney, although expensive, is in a position to better understand (a) what the company would look like if it fell apart; and (b) what the standard valuation is of work time vis a vis money. If you have $300K, spending some % of that (maybe less if you can manage to avoid the big firms) to help provide for stable relationships and a sensible valuation has to be worth it.

To be brief, if you screw this up, you can create irreparable problems in the company. For example, if you value the work time at 90% LTV or (equity to value) then you have created a $3M dollar company. A $1M investment is thus only worth 33% of the corp. Would that valuation be unappealing to investors?

Moreover, there are other kinds of investments: convertible debt securities, and the like, which might be attractive to the investors. An attorney will be able to provide guidance there.

The bottom line is that you need to have someone to look to, both in the event that you want to grow, and in the event that something screws up.

...an attorney, hired by the company, representing the company, will do what's in the company's best interest. Your attorney will give you the resources to have an intelligent conversation about this issue, as so much depends upon the type of work that you are doing, the jobs you quit to do the startup, and etc. etc. etc.

This is obviously not legal advice, rather this is advice to seek legal counsel.

My opinion:

You need to make sure that the people that are going to drive the business forward (ie. those putting in their time) are adequately incentivised. If they don't feel they are being fairly rewarded, they are likely to lose motivation and the business will go nowhere.

The money is important, but without the people putting in the time to execute, it is worth nothing.