HOW TO SHARE OWNERSHIP AMONG STARTUP FOUNDERS*
Splitting ownership (a.k.a. equity) should be a central consideration when forming a company. Doing so effectively promotes growth, synergy, enthusiasm, and a feeling of camaraderie. Doing so improperly can frustrate development, create disunity among team members, and in worst cases critically compromise a venture. This article provides guidelines for allocating equity among founders by answering three questions:
1. Who is a founder?
2. What % of ownership should each founder receive?
3. When should each founder vest in such ownership?
Bearing in mind there are many issues and nuances not addressed in this brief article, let’s move ahead:
1. Who is a founder?
Imagine being tasked with the responsibility of putting together a sports team with the mission of winning a national title (think of the Chicago Bulls in the 1990s who won six NBA championships between 1991 and 1998 with two three-peats). Yes, most people recall Michael Jordan (shooting guard) was at the helm for every championship, but so too were Scottie Pippin (forward) and Phil Jackson (coach). The 1990 Chicago Bulls synergized masterfully. Your founding team should have the time, devotion, mutual respect, communication skills, and expertise to pursue and, indeed, achieve its own masterful synergy.
Let’s drill down into the criteria for determining whether a person is a founder:
a) Part of the founder team. He/she should view himself/herself as part of the founder team and at least some of the other team members should see him/her as part of the founder team. Having a shared perception of belonging promotes team cohesion, rapport, camaraderie, respect, and comfort. Giving a new venture lift and longevity is no modest undertaking and the team members must sync well together to get the job done.
b) Pre-existing and favorable working relationship. This is a complement to the previous point and provides empirical evidence of a reasonably good fit potential with the other founder(s). Again, compatibility of personality and skills is key.
c) Essential skills and experience. The individual must be able to contribute essential ongoing services to the company, such skills and experience not being available from (i) other founders or (ii) a third party against payment in the future if/when the company has sufficient funds to pay.
d) Prepared to work full time in the not so distant future. If the person possesses the requisite skills (point (c) above), such person must commit ample time/focus to developing the business. This issue is further addressed under point 3 below. Sporadic contributions are the work product of consultants, not founders.
e) Can accept payment in solely shares (sweat equity) for services. Founders generally must accept not getting paid any salary for 1-2 years and thereafter will only take modest salaries relative to the industry standard for their respective positions.
2. What % of ownership should each founder receive?
There are two ways of viewing this. Firstly, forget about varying degrees of contributions and give everyone an equal equity stake. Secondly, take into consideration each person’s respective contribution and weigh such contribution against the other founders’ contributions.
In my view, it is better to start from the perspective of each individual listing his/her anticipated contributions, i.e. pre-existing intellectual property, technical skills, network, sales proficiency, money, lessons learned from prior exits, fundraising capability, industry know-how etc, and then try to, in good faith, ascribe a weighted value to each individual’s aggregate list of anticipated contributions. It can be helpful to review the items on the list and differentiate between ordinary (i.e. reasonably obtainable elsewhere) and extraordinary contributions (truly unique and difficult to substitute). The extraordinary contributions may be the ones to demonstrate reasonable value differentials and therefore justify higher allocations of equity.
If you succeed with listing and weighing different contributions at varying levels, the founders will likely start from a place of enthusiasm, alignment, and mutual respect. If this doesn’t work, the parties can still elect to share equity equally which may itself foster a feeling of fairness, especially if having first tried to distribute equity on a weighted basis.
3. When should each founder receive such ownership?
So, we have now explored “who” is a founder and “how” much equity such founders should receive. Now, we'll consider “when” such equity should vest (i.e. when the founder will become the owner of the shares). Vesting is used to incentivize founders’ ongoing commitment and provision of services. Further, vesting protects against a departing founder leaving with unearned shares when such shares will be crucial for incentivizing his/her replacement.
There are many different ways of sequencing when tranches of shares shall vest. Regardless of the method selected, a key issue will be that each of the founders feels the timing is fair and consistent with the vesting periods of other founders. Consideration should be given to what, if any, pre-existing property (i.e. intellectual property, equipment, etc.) a founder may be contributing upon company formation.
Shares can vest based upon the passage of time or even the fulfilment of agreed milestones (which should be measurable), for instance: prototypes, launched products, partner agreements, customer agreements, recruitments, financing, etc.
With that said, let’s have a look at one example of vesting over time, where each founder becomes fully vested in his/her shares over a period of 4 years (48 months) of full-time work. Note, if part time work is applicable—the vesting schedule should be adjusted to the work cadence.
Let’s assume the founder in question has a right to 15% of 100,000 shares (i.e. 15,000 shares).
Did you find this post helpful? If so, please share it!
*This article is not legal advice and is offered for educational purposes only.