How to calculate the equity split between co-founders in a startup

How to calculate the equity split between co-founders in a startup

George Deeb is the Managing Partner at Chicago-based Red Rocket Ventures, a startup consulting and financial advisory firm based in Chicago. You can follow George on Twitter at @georgedeeb and @RedRocketVC.

There are a lot of variables to go into calculating a fair equity split a startup team. These key factors must consider each employee’s role(s) within the company, the compensation they receive for their work, the people investing in the company, and the people behind the idea of the company.

Let’s tackle each of these points below.

Whose idea was it?

In my opinion, there should be a premium placed on being the originator of the idea. With all other things equal, that means that a 50/50 split between two co-founders (evenly split if there are more than two), or a 66/33 split based on the premium for coming up with the original idea, and for starting the initial development efforts and sourcing the original team.

Who is funding the business?

If people are funding the business, they should get a premium because at the end of the day, cash funding founders are acting no different than a seed stage investor. That means a 50/50 split, with all other things equal, would need to be adjusted for the cash investment.

So, let’s say that one founder puts in $100,000 in seed capital, that could be worth 20 percent of a seed stage company’s valuation. So, a fair split, would be closer to 60/40 in favor of the funding founder, when diluted for the cash.

The calculation comes as follows: original 50/50 diluted down 20 percent to 40/40 for the financing, and then the one funding founder gets that 20 percent.

How important is this person’s role?

Key executives should get a premium stake over non-key executives. So, a CEO or CTO, would get a much higher stake than an office manager or a graphic designer, as an example.

In this case, I would take your total ownership and divide it up by employee tiers. Maybe something like 10 percent each for five C-level executives; 2.5 percent each for 10 VP level executives and 1 percent each for 25 director/manager level staff (adding up to a total of 100 percent, with all other things being equal).

Understand that not all of this will be granted day one, with everyone having higher stakes in the short run, but you will have an equity cushion to play with as the employee base scales.

Is this person taking a salary or not?

People that are not taking a salary, should also get a premium stake. To me, that is no different than financing the business. So, if someone is deferring a $100,000 per year salary, this is like a 20 percent stake in a brand new startup.

With all other things equal, a 50/50 split, would be closer to a 60/40 split, with the same calculation and logic we used in the cash investor example. Notice that I repeated the line “with all others things equal” in each section. You need to collectively take all four paragraphs into consideration, in calculating a fair equity split between the founders.

Keep in mind, there may be additional considerations to take into account, like contributing patents, sourcing investors or other value to the startup. So, make sure to take a holistic view of what a founder is bringing to the table, across the board.

It’s also worth mentioning that splitting up the pie is only half of the exercise. You should also make sure you have a vesting schedule in place on any equity granted, typically earned 25 percent per year over a four year period of time, starting at the end of the first year of the grant. This way, in the event the founders split ways, there are mechanisms in place to get any unearned equity back into the hands of the company.

How do you manage your equity split in your company?

Image credit: Lightspring/Shutterstock

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