This post was originally published in technext.it, See the post here: How to Split Equity in a Startup Fairly in 2023
You have started a startup or thinking of starting one with some similar-minded co-founders. Both you and your co-founders are excited and working hard to make this dream a reality. At the same time, you guys are riddled with one question “How to spit equity fairly.” so that everyone remains happy and provides as much effort as they are providing now.
It’s a no-brainer to say that startup share distribution is a challenging and equally important decision to make. This decision can have long-lasting implications for the future of your startup, and it is crucial to get it right.
The goal is to divide the equity fairly, taking into account each co-founder’s contributions, skills, and plans. But how do you determine what is fair? In this article, we will explore different types of equity split in a startup and provide a few rules that founders must follow while dividing the equity among themselves. So keep reading, and you’ll have a better idea of how to split equity in a startup that will satisfy everyone.
Understanding Startup Equity Basics in Simple Terms
When it comes to startups, the term “equity” refers to the ownership stake each founder has in the company. This can be in the form of stock options, restricted stock units, or actual shares of stock. Equity gives co-founders and early employees a financial interest in the success of the company, aligning their interests with those of the shareholders.
In most cases, the equity split is determined by the amount of money or resources each founder contributes to the business. For example, if one founder invests $100,000 in a startup and another only invests $50,000, the first founder will likely have twice as much equity as the second. But is it that simple?
No, equity can also be affected by each founder’s role in the company. For example, suppose one founder is solely responsible for developing the product, and another is responsible for marketing and sales, and both invested the same amount at the beginning. In that case, the former may have a more significant equity stake. The idea of the product itself has an essential role in equity split. The original owner of the idea usually gets a substantial portion of the equity. We will dig deeper into this topic but let me briefly tell you why equity spit is so important.
Equity can significantly impact a startup’s valuation, as it represents the portion of the company that each founder owns. Therefore, carefully considering how equity will be divided among the founders is essential. Otherwise, there could be conflict down the road over who owns what percentage of the company.
When Should Founders Split Equity?
There are different options on when co-founders decide to split the equity in a startup. Some co-founders choose how to divide the equity without disagreement; some engage in lengthy negotiations.
Some divided the equity right once, while others waited until they established their organization. Some may believe in equal distribution; some in dynamic. Every startup has its own way of sharing equity in the startup.
Anyway, one thing we all know is that the co-founders complement each other and work together to achieve a common goal, “company success.”. What’s worse than having trouble among co-founders and not being able to work together at all? Equity spitting is something that can cause such a situation.
The sooner you sign an agreement about how your equity will be divided, the less likely it is that conflict will arise later on down the road when big decisions need making and disputes over shares pop up in every instance imaginable–even ones as popular as Facebook!
It’s normal that, you are worried about dividing equity at this early stage. It can put your company in a risky situation if any of your co-founders fail to prove themselves. Don’t worry; we got you covered. A vesting schedule safeguards you and your co-founder against this risk.
If you don’t know, standard startup vesting lasts four years, with a one-year cliff. It ensures that the founders stay in the startup for at least a year. This means that a founder will fully retain all shares after four years. Now that you know you have security, you must feel relieved to move on to learn about how equity works in a startup.
The Different Ways to Split Startup Equity
There are two options for splitting equity: evenly and dynamically (unequally). Before using any of these splitting equity methods in your startup, you need complete knowledge of when to do which splits and their benefits and drawbacks.
Equal Splits:
When Should You Use Equal Splits?
When you are at the early stage of your startup, all the work is ahead of you. Finding a co-founder or co-founders allows you to divide the labor involved in getting a business off the ground in these early years. You must ensure that all the co-founders are equally committed to and invested in your company and its success. Equal equity distribution is the key to doing this perfectly — and why not? These are the people you rely on, face crises, and celebrate your success. They deserve equal or close to equal equity splits. If you are doubtful about offering your business partner an equal share of the equity, you should rethink partnering with them. If not, here are the benefits you will get if you use equal splits.
