Founders

Allocating equity among founders

Equity allocation discussions among founders can be emotional and difficult, but it is critical to have an honest and robust discussion about founder equity early. Allocating too little equity to a founder whose role will be key to the venture creates an obvious challenge. However, allocating too much equity to a founder whose ultimate contributions will be less significant than others can have equally devastating consequences, as doing so has the tendency to create a lot of ill will among the other founders over time (“I have more responsibility than he does, so it isn’t fair that he has the same ownership stake as me”). So it’s important to think through these allocations very carefully.

You may decide that splitting up the pie equally among the founders is the easiest way out to avoid the friction that often is part of these discussions. However, studies show that companies that divide the founder equity based on what is fair and thoughtful (rather than what is simple, frictionless or expedient) are more successful in the long run. When deciding what is “fair,” you should consider what each founder brings to the table. Did one of the founders, for example, develop the idea and devote a significant amount of time to it before forming the company and bringing on the other founders? If so, then that contribution should be recognized. However, be careful not to overvalue past contributions—investors care a lot more about the future contributions the team members will make and so should you. After all, it typically takes several years to build a great company and so a founder’s past contributions—even if made over several months before bringing the venture to reality—are typically not valued nearly as much as the contributions the team members will be making going forward.  

And so you should also account for the roles each founder is anticipated to take on in the venture as things move forward. Initially, everyone will have lots of different responsibilities—that’s the nature of a startup. Over time, however, people will generally fall into specific roles and you should consider the importance of those roles as you determine your equity allocations. For example, the person who will take on responsibility for running the venture (whether called the CEO or otherwise) should typically be allocated more equity than the person who will take on responsibility for a single function in the venture (for example, marketing, sales, engineering, etc.). Of course, titles are often not dispositive, and in many technology companies founders who are coding, designing or masterminding the science might not necessarily be the face of the company, but may be equally, and sometimes more, important in making the startup successful.

In the end, there’s a lot of variability when it comes to founder equity allocations. Every company, every situation and every group of founders will look at this issue differently. Calibrating all of the factors is a difficult exercise and may be ongoing. It is therefore equally important that the allocations are socialized early enough to obtain input from all co-founders. Once the founding team generally agrees on allocations, counsel can further be involved in helping fine-tune exact equity holdings by implementing vesting requirements such as vesting cliffs and vesting commencement dates.