FEATURED, FOUNDER EDUCATION
How co-founders can think about an equity split
August 16, 2021
The Carta Team
Joe Beninato has co-founded four different startups over his career. Each time the inevitable question of how to arrange an equity split came up, the conversation—and the outcome—was different. In some startups, he held on to the majority of the ownership. In others, the equity split with co-founders was even. “I’ve seen it done many different ways, and I would argue there is not a consistent one-size-fits-all way to do it,” says Beninato.
Data gathered by Carta on more than 20,000 companies shows that there is a high degree of variability in equity splits. Equal division among co-founders may seem like the easiest and most natural arrangement. But actually, most founding teams choose a different structure.
Figuring how the right allocation for your startup is critical. So, if you there’s not a single way to do it, what should you keep in mind? Here are some tips from founders and experts for how to go about it.
To split evenly—or not
While there’s no shortage of online calculators and suggested formulas to give co-founders data they can use to start, seasoned entrepreneurs and VCs alike insist these tools should be viewed as just that: a starting point. Far more crucial is for co-founders to have open and candid conversations with each other early on, so they can arrive at a split that makes sense for everyone.
Carta data shows that 37% of startups are launched by two-founder teams, with single-founder companies making 24% of the total and three-founder companies comprising 23%. While a 50/50 split may seem like the most straightforward approach for a two-person team, only 32% of two-founder companies settled on an equal equity split, according to the Carta data.
“The majority of founding teams no matter what the size, do not split things equally,” says Peter Walker, head of insights for Carta. “It seems to shake out that there is one person who takes up a greater share of the cap table than everyone else.”
For companies with three or more co-founders, figuring out how to divide equity is even more complicated. Open conversations about the value that each co-founder brings to the table is crucial, says Michael Goldberg, executive director of the Veale Institute for Entrepreneurship at Case Western Reserve University. “There is an allocation of how much work people are doing and the value they bring,” he says. “Is a technical co-founder bringing more to the table than a business co-founder? There’s an argument to be made that perhaps that’s true.”
Candid conversations are a must
Many factors can help influence what share of equity each founder gets. They include who came up with the original idea, who is the CEO, who is doing most of the coding, and how integral each founder is to the development and launching of the business. Financial contributions to the company and industry connections can be important, too, depending on the situation.
“That first negotiation is really a negotiation over what you bring in terms of value,” says Goldberg. “You go to the marketplace with this hypothesis about what you’re worth.” Another way to think about a founder’s worth is to envision how a startup’s prospects for success would change were that founder to leave.
Marina Tarasova and Guillaume Cohen-Skalli are the co-founders of Paloma Health, an online medical practice focused on hypothyroidism. When they began talking about equity, the discussion quickly broadened beyond individual contributions to personal situations and risks. “I remember thinking: ‘This is going to be a test of how the partnership might go,’” Tarasova says. “We had a really dispassionate conversation focused on what we can each bring. I was leaving a very stable wage-earning job, and it had to be worth it for me.”
While Tarasova had industry experience, Cohen-Skalli had come up with the initial idea for the business and had done market validation prior to bringing Tarasova on. He also had previous experience as a founder and would be taking on the role of CEO. As they weighed these factors, the two agreed to a split that gave Cohen-Skalli a larger share of the equity, but satisfied Tarasova’s needs. “The conversations you have around equity can be very defining of how your relationship will be together,” says Tarasova.
Take a long-term view
No matter how you divide the equity pie right now, taking a long-term approach is crucial. “Sometimes founders get tied to the idea that ‘I’m so valuable now.’ But are they going to be valuable for the next ten years? Is there an even distribution of value-add and responsibilities you have over the next decade?” says Shruti Gandhi, general partner and founding engineer of Array Ventures.
Also crucial to that long-term view is building in a contingency plan should things not go as expected. “Many founders don’t want to have that awkward conversation I call the founder prenup,” says Beninato. “You have to think of all the disaster scenarios: somebody leaving, somebody dying, somebody getting fired.”
For Chris Wentz, founder of EveryKey, a universal smart key technology company, not having a vesting cliff in place made for a complicated transition when his co-founder left the company six months after they launched. “Vesting is the most important part of the co-founder relationship,” says Wentz. He recommends a four-year vesting schedule with a one-or-two-year cliff. “The cliff helps people stay longer,” Wentz says.
Keep potential investors in mind
A startup’s cap table can be a significant value indicator for potential investors, says Goldberg. “Investors want to make sure the management team is properly incented. If someone looks at a cap table and the majority of the shares are not with the people running the business, that could be a red flag,” he says. “Is there enough upside for management, particularly if they were brought in?”
While maintaining a sense of vested interest is crucial to keeping all founding members motivated, investors want to have a clear sense of who makes decisions when it comes down to it. “If you have equal equity, it’s sometimes hard to break ties,” says Gandhi. “There has to be someone who calls the shots.”
Don’t avoid the topic
There’s no doubt that conversation around how to divide equity can be difficult. But avoiding it altogether has more harmful consequences. Research by Harvard Business School professor Noam Wasserman revealed that teams that negotiate longer are more likely to settle on an uneven split, having taken the time to engage in serious conversation on the topic.
Those who instead choose to split equity evenly by default rather than having those tough conversations up front, were almost three times more likely to have unhappy founding team members, Wasserman found.
And while founders may think they’ll do better financially if they fight to hold on to more equity, Wasserman’s research shows that’s not necessarily the case. “A founder who gives up more equity to attract co-founders, non-founding hires, and investors builds a more valuable company than one who parts with less equity,” Wasserman wrote. “The founder ends up with a more valuable slice, too.”
Once you’re done with the tough conversations, it’s time to start putting your equity decisions into action. Here are some ways you can start thinking about that:
How to manage equity dilution as an early-stage startup
How to make compensation your competitive advantage
