Splitting Equity: How to Fairly Split Startup Equity with Founders and Early Team Members.

I am a self-started consultant. I am young, business is hard, and the market is cruel. But I sometimes consult entrepreneurs, investors, and emerging companies on a broad range of domestic and international corporate and commercial matters. How to allocate initial equity is perhaps one of the most misconstrued issues in a new business venture. Cutting up the “corporate cake” in your business is often critical, difficult, and defining. Many times, people will settle on some arbitrary number because it is more convenient than a difficult and uncomfortable back-and-forth conversation (And this is where I come in).

I took inspiration from L. Frank Demmler, an Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University.

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At the beginning of a new business, everyone is all excited and sees the massive potential of what could be. Ideas are flowing, people are committing, and you even have that “right and particular” person in mind to join your team, so that you could finally put together “The Dream Team”. Apple, HP, Amazon, and Google all started like this, most relationships start like this, the honeymoon phase… where we ignore flaws, spend lots of time together, and avoid conflict. “We’ll go 50-50,” one says to the other. And just like that, within twenty seconds of deciding to start a business, the seeds of its destruction are sown.

Fast forward a few months of effort, things begin to change. The business starts to hit what feels like roadblocks: lack of money; learning new facts about the industry; humbled by unrealistic expectations; or whatever the case may be. These issues begin to suck the energy out of the team, and some partners start to lose their passion for the business. Another story can be true, the business may start to take off and the Greedy Bone effect takes root: A partner begins to question why they agreed to accept a 30% equity when the other partner is getting 70% - “I do all the work… he even used my uncle to plug him up for the loan at the bank”. This leads to full-on resentment between partners. Before you know it, feelings are hurt, friends become enemies, blood is no more “thicker than water”, you are seeing lawyers and the business is PashAway (dead).

Discussions about how to split equity among partners can be emotionally charged, so it’s not at all surprising that many founders avoid the topic altogether. It sometimes feels like I am a group psychologist when we sit down with the founders and say, “let’s talk this through… Here are some things to consider, here are some ideas to think about it.” It often ends with them looking awkwardly at each other and saying, “Uh, we have some things to talk about, we’ll get back to you.” This is also the same experience of more experienced lawyers like Dettmer – founding partner at Gunderson Dettmer.

So how does one put a value or quantify what partners bring to the table? There is no magic formula, but we can use the “Founders’ Pie Calculator”, invented by L. Frank Demmler to divide equity among founders in a way that is both logical and fair. I have often adopted it to different groups of people and business models, weighing up a variety of factors including circumstances, experience, contributions, and roles.

Let’s dive right into the elements that I often use:

1. Idea – This is where most partners put a lot of weight, and rightfully so in my opinion. Coming up with the original idea is critical, but if the person who came up with the idea takes a backseat, weight should be taken off this element and perhaps placed elsewhere. Consider Uber. Garret Camp is essentially the main founder because the company began when he started working on an app that would let people use phones to hail a car. Travis Kalanick led the company until 2017 as CEO and pushed towards an IPO. Camp owned 4.6 per cent of Uber, whereas, Kalanick owned 6.7 per cent.
2. Business Plan Preparation & Strategy – Putting an idea on paper is a surprisingly difficult and time-consuming exercise. Framing it in such a way that it makes commercial sense, and that it accounts for as many assumptions as possible to identify and manage risks is perhaps even harder. “To pull together and organize all the thoughts of the founding team, filling in the blanks, identifying and reconciling the differences, and producing a document that captures the essence of the business and helps persuade banks, investors, board members, and others to support the company is a mammoth undertaking, as anyone who has done it will attest.
3. Domain Expertise – Specialised skills are needed for many of today’s business ideas. To what degree do you and your partners have meaningful skills and experience in the business of your business? Knowing the industry, having relevant experience, and having accessible contacts can greatly improve the company’s probability of success and speed its growth rate. Otherwise, it will take longer to get commercial traction and you’ll have to pay for these assets, usually by hiring someone and including equity in their compensation package.
4. Commitment and Risk – You’ve probably heard the old saying that “a chicken is involved with a breakfast of bacon and eggs, but a pig is committed.” Similarly, the founders who join the company full time and are committed to making it a success are much more valuable than founders who are going to sit on the side-line and cheer you on. In addition, the opportunity cost of joining the company rather than pursuing an existing career is not trivial.
5. Responsibilities – Who is going to do what? Who is going to stay up at night when you can’t make tomorrow’s payroll? Who is involved in execution? Some ventures don’t need so much in operations and execution, others do. A plan is a necessary element of starting the business, BUT execution against the plan is where the real value can lay.
6. Capital Contribution – This is the most traditional way of dividing up equity. You measure how much each person brought to the table and you divide the equity accordingly. Dammler has not included this in his Founders Pie, but my clients seem to put quite a lot of weight in it. It should not scare you though… there are a lot of ways on how to consider and factor in how much money someone is bringing into the venture. You could also structure it in such a way that fits the risk apatite of the partners. You could, for example, say, we are both contributing $3000.00, but additionally, Peter is going to “borrow us” $5000.00, and we will apportion him a certain number of shares in the company reflective of this…or the other way around as a convertible loan.  There is really a myriad of ways to do this… come see me or a corporate lawyer.

 For every business venture, the relative importance of each element would be different. You could have a conversation with your partners and discuss what other elements are needed so that they are to be added to fit your particular situation. I, for example, have made a habit of weighing in “Capital Contribution” because my clients demand it. I was even instructed to factor in “Family Relations” because the group was starting a family business – Imagine me telling your step-sister that she is going to score low because… well, she is a step-sister. As a partner, you can tell that the elements can be considerably more complex than how I have laid them out, but that is why you have people like us to help you out. :)

Let us look at a hypothetical example. Assume that we have a high technology business venture out of a university with four members of the founding team. We will use Demmlers example, but I am going to add Capital Contribution.

a)         Abner, the inventor who is recognized as the technology leader in his domain. He studied technology abroad for the last five years, and his thesis was even on this particular idea. He has given up a promising career to pursue this dream.

b)         Marian, the “business guy” who is bringing business and industry knowledge to the company. He is local and knows his way around. He also has a few similar commitments with other business ventures, so he doesn’t always have time.

c)          Foreman, the technologist who has been the inventor’s “right-hand man.” He is not the most enthusiastic person, nor is he the smartest in any room. He works for a big company that is probably going to compete with you. He is not willing to leave his job until thing become a bit stable.

d)         Keanu, the team member who happened to be at the right place at the right time but hasn’t and won’t contribute much to the technology or the company in terms of substance. He has a full-time job as a gym instructor, but he is happy to take on any responsibilities that he can for the team. He is nice though, and he got all of you into the right social circles in high school because he is an upcoming artist. He is, however, willing to use all his savings to inject into the business.

e)         Vena, the Trust Fund Kid who’s friends with everyone, doesn’t really believe in the business, won't be doing much except injecting initial capital, which requires travel and accommodation to a technology conference, building the prototype, and basic expenses.

If these were all first-time entrepreneurs, they would likely each get 33.3% of the company’s stock (equally), because “it’s fair” (it’s not! – unless you don’t want to hurt people’s feelings and all that. I am usually indifferent).

Let’s take a look at what the Founders’ Pie Calculator says. First, we evaluate each of the element on their relative importance and each of the founding team members contribution to each on a scale of 0-to-10.

Absolute Scores (1-10)

 Weighted Scores (1-10)

Usually, for me, an exercise like this takes days. I have to drive the conversation with the clients while meandering their sensitivities, internal hierarchies, cultures and other social and psychological considerations. One must have a good understanding of how people think and make decisions and must possess good people skills. All this, while figuring out their exact business model to determine who is actually essential to the business. Then I have to communicate (lowkey convince them) of my finding and go through a series of exercises so that THEY, and not ME, makes the final decision on what element should weigh how much and how to put a value on everyone.

In conclusion, this is the model that I tend t use when the issue comes up. It is, however, important to note that question could be posed differently. So the above is only but one approach. For example, what are the allotted percentages for the Founder Group, the Investor Group, Advisors, Executives and even employees? As a founder, you could cross your arms and decide that you will not be letting go of more than 30%, that means we compute this into the “calculator” and come up with something you can agree on. Also, if the business grows, some people might become less valuable. A graphic designer who is helping you design your logo (only) might not “deserve” equity at all. Unless of course, you can make a case for him or her. If you have these problems, send me a message, let’s have a conversation and I will help you until I can’t, and refer you to someone with more insight if need be. 

A few friends and I started a consulting gig called Swangeni, where we provide business, legal, policy and some technical consultancy services across private, public, and the social sectors. We are basically commoditising our combined skills, knowledge, and networks. We come in, learn about your problem, and use our processes, approaches and insight to solve it. Quite the team… true interdisciplinary work in action if you ever want to see. Hopefully, you use some of our services if you ever need fresh eyes on whatever challenges you are facing.

Gawie Kanjemba is a Lawyer & Energy Specialist. He holds a B.Juris and LLB from the University of Namibia, an MA/MSc. in International Energy (Project Management & Emerging Economies) from Sciences Po Paris, and FACES exchanges at Stanford University (USA) & Peking University (China).