The Mistake of Splitting Founder Equity Based on Who Came Up with the Idea or Very Early Contributions
I’ve heard many reasons from co-founders for not wanting to split founder equity more or less equally. Two of the more frequent are (1) the idea for the company wasmine, and/or (2) I started working on the company for “x” months before myco-founder(s). The problem with this, in my opinion, is it tends to overestimatethe value of the idea and/or those making very early contributions when almostall the hard work of building a really valuable company lies ahead of you. Thereare many who will disagree with this, but allocating co‑founder equity in amaterially unequal way seems to be disadvantageous to startup success.
It’s a truism, but from what I’ve observed as startup counsel (a limited sample of 100+ companies), startup success is more about execution than the idea. And the challenge this presents – market bubbles like crypto aside – is your core team will likely have to execute more or less spot on for many years if your startup is going to build a really valuable business. Many Valley serial entrepreneurs and investors say this duration is between 6 to ten years.
So, setting aside for that moment that most (if not all) ideas are probably not all that original, does it really matter which co-founder first articulates the idea for the startup, or who started “x” months before other co-founders when the time from idea to team assembly, minimum viable product, production, initial traction, and ultimately scale is a landmine strewn path stretching 6 to 10 years? Do relatively small variations in contribution in year one justify materially different founder equity splits which persist for years two through 10?
If one is being realistic, you’ve acknowledged that your start-up will, like most, probably fail. Given this, and the long, long road ahead, I suspect that you – the ‘first’ co-founder, will want to secure the most talented team of core co-founders possible. Beyond smarts, genuine excitement, and a burning intellectual interest in whatever it is the company is trying to achieve, you will also want this core team to be super motivated to put in the hard work. And people being people, the greater their equity interest often the greater his or her commitment. So, I would ask: is it worth getting a materially larger slice of the equity pie if it tends to undercut your core co-founding team’s commitment and motivation?
The other truism often heard, and this too seems largely accurate, is knowledgeable investors – venture capital and the corporates – invest as much in the quality of the founding team as in the idea and its scalability. With that in mind, many investors draw inferences from your co-founder equity splits. If you only give a co-founder 6% or only 3% of total equity allotted to founders, what message might you be sending? Possibly, that you aren’t sure if your co-founder is very good or is going to be all that impactful for your business. Why signal investors that you have a team that you don’t highly value or aren’t sure about?
Vesting can mitigate risk of roughly equal allocation of founder shares
No one can really be sure in advance whether a team member on whom you will rely on to make a key contribution can and will make that contribution. This depends on your initial assessment of that person being largely accurate, their remaining healthy, and not otherwise deciding to leave for reasons of financial stability or perceived greener pastures. Given this, it is not just investors, but founders, who can protect themselves to a degree by imposing vesting on founder company shares. Founder share vesting means, in essence, that only after certain specified time intervals (generally three or four years) or a defined event can a co-founder leave and keep all or a certain percentage of his or her company shares. Shares that remain unvested at time of separation from service get repurchased by the company at the same low price the founder initially paid.
See Insights: 5 Reasons Why Startup Co-Founders May Voluntarily Impose Vesting on Their Founder’s Shares