How should equity be split in a startup?

As you can see, this is an incredibly huge discussion in the world of business. There are a lot of people who feel strongly about particular methods to equity splits, but there are quite a few ways to go about it.

Here are a few tips to keep in mind:

  • Don’t let your personal relationship dictate the decision. Time and time again friends or family members go into business together and the decisions quickly become personal. You really have to learn to switch your mindset when you work with your friend because when you are doing business together, you have to tackle those discussions in a professional way. It’s not easy, but it can be accomplished. Just keep in mind what you would expect from working with a stranger and that may bring some clarity to your decisions.
  • Think long-term. Equity splits will likely be the cornerstone for how your business functions overall. Don’t just think about now, but also well into the future and how that split will impact success.
  • Don’t focus entirely on who came up with the idea. Ideas are great, its’ how everything got started, but that is just one piece of the puzzle and should not determine the overall split. Consider how much sweat equity and risk each person is contributing. In many cases, the person with the idea does happen to be the one that is putting forth most of the effort, but this is not always true. Consider the contributions of each person completely without focusing entirely on who thought of the basic concept.
  • Consider the type of contributions. Quitting jobs to work full-time is a huge risk. That isn’t to say that monetary contributions don’t account for anything, but really think about the person who is willing to go all in on the endeavor. Consider who will be taking on the lion’s share of responsibility even if it may not be monetary, but rather time and effort.

Splitting equity in a business can be incredibly hard to do, no matter what the situation is. However, there are certainly special circumstances in your situation that may make it feel absolutely overwhelming. Many businesses opt to seek the guidance of a startup attorney. They can help you consider various aspects that impact equity splits and help you draft up the proper documentation that outlines everything clearly.

Equity in a startup is a uniquely valuable asset and should be treated as such. It can be tempting to dole out equity to everyone who has helped to get a startup off the ground. But because equity is both precious and finite, the question of how equity should be split is one that must be handled with care.

There is no single “right answer” to the question of how equity in a startup should be divided and distributed. There are times at which it may make sense to hand over sizeable ownership interests in order to secure necessary financing without which a startup could not launch. Similarly, there are times at which it makes sense to offer equity to respected industry advisors, top talent or other interested parties in order to ensure that a startup has what it needs in order to better ensure that its founders’ visions are realized. But these situations must be considered carefully and should generally be discussed with experienced business counsel before any contracts are signed or decisions are otherwise finalized.

 

Primary Considerations

When determining how to divide your startup’s equity, you will need to consider a few primary priorities. Among these priorities are fairness, the short-term success of your startup’s launch phase and the long-term success of your business as a whole. Fairness is a consideration that is contextual, so it is best discussed with your attorney. For example, any deals you have already made concerning equity distribution should generally be honored unless they may be successfully renegotiated. Beyond honoring existing contracts and generally conducting business in a fair and honest manner, your primary equity-related concerns are the short-term success and long-term potential for success of the company itself.

In order to get your company off the ground, you may need to offer equity to investors and advisors acting in a limited capacity. These arrangements may simply serve as some of the necessary costs associated with the launch of your startup. But looking towards the potential for long-term success, it is generally a good idea to prioritize so-called “sweat equity.” This essentially means that equity may function as a valuable incentive for those individuals whose efforts, talents and loyalties will earn your company the most benefits over time. When someone contributes to your company in a way that makes them an invaluable asset, they are likely deserving of equity in ways that limited investors, limited advisors and employees whose work is less valuable and/or rigorous may not be.

LawTrades is a solid resource for finding quality startup attorneys. Our rates are not only affordable, but we also try to be as flexible as possible with scheduling so we can better serve you. Our business attorneys are among the best in the industry, and we are committed to your satisfaction. Take a look at our website and get in touch for your consultation.