• August 2019
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Founders Equity: How to Allocate Shares in a Startup

lawtrades equity compensation shares

When you incorporate your startup, you would have authorized a certain number of shares. As a general rule of thumb, the typical startup tends to authorize 10,000,000 shares of common stock. It is an easily divisible number, large enough that you will be able to hand out round amounts of shares, and – it is common practice. No need to surprise future investors with unnecessary creativity here.

Now, you and your co-founders have a new challenge: your equity agreement. Deciding on equity allocation between co-founders is never a straightforward process, but we can provide some pointers.

An example of a typical equity allocation

The co-founders’ equity agreement should be concluded, and the respective shares issued, as soon as possible after incorporation. Unfortunately, this is one of those cases where a startup is forced to make an important decision without much information. Re-allocating shares down the line is a messy process, and has negative tax implications. As far as possible, your equity allocation should be final, therefore.

As a (very general) rule of thumb, startups generally tend to issue about 8,000,000 to co-founders (and sometimes very early employees). This leaves 1,000,000 shares for an option pool from which future shares can be allocated to new employees, consultants, advisors, and directors. The final 1,000,000 are usually left unissued.

The unissued shares are left to allow for unforeseen circumstances in which the startup might need to issue additional shares. To authorize new shares is a costly and time-consuming process, and it is therefore prudent to have some part of the company equity in unissued shares at hand should you need it down the road.

Founders’ equity

As to the question of how to allocate shares between respective co-founders, there is no universal answer. The equity allocation between co-founders has to be agreed upon based on the unique context of your startup.

Deciding on equity allocation will necessarily be an imprecise art. At the start of your company, you do not have enough information to accurately predict each co-founder’s respective contribution and value to the startup. In addition, you do not have any objective data points that could help you to accurately predict your company’s potential value. Your equity agreement will have to be an approximation based on your collective best guess.

There are two main considerations that should be taken into account when deciding on equity allocation between founders:
The long-term role that each co-founder will likely play. Clarify the respective roles between the founders with reference to each founder’s experience and expertise. Who is most likely to be a successful CEO? Who will be best suited as CTO? These role allocations will probably change as the startup evolves, but it is important to start with some clear role division in mind.
The relative risk that each co-founder is taking. Not everyone is facing equal opportunity costs for joining the startup. Those taking higher risks should be rewarded with more equity.

Importantly – don’t avoid this tough conversation by simply deciding on an equal division of equity between co-founders. This might lead to conflict in in the future because roles and expectations were not explicitly raised. It will also raise potential investors’ eyebrows if you don’t have a logical, rational motivation for the equity allocation between co-founders.

Typical startup vesting schedules

It is common practice for startups to issue shares subject to vesting schedules. This incentivises everyone to stay with the startup, and it reduces the risk of unnecessarily diluting ownership. Vesting schedules and provisions will depend on your startup, but standard provisions usually include:

A four year vesting schedule
With a one year cliff
And single trigger acceleration

These restrictions and provisions essentially means that each stockholder’s equity vests in equal 1/48 parts each month for four years. If he/she leaves the startup within the first year of joining, they forfeit all equity that have vested. And if the startup exits before all the shares have vested, they all vest immediately.

These standard provisions can, and should, be amended to reflect the reality of your startup’s specific situation.

Post-incorporation lawyers

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