• February 2019
    M T W T F S S
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How should equity be split between founders, (early) employees, consultants and investors when the company is bootstrapped?

Most equity splits are fixed. That means there’s a percentage of ownership that’s firmly allocated and not subject to change. Because of its rigid structure, it’s a minefield loaded with potentially explosive variables. For instance, it tends to lack the precision required to accurately weigh one person’s sweat equity against another’s financial contributions, especially as those inputs change over time. However, another model offers startups the kind of flexibility that can reduce tensions and ensure an equity split that is more fairly based.

The dynamic-split model is being increasingly used as an alternative to the fixed-split paradigm. The fluidity of this system empowers owners to periodically re-assess appropriate percentages that more accurately reflects the contributions of founders, consultants, investors and employees as they shift over a company’s lifecycle. By ensuring fairness, the potential for conflict is reduced freeing up owners to focus on productivity.

Using simple formulas, it’s possible to measure with precision how equity should be calculated based on a person’s influence and contribution to the company. Mike Moyer, a startup expert, explains how dynamic-splits work in Slicing Pie.

Essentially, values are assigned relative to the specific contributions. For instance, consider the example of two co-founders where one has extensive experience, access to financial resources and a mature network of contacts, while the other person is younger, but has the expertise to develop the product. The first step is to assign an hourly value to their contributions.

Next, they decide to assign a factor for cash contributions at four times actual value. Similarly, they set a factor for equipment contributions at twice cash value.

Moyer explains this in greater detail with a snapshot example of how it works. The most important take-away – aside from its built-in conflict management mechanism – is that it is exceptionally well suited to startups.

On the other hand, if using the traditional fixed-split model is more comfortable for you, then there are ways to adapt it to fit you’re your organizational values. For example, founders injecting seed capital should receive a higher percentage relative to their contribution. Those who contribute sweat equity or intellectual property, and not receiving a salary, should also take a higher percentage. C-level decision makers should have a higher premium value to the company as compared to non-key employees. More about how to refine percentages according to this approach can be found in George Deeb’s article, “The 4 Key Drivers When Calculating Equity Splits Between Founders.”

Finding your equity-split sweet spot is a challenge being addressed with a host of tools. Founder Solutions has an online calculator where you can fill in the question fields with answers from a list of options. SmartAsset offers an interactive infographic. Similar to the calculator, it offers emerging companies flexibility in calculating percentages, and it can used for assessing either fixed-equity or dynamic-equity percentages. The Founder’s Pie calculator is yet another tool. Similar to Moyer’s approach, Frank Demmler uses a method that quantifies key elements of decision making that include (1) Idea; (2) Business Plan Preparation; (3) Domain Expertise; (4) Commitment and Risk; and (5) Responsibilities.

Finally, vesting rights should be restricted as a precautionary measure against allowing an owner to walk away too early with financial benefits. All equity owners should have a minimum vesting period, requiring them to contribute to the organization’s growth for at least one year before they can access the value of their ownership percentage. If they leave before the end of the first year, they forfeit their ownership. If they continue with the company beyond the initial year, they can start to accrue a percentage of their ownership (for example, an additional 25% each year for four years, with full vesting after the vesting period has been satisfied).

These tools offer simple guidelines to potential co-founders just beginning the discussion of how to split ownership. Using them as a substitute for sound legal advice that’s tailored to your specific needs isn’t recommended since they intersect with many other critical issues regarding everything from vesting cliffs to intellectual property.

If you’d like to get equity documents drafted by experienced startup attorneys or learn more about the best fit for your company, feel free to check out LawTrades. I’m also happy to answer any additional questions you might have about calculating the equity percentages of your startup.

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