There’s no one-size-fits-all, although there are some guidelines.
Many founders often lean toward equal and fixed splits. Let’s break this down.
This should be carefully considered since each founder/partner usually offers a different value to a startup – some provide more cash, others more experience or broader networks, while still others might contribute inventory and equipment. Accordingly, each founder’s contribution should probably be weighted differently to reflect as accurately as possible the value of their contribution, which will usually result in unequal percentages.
Next, equity splits tend to be fixed, meaning that the assigned percentage of ownership remains firm. This, too, should be carefully evaluated since founders’ contributions are typically more fluid, changing over time. A founder who initially contributes substantial sweat equity may later inject significant capital. Since cash is usually awarded a higher weighted value, it would be more appropriate to adjust that person’s equity share upwards to reflect their larger contribution.
In response to the minefield of challenges that fixed equity models have presented to startups, new equity sharing arrangements have been developed. Themodel is one alternative that’s finding popularity. This system allows founders more flexibility in assessing equity percentages as contributions shift over time. Since it allows for a more fair and accurate apportionment of founders’ contributions, it reduces conflict among founders, which helps to ensure a startup’s longevity.
The way it works essentially is that relative values are assigned to each person’s contributions. For example, one founder might have greater access to financial resources, while another founder has more product knowledge and the ability to enhance the company’s intellectual property. Each type of contribution would be given an hourly value to reflect the premium value of the contribution.
For instance, capital injections might be assigned a factor of four times the actual value, intellectual property might be equal to or greater than cash contributions, equipment might be given a value at twice cash value, and so on. There’s a good article about what should drive equity splits. A recent piece I wrote also explains more about how equity splits work and factors that should be considered.
There’s an online calculatorwhere you can fill in the question fields with answers from a list of options. Another tool is one from SmartAsset that you can use for evaluating either dynamic-split or fixed-equity percentages. There’s also helpful graph that’ll give you some ideas on how to calculate equity splits.
You will also want to ensure that vesting rights are restricted in order to protect the company from a founder who exits too early with financial benefits. The typical vesting period is four years with a one year cliff. Vesting normally requires a founder to stay with the company for at least one year before they could realize any financial gain. If they stay for more than a year, they begin to accumulate 25% of their equity ownership each year over a four year period; if they depart within the first year, they’d receive nothing.
If you’re interested in learning more about how to split equity and need additional help with drafting the proper documents, please feel free to check out. I also invite you to message me directly if you have any other questions.
Best of luck with the business!