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February 7, 2020
Running a startup is tough. Romanticism aside it’s often a gruelling journey with long days, sleepless nights and lots of difficult decisions. One of the first ‘big’ things you need to decide is how you’re going to distribute equity between co-founders.
But what is startup equity? How do you split it? When do you split it? What can you do to make the process as painless as possible? With so many equity splitting questions to answer, we’ve put together this guide to help you get a handle on the key points worth considering.
Let’s start at the beginning…
Startup equity refers to ownership in a business and is typically allocated between co-founders, investors, advisors and sometimes employees. For early stage startups equity is normally given in shares. If the business has been through a funding round, then it’s share options (this helps avoid any potential tax issues).
Half of all new startups split equity equally between co-founders. While this can appear to be the fairest way of doing things (not to mention the easiest), it isn’t always the best route to take.
If you’re looking for agreement on equity split based on value, here are five points you need to think about:
This can often be the most controversial point when negotiating equity. Obviously, the person who came up with the idea will argue that there would be no business without their idea! And while this is true to a point, it’s worth noting that no matter how good the eureka moment is, it counts for diddly squat without proper execution.
Following on from the first point, the person who knows how to run the startup, allocate work, raise an investment round and develop a successful business plan should be given a reasonable proportion of equity.
Co-founders with industry knowledge can help develop the original idea and leverage their gaggle of contacts to introduce potential investors. This experience and know-how needs to be considered during equity distribution.
Some co-founders and employees can be undervalued during the equity split if they haven’t come up with the idea or lack industry experience. This isn’t always the correct approach. You need individuals committed to putting in the hard yards and turning the dream you all have for your new-fangled startup into reality.
When distributing equity, it is crucial to consider who bears the most risk. Many co-founders invest their own capital and quit their day jobs to try and build a successful startup. They’ve sacrificed a lot and the equity they’re offered needs to reflect this.
To sum up…
There’s no one-size-fits-all approach when it comes to splitting equity and no hard and fast rules on when you need to make the decision by. Some co-founders decide to do this from the beginning to help minimise the risk of disputes further down the line. While others evaluate the different strengths and weaknesses within the team before making the call.
Whichever route you decide to take it’s important to ensure all founders are happy with the split, that roles and responsibilities have been clearly defined for all involved, and that all necessary documents are prepared, executed and registered.
Once you’re confident on these points you can archive ‘equity split’ on your Trello board (other to-do list apps are available) and move onto your next item of business.
Here at Stephenson Law we can support you and your co-founders through the equity split process. From drafting and reviewing written resolutions and board minutes to preparing share certificates, completing an SH01 form and helping your team identify and work through any issues.
If you would like to discuss equity split between your co-founders or employees with a member of our team, please contact us.
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