Determining Fair Equity Splits Among Co-Founders

The co-founders’ fair equity splits are more than making things fair on paper-yes, the founder’s early decisions about allocating equity influence the SMB’s long-term financial health.

The immediate question will be, how to ensure fair equity splits among co-founders? The answer depends on the co-founders and is business-specific. All it takes to ensure everyone gets a fair share is knowing when and how to split co-founder equity.

The key benefits of establishing clear guidelines for determining fair equity splits among co-founders are:

• Evaluate Contributions and Roles
• Assess Future Value Potential
• Establish a Fair Allocation Methodology
• Enable fundraising and growth
• Avoid future conflict and resentment

Let’s learn more about these tactics in detail and how co-founder fair equity splits can be done effectively.

Fair equity splits among co-founders

Having a company is a rewarding journey but also involves handling uncertainties. One such risky decision is to split co-founder equity fairly. Though it is a complex process, fair equity splits are unavoidable and necessary to eliminate future complaints.

Here is an example for EQUAL SPLIT among co-founders, an equal split 50/50 is common for startups with two co-founders who have similar contributions. Examples for this include the founders of Google – (Larry Page and Sergey Brin) and Airbnb (Brain Chesky, Joe Gebbia and Nathan Blecharczyk).

Understand fair equity distribution

Equity is the percentage of ownership the co-founders have in a company, and it gives them the right to get Profit, Dividend and Voting rights.

Proper planning and understanding of each co-founder’s ability are needed to maintain fair equity splits. Co-founders can do this in the SMB’s beginning phase or after assessing their contributions to the company’s growth.

Here we like to simplify the situation with another example, WEIGHTED VOTING RIGHTS with the same case of Google and Airbnb founders. In this case each founder has 50% voting rights despite an unequal equity split. Here co-founders can maintain control with a weighted voting structure even if they own a smaller percentage of Equity.

There is no right or wrong time regarding fair equity splits, and distributing co-founder equity varies from business to business. No matter when you do it, ensuring fair equity splits is important to avoid conflicts among co-founders, attract investors and avoid future dilution.

As an entrepreneur, getting support from professional valuators will help you do the process more precisely.

Factors that influence equity distribution among co-founders

Ensure that each co-founder receives a reasonable amount proportional to their contribution when dividing the equity. To make that a reality, consider the following:

• Contributions and Effort – As a co-founder, your effort in making the company meet its goal is important to guarantee fair equity splits. If your contributions are more, equity stakes will also be higher. For example, take this case if One co-founder developed the original business idea, while the other joined later, then the company should consider this factor when deciding on fair equity splits.
• Risk Tolerance – The level of risk that each founder is comfortable taking affects their readiness to make important, high-risk business choices. This factor might influence the equity share and, consequently, the degree of control each co-founder should have. In other words, more risk-tolerant co-founders may take a large equity stake in return for their high risk.
• Vesting Schedules – Though there is no direct connection between vesting schedules and initial equity split, they are an important aspect to consider when making major business decisions in the company. Vesting schedules can be particularly important if the business has multiple co-founders. It is one of the main points potential investors will notice. For example, if the vesting schedule is four years and the co-founder decides to leave the company after one year, the other co-founders will repurchase the shares to prevent the shareholder from leaving the company with huge stakes.
• Exit Strategy Preferences – As a co-founder, each person will have a different exit preference if your business gets acquired or goes public. These varying choices will impact the co-founder equity portion, especially when some employees decide to stay long instead of quitting.
• Legal Responsibilities – Each co-founder’s legal responsibility affects their equity share in the company. The company should consider the co-founder’s responsibility when deciding on their equity share. The company will grant a high equity portion to an individual with more legal responsibility or a key position and vice versa.
• Opportunity Costs – Has any of your co-founders left a high-paying job or an income source to join your SMB? The sacrifice they have made is what we call opportunity costs, and it is an important factor to consider when distributing equities among the co-founders. A person with high opportunity costs will have a better portion of shares and vice versa.

How to fairly split equity among co-founders?

We now know the factors to consider in co-founder equity; the next step is understanding how to do a fair split.

Evaluate Contributions and Roles

As mentioned earlier, understanding each co-founder’s contribution to the SMB’s growth will help in fair equity splits and ensure recognition of everyone’s effort.

This is possible by considering the following factors:

• Financial investment – Investing with money is straightforward. If your investment in SMB growth is higher, you will receive more shares.
  • For example, two co-founders, A and B, invested $50,000 and $10,000 in an SMB. In this scenario, co-founder A will receive more shares than B because of the larger monetary investment.

• Intellectual property – This category includes the person who had the initial idea and helped create a particular piece of intellectual property (IP). The idea’s originator deserves considerable equity.
  • For example, in a software as a service (SaaS) company, developing the initial backend code will yield better results than planning and executing the product’s eventual growth. Both are important, but your market will decide how much weight each should have collectively.

• Industry enterprise – If a co-founder has good industry knowledge about the products/ services you offer, it eventually means they are in a better decision-making position. So, their equity share will vary depending on their relevant knowledge.
  • For example, a co-founder with ten years of experience in the relevant industry can contribute more to the company than those with less experience and knowledge. The equity share for the one with high experience will be high.
• Time commitment – Time commitment is important for SMBs as they brainstorm every activity. A co-founder who dedicates much time to the company’s aim will receive higher equity value than part-time contributors. At the same time, it is important to consider the quality and impact the individual has made in the time spent.
  • For example, if a co-founder commits to working full-time on the company, allocating 40+ hours per week to product development and business operations, another co-founder, due to other commitments, contributes only part-time, working 10 hours per week.

In this case, the former gets a higher equity share than the latter.

Assess Future Value Potential

When determining co-founder equity, knowing the future value potential is as important as understanding the immediate contributions. Assessing the company’s future value potential involves looking beyond the current status by considering factors like:

• Growth opportunities – Co-founders should assess the company’s growth opportunities while determining the equity shares among them. The process includes looking into the market trends, potential customer base expansion and scalability of the product/service. The co-founder who brings more insights or networks to these opportunities will have a high equity portion.
• Market trend – Understanding the product’s market needs is important for estimating the company’s future value. Co-founders who can contribute more to these standards will support in making the business successful, and the standards include knowing the target market, Competition and Customer needs
• Scalability – Scalability is the ability to perform well even if one experiences a high workload. This is one of the important aspects that determines the SMB’s future potential, and the co-founder with the skill to scale well to maintain or increase the company’s performance will have high equity.
• Innovation – If your company wants a good future value, it should be innovative. What should the co-founders do for the company to be creative? They should bring new ideas, technologies, or business models to grow the company.

Establish a Fair Allocation Methodology

A company can use three common methodologies to guarantee fair equity splits. They are:

• Equal partnership approach – Each co-founder receives an equal stake in this approach. This belief comes from the fact that each partner contributes equally to the business’s success. Strengthens partner relationships by ensuring fair equity splits among them. By allocating shares with equal value, the SMB can avoid future problems of unequal value among co-founders. When partners place a higher value on their previous contributions and a lower value on their future contributions, an equal share can lead to future conflicts. Disagreements may arise when one or more founders decide to cut back on their contributions in the future.
• Transactional approach – The question “What do I get in return for what I put in the company?” is the basis for this approach. The co-founder’s contributions, including Idea, Time, Money, Relationships, Equipment, Supplies and Other assets. It gives a clear way of dividing equity based on specific tasks, roles, and financial investment. Decision-making is easy, especially in early-stage companies. It may eliminate the scope of the future potential value of the co-founders. Chances of disputes among partners on measuring individual contribution
• Relational approach – This is a common method most companies use. Under this approach, each co-founder contributes equally to the company’s outcomes. As it only considers the company’s result, you need not calculate the partner’s asset values. It does not consider individual contributions. In certain cases, disagreements may arise if one of the co-founders feels they can contribute more.

Tips to have a transparent and effective allocation methodology

• Find out what works for your company and what the co-founders have to say.
• If you use a transactional model, give each founder credit for their contributions.
• It is important to have a dispute resolution system in place after selecting a plan to prevent issues.
• Make sure to document the agreed-upon method and the equity split.
• Finally, regular reviews are required to make future adjustments.

Seek Professional Guidance

Professional guidance is important to ensure fair equity splits. Legal advisors, business consultants, or equity compensation experts can help you. At Eqvista, we handle all the activities related to co-founder equity allocation. We can help you in:

• Having productive discussions – We can help clarify each partner’s contribution, responsibilities, and expectations, making the split transparent and accurate.
• Resolving conflicts – Conflicts can arise when co-founders doubt the equity allocation. In that case, Eqvista can act as an unbiased mediator to help them reach a compromise.
• Ensuring legal compliance – The allocation of co-founder ownership must adhere to all applicable laws and regulations. Eqvista protects small and medium-sized businesses (SMBs) from possible legal problems and liabilities by ensuring the equity split is compliant.

Tips to choose the right professional

• Determine why the equity split is necessary. Then, know the precise knowledge you’ll need for the equity allocation.
• Seek out experts who always have the necessary certifications. To ensure their credibility, look into their certificates and previous work.
• Get all the information you need about the pricing and billing terms to ensure they fit your budget.
• Ensure the expert has all the knowledge they need to finish the task.

Get your Company’s Equity Support from EQVISTA!

Assigning ownership shares to co-founders is the initial stage in launching a business. For this reason, allocating fair equity splits to them is critical to prevent injustice and disputes. Professional assistance is required for equitable distributions because the process necessitates a thorough understanding of the ideas.

Eqvista could be useful in this situation. Our platform covers all your needs, from incorporating to dividing out equitable stock amongst co-founders. Our professionals, with their experience and knowledge, can also help you with other equity-related processes. To know more about our services, contact us today!