Two Dogs and a Startup is expanding….Our guide to dividing equity up between founders

Posted on July 5, 2011 by

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www.picclash.com

www.picclash.com

Sure sign of growth is when you double your company’s headcount in a month…right?  

This week two dogs and a startup officially became four dogs and a startup when we added two more talented founders to our www.picclash.com team. This exciting news also came with a deceivingly hard set of questions relating to how to divide up the equity within our company. For the record, I must say that I wished there was a class at doggy school for this issue.

Initially when we started debating the equity issue, Ham and I saw no complicating factors, thus we initially decided to simply divide the equity up equally. However the more research we did into the equity question, and the more we talked about it with seasoned entrepreneurs we realized that despite our rosy outlook for our company and belief that people will do the right thing, there were a lot of other things to consider.

So what were some key insights of the week:

1. Key things to consider when deciding whether or not someone should be a founder:

  • Equity is really easy and cheap to give away when you are just starting. But just because it is the easy way doesn’t matter if it is the right one.
  • When you are selecting founders remember to pick people with skills that you don’t have and that are vital to your company long term (not just right now).
  • Consider whether each person can grow with the company – if they can’t be an ongoing contributor then maybe paying the money in the form of IOU is more appropriate.
  • While equity is a great way to create ongoing buying in and commitment to the company – this may or may not motivate people on your team.

2. How much equity is appropriate for each founder? Should all founders be treated equally?

In reality, not all founders are created equally therefore it is not appropriate to divide equity equal.  The key themes we looked at when making our decision on how to value sweat equity were?

  • Time commitment: we considered two main issues: how much time do they have to spend on the company and what the ongoing time commitment is to build a successful company.
  • Opportunity cost: Are they foregoing another opportunity to work on this opportunity? For example, two founders view this as a fulltime job while others have another fulltime job and this is a side project for them.
  • Cash investment: easily valued and tracked.
  • Future effort and time commitment required: When estimating this we found it best to allocate roles within the company and go from there. Communicating these roles to each founder also makes their expected commitment (time and effort) clear.

Another thing to consider is whether or not to allocate a % of the equity to a pool to be held for future hires or investment.  Another use for this pool is that founders could potentially divide it up at later date for any additional value an individual has brought into the company that was not originally accounted for (i.e. to balance any perceived unfairness).  

Remember coming up with the perfect equity split % among founders is a game of pluses and minuses and the process is made easier though walking through your logic and rationale with others.  

3. How to structure the equity agreement:

  • Vesting or Non Vesting: Vesting can create an ongoing incentive for founders to remain active contributors in your company. Most companies have a vesting period, usually around 4 years (we decided on three). There are pros and cons on vesting and each entrepreneur should make their own decision on the topic. We have included a link on the bottom of this article to help you make your own decision.
  • Transparency and honesty are important. Always provide reasons behind decisions and honest answers to questions in regards to equity. It is the only way to start a positive new relationship.
  • Get it in writing and make sure it is understood.  There are a lot of templates available on the web, choose one but make sure you tailor it to reflect your needs.
  • Always consider an OUT: If things go bad (between founders), how will that affect your company? These things should be addressed in your founder agreement.

While this is by no means a complete guide to dividing up equity, it is a compilation of what we discovered through our experience. If you have any thoughts or comments to add from your own experience please leave a comment as we would love to hear about them.

-Boomerang

Resources that we used:

http://www.thedailymba.com/2010/02/13/how-to-divide-up-founders-equity/ – Great quick read about the different types of founders and what they bring to the table.

http://karlulrich.pbworks.com/w/page/12879731/Allocating-Equity-to-Founders – Easy and insightful read, it even has a worksheet you can use for calculating future effort (from multiple partners perspective).

http://blog.simeonov.com/2010/04/25/founder-agreements-vesting/: Talks about vesting in relation to founders agreements.

http://www.feld.com/wp/archives/2005/05/term-sheet-vesting.html – Talks about vesting and is part of a series about term sheets (relating to VC investing) – interesting read.

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