This task can be thought of as either splitting hairs (since the startup is so new, who even knows if there’s anything real), or dividing the ocean (because its possibility is nearly endless). Alex Blumberg, in his Startup podcast from Gimlet Media, refers to this as “dividing an imaginary pie.”
We were reminded of this challenge recently as several alumni have reached out to us for help with dividing their own pies. Their challenge was trying to divide a pie when they are still trying to figure out what kind of pie to bake, assembling the ingredients, and settling on a recipe. But, kudos to them for asking the right questions at the right time. Many founders simply divide all the equity equally without realizing the hidden debts this incurs. Instead, these alumni founders are asking questions like:
- How much equity should be allocated at the start?
- What’s the value each party brings at the start?
- How is equity earned over time based on contribution?
- What is fair from each party’s perspective?
- What’s the typical equity division for a startup?
So let’s cover the absolutes for equity distribution allocated early in a startup’s life:
#1 – Vest equity over time. At the start, everyone is excited about what they might do. It’s a long journey and a lot of tasks have yet to be revealed. So create a plan that allows people’s equity to grow commensurate with their contribution to the venture’s progress.
#2 – Preserve some equity for future key leadership team members. This is called a set-aside pool. It is earmarked for bringing on management capabilities beyond the founding team, typically like a CEO, CTO (Chief Technology Officer), or Chief Revenue Officer. These experienced leaders will also want equity as part of their compensation. It’s easier to set aside equity at the beginning, as opposed to giving up what is perceived as “my equity” later.
Here are a few startup scenarios that have happened recently. In the first example, they wanted to bring in an outside CEO because this startup was a side gig for the founders. They needed an experienced entrepreneur to move the new venture forward while they kept their day jobs. They interviewed several people and picked one. But they hesitated to agree on terms for either equity or decision making because it was so hard. After six months, the new CEO amicably departed, and the venture is still stuck in neutral. The Lesson Learned: Tackle the hard questions early. Trust is eroded when people are unsure of their status. You should not divide up all of the equity, but people need to know where they stand in order to be productive.
In the second tech-based startup, a CTO was recruited and brought on early as one of three co-founders. In pushing for resolution about equity distribution, the initial allocation plan from the CEO was 80% for the CEO and 10% each for the CTO and another key founder. This was a bit disturbing to him considering all that was on his plate to deliver and not to mention he gave up his day job to join this venture. He had done his homework by reading our book The Titanic Effect. So he was able to map out key sources of uncertainty, tasks to be done to reduce that uncertainty, and equity allocations that should accrue from completing these tasks. He is now more motivated than ever to get through those milestones. The Lesson Learned: While you can’t take emotion completely out of the equation, you need a path forward beyond “that doesn’t seem fair.” Consider involving objective outsiders to help find a win-win.
Startup scenario number three looked at working with an accelerator and a venture studio to get some momentum behind their technical proof of concept. Accelerators and venture studios often require giving up some equity, maybe even a majority, in exchange for their expertise. The idea is they can build value and get to exit faster with a higher chance of success. And with venture studios, this might also include giving up some decision making. Giving up equity and decision making can be difficult for a new founder. They often are looking for someone to “help raise their child,” as part of the family, rather than putting the child up for adoption. The Lesson Learned: Know what equity as well as decision making you are willing to give up to move your startup forward. This soul searching needs to happen before signing any deals.
As we said earlier, dividing up equity is hard. So remember to allocate equity over time. Consider both the decision making process as well as equity itself. And keep moving forward. Don’t let these decisions paralyze you. Grow your startup and everyone gets a bigger piece of pie.