Founding is hard and the equity topic can range from awkward to really stressful. It’s surprising how many founding teams breeze through this discussion but not all do and emotions don’t make it any easier.
Regardless of the emotions I always come back to similar thoughts…
Everything is ideally split evenly with an intellectual desire to give someone else more without actually having to. I think it was Nivi or Naval who said something to the affect of “only start companies with people you’d want to give 51% to.” That has always resonated with me. This thinking is normally reciprocal which is why I think equity just ends up even and normally everyone feels pretty good about that.
Founding teams should recognize different people’s financial situation in the construction of the cap table but not punish one another for it. When there are major outliers it should be accounted for* but it should feel equitable to everyone involved. Some will not need to take a salary and others may not be able to afford that. Both are ok but it should be transparent on day one who will be taking what and how the company is going to handle it. I don’t personally feel that taking a modest salary to keep your head above water is a reason to be crammed down in a cap table. If the company’s plan cannot financially keep the people involved above water in the early days, everyone has to go into that eyes wide open.
My last thought before I jump into the framework I share is that most founding teams ideally have these conversations (and most of the time do) before capital comes in.** High functioning founding teams are normally comprised of those who will be working in or on the business.
The vanilla approach I’ve seen work time and time again is simple and always starts with assuming equal contribution. So.
- If two people, it’s 50%/50%
- If three people, it’s 33.33~%/33.33~%/33.33~%
- If four people, it’s 25%/25%/25%/25%
- And so on.
There are also times when it’s only one person who desperately wants there to be a second person but can’t find them or the second person isn’t fully committed. If that’s you and the equity of future team members is important to you, don’t worry because you can solve that with an option pool. That’s a different topic. Just start the damn company.
How fully committed founding teams handle this conversation is a time when you start to see how conflict will play out in future situations where a real customer or partner is involved. Communication can unfortunately become polemical. As a result, I try to suggest folks have a real honest conversation and start talking about roles and responsibilities.
The normal questions are:
- Are any founders putting in money that isn’t coming from an investor? (+10% for them)
- Who is the CEO going to be? (+10% for them)
- Which founders are going to be on this 100% full time for the next 5-10 years? (+10% for them)
- Does anyone want ownership because it was their idea but that’s where their contribution ends? (-99.999% for them)
- Who is going to be responsible for running what part of the organization? ( +10% for clear lines of ownership be it product, board, company, finance, whatever.)
- Are there any founders with unique superpowers for this particular project? (+10%)
- Already quit their job and is already working on it even though there is no company formed and is willing to mortgage their assets to pay other people? (+10%)
- Wants their FAANG equivalent salary to join*** (-99.999% for them)
I generally like to advise people to tick up/down 10% for each one of the rational points and let math do the work so their emotions don’t have to. You can pick others you feel are important as a team but the team should agree on them. This format isn’t as important as trying to remove emotion if you’re having trouble getting over the ownership discussion. A nice output of this exercise is understanding where disconnects are and what the team values more/less than the 10% baseline.
It’s important to note that in this example 10% is not 10% of the company. It’s 10% of whatever the individuals represented share ownership would be.
- In 2 people (50%/50%) – 10% actually represents 5% of the company but 10% of an individuals ownership.
- In 4 people (25%/25%/25%/25%) – 10% actually represents 2.5% of the company.
- This goes on with however many people you add.
When 1 person’s contribution goes up, it comes from everyone else equally. When 1 person’s contribution goes down, it goes back to everyone else equally.
If there are upticks for everyone then they all cancel each other out. Same for downticks. In the equal downtick scenario, I normally suggest that a -10% deficiency in the team start going to the option pool proactively.
This framework has been helpful for getting some early teams through conflict but generally most teams I’ve seen just split it and move on. Most teams aren’t afraid someone will walk away when they start a company but that can be solved in other ways as well.****
Many problems are resolved quickly from a place of equality and trust. When starting a company this is just the first of many things that normally gets resolved that way.
I normally invoke this framework as a straw man to enable a team to discuss responsibilities and align on them when starting a company.
* The major outliers increase risk of problems later on if they aren’t handled up front. Is one person financing the company personally for 18 months or does one person not anticipate on leaving their regular job for a few years? These normally are tough discussions and if they go badly can be a signal of a lack of alignment. Best to handle it right away if possible.
** Once significant or professional capital is present there are more complexities and more often than not you have to ask the person representing the capital what their requirements are to participate. That’s a totally different conversation than a few people trying to set something up. Talking about founding shares after capital is always kind of weird to me because the company is probably off and running or someone has probably made a meaningful time or financial commitment that is hard to forget. After the company is already founded so to speak you are having an ownership conversation with potential team members as opposed to a founding conversation.
*** A really well funded startup may hit ~70-80% of market comp overall but pushing these companies on cash comp is actually putting them at risk. By focusing comp on long term gains you may win big or you may not. This casual model is an interesting way to explore those outcomes. I have a feeling this model is totally irrelevant for most founders.
**** Founder vesting or re-vesting has always been emotionally counterintuitive to me. I do like some form of walk away language being included amongst the founding team members on day one if the team actually has walkaway concerns. If someone walks in X amount of time or they are voted off the island due to a predetermined set of egregious violations, their ownership goes to zero and is redistributed to the other founders and/or the option pool at the time of their exit.