“Experience is a good school, but the fees are high.”
— Heinrich Heine
It is the lesson of the true cost of recruiting the wrong founding team in a startup. You fill a role out of desperation, or even worse, recruit a friend or family who will do for now but never was quite the right fit. There are moments of convenience and other times, rationalization, for hiring people you trust, forgetting to foresee roles and consequences. Hiring at the top of a pyramid, the bottom grows over the years even when founders leave. And then the recruit in turn takes the organization down the garden path, hiring more of the wrong people, perpetuating one error to final destruction. The good old adage for entrepreneur CEOs – hire the very best for your life depends on it – we have heard it all, many times. And again, to do it in reality, even the brave will falter.
How does an entrepreneur divide equity among co founders?
Should I divide the equity in my startup equally?
How do you do it?
- Connecting a World Changer / George Page - February 17, 2012
- Roar of the Cloud - September 22, 2010
- IIT Kanpur Golden Jubilee Initiative: The Next50 Global Innovation Challenge - March 5, 2010
Based on a couple of real experiences, here’s a summary of thoughts:
* WHEN you join as a co-founder is very important because lots of negotiation goes around that and startups do over-sell the “progress” they have already made. (Well if they are that good, why are they diluting even 1% to you and why are they asking you to take a huge paycut?) So evaluate such situations carefully and do not feel hesitant to walk away.
* Advisors / mentors add tremendous value (especially if the entrepreneur is below 30). If you are an advisor / mentor, never settle for something ridiculous like 0.75%. As a advisor/mentor you will be fully milked for your expertise, you will even help resolve crises, and you may also get loads of praise, but make little money for yourself. Note that praise and fullfillment do not pay for your bills and retirement. Real money does. Do get the return on your skills and your network. I’d say also add a bit of capital investment to your value addition and never settle for anything below 10%.
Division of ownership is a tricky issue. The most common and wrong approach (that needs little or no thinking and discussion) is to assume that everyone is equal. This also takes care of getting into debate and discussions on value that every co-founder adds to the start-up. Though 50/50 approach is commonly followed, it brings in mediocrity. Entrepreneurs must realise that no two individuals are equal so far as a start-up is concerned.
The attention of the entrepreneurs at start-up must not be to count equity percentage but to ensure that the start-up starts!
One must consider that 99% of nothing is nothing and at the same time, 1% of a billion dollar venture is 10 million dollars. Therefore, the key aspect is to link value-addition to the success of start-up.
The other aspect is that the value of an entrepreneur is not static. It goes up or down with time. Therefore, the preferred arrangement for partners is to debate and discuss the value that one gets to earn equity in the business and also consider the future value-addition. Many entrepreneurs are not comfortable discussing equity with partners as they look at it as zero-sum game. My recommendations:
1. Discuss in a systematic and exhausted manner the value addition by co-founders before arriving at sharing of equity.
2. Include the element of variability to ensure future-proofing and avoidance of free-rides.
3. Focus on start-up becoming successful rather than who gets what percent. Link percentages with performance of the start-up.
4. Typically the following are in the order of importance in the life-cycle of a start-up:
a. At birth (0 year): Idea, leadership, investment, sales, delivery, finance,
b. Stage 1: Leadership, sales, delivery, idea, finance
c. Stage 2: Leadership, sales, delivery, finance, idea
d. Stage 3: Leadership, delivery, sales, finance, idea
e. Stage 4: Leadership, finance, delivery, sales, idea
From the stages above (which could range from a few months to a few years, clearly the entrepreneurs need to get different type of skills in the start-up. Entrepreneurs must recognise their value addition in each stage while sharing the equity (I do not like the phrase ‘splitting the equity’).
In summary, existing and future value addition must be considered with arriving at the sharing of equity amongst co-founders. All discussions and debates must be centered to the start-up becoming successful.
Good luck.
Best regards, Vijay Shukla
vijayshukla@yahoo.com
vijay.shukla@vfirst.com
Mentor wise: Would you risk offending future business by offering a stake to a certain customer only? I would say don’t do it. Given them a call option on stock instead, callable after x years at a certain price. The idea there is – stake exists, but is not assigned, so technically they don’t own anything.
Exit valuation: I’ve seen founder exits and honestly no outsider will buy your stock unless it gives them executive position. Even at 1 paisa per share, I would not buy an exiting founder’s shares in an unlisted company unless I can be on the board or even get data. The fear that someone will sell to outsiders in the nascent stages is unfounded.
And you can’t restrict someone from selling shares to anyone else, the only thing you can do is to have a “first right of refusal” meaning tht if someone gets an offer of X per share, the other founders have the right to buy stake at that price – or refuse. But if they refuse, the shareholder can still sell to anyone else.
Valuation can be anything – it could be based on networth, or price to earnings or whatever. Nobody will (or should) sign up to a fixed valuation exit – what’s the point.
And if a founder wants to opt out, why not let him keep his shares? If you really want to rebalance stakes in favour of the remaining founders, set up a special resolution to expand capital by offering rights issues at a certain (low) price and the exiting founder won’t buy (why would he, he’s exiting).
To avoid such scenarios the concept of “vesting” and staggered delivery of shares is perhaps a better approach. Yet, when one has vested and earned shares, it is not fair to deny that person those shares by asking to compulsorily sell at a valuation etc. (If he doesn’t want to sell, he has every right to keep it) Plus, it may be illegal as it infringes on his ownership rights to the property.
Hi BB;
You raised issues that all entreprenuer has to face and for which we do’nt have any “ideal”, “practical” , “fixed “solution.I would like to hear from every entreprenuer reading this blog asIndina context play a big role.
Finding right partners is a must. But how to find “the wining” team? They say “Hire only A people, and they’ll hire other A people. If you hire the B person, they’ll hire C or D people”.Agreed.But is that also mean I have to be A people to hire first Ain my team 😉
If we look into the history of US companies most of them have 2 founders and these two were balanced as techie and marketing guy combo.In contrast in India most of Indian sofware giant we have team of 5-6 plus of all-woking-in-same company-doing-same stuff kind.
If you are freshly passed out then you have very few option other then picking your friends whom u “trust ” ,share passion and dream.At this stage you look more for trust then “right fit” as u have arrogance and “i will change the world atitude”. I find nothing wrong in that.
After 5 plus year of experience your attitude is little mallowed down and you look more for “right fit ” then trust.
Challenge here is to founders who share same vision, commitment,passion and last but not least who will finih the task once started.I find its tought all your Self-knowledge,poeple-skills,decison making skills get exercised.
I am desperate to hear views from someone “been there done that” in india.
Once you zeroed down on your team next important question if equity ditribution. I read lots on this on net and come to conclusion that how you divide equity is very subjective and have “to each their own” kind of solution.
Equity distribution is basically Risk-reward distibution.Now its on you and your partner to gauge “size of risk” involved in venturing with you.Risk evalution is subjective and you have to cmmmunicate a lot to your partners to make them agree with what equity distrintuon you have come-up with.
Equity is the only sweet money/asset a founder have effective utilisation of equity is as important capital utilisation.No single solution.
You may find interesting views here:
a.http://discuss.fogcreek.com/joelonsoftware/default.asp?cmd=show&ixPost=61808
b.http://www.angelscorner.com/articles/equity_distribution_in_startups.htm
c:http://www.discussit.org/knowledge/ds/IP/equity/
d:http://onstartups.com/home/tabid/3339/bid/146/Startup-Founders-Should-You-Divide-Equity-Equally.aspx
e:http://www.tjacobi.com/50226711/equity_distribution_for_startups.php
f:http://www.feld.com/blog/archives/002203.html
g:http://blog.negonation.com/en/how-to-distribute-shares-in-an-internet-start-up-the-market/
There is another tricky issue which needs resolution. That is exit valuation during the initial few months/1-2 years of the company.
To prevent ceding control to outsiders, typically, there is a clause which states that an existing founder can sell his stake only to other founders. But the issue is at what valuation.
What if a founder wants to opt out during the initial phase itself? How does one value his stake? The classic valuation models may not be applicable in such cases?
I’m against a revenue/profit multiple based valuation during the initial phase of a company’s existence. This would give incentive to a fence-sitter to rock the boat at the first available opportunity, i.e, the first large client win.
Any thoughts….