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Deciding how to split equity amongst co-founders.

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MitchM

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Hey there, so a close friend and I have decided to start a website together and the project is quite ambitious. Right now we are trying to get funding and decided that right now would be a good time to figure out the equity split.

He came up with the idea and nurtured it for a few weeks before ever bringing it up with me. At first we just talked about the idea as a project he was personally working on, but over time as I became more involved with the idea he asked me to cofound it with him. My response was uncertain at first and we decided to give it time.

Basically where we are at now is that we are working on it together and plan on applying to Y-combinator next month. What I have said is that my level of commitment will be contingent upon whether or not it is accepted, although this does not mean that I am not going to still contribute.

If it is funded I drop everything and commit 100 percent. I understand that due to this contingency we are both assuming different levels of risk - and he also came up with the original idea - so it makes sense to me that we would not split equally.

What are your thoughts on how we should split equity? The long term goal is to maintain a majority of the equity between us. So, here are some things that have been considered:

A 75-25 split. My share would not be touched in this instance. He would be soley responsible for the distribution of equity moving forward. This came up as a means to prevent too much dilution and complications.

He also originally considered the 60-40 split, but didn't know how that would work out in terms of dilution and control.

What do you guys think is the best way to set this up? If there is no objective answer - are there any resources that we can use to help make the decision? Thank you.

I would also add that in terms of contribution we both are equally essential to the success of the business.
 

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JScott

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Create a set of heuristics that allocates equity based on time, effort and/or milestones committed. So, it might look like:

- After 6 months, 50% of the equity is split based on the proportion of hours each of you worked
- Each of you get 5% equity for each hitting your first 5 milestones

So, as an example, if in the first 6 months, you work an average of 70 hours per week and he works an average of 30 hours per week, you get 35% equity and he gets 15% equity. When you hit all 5 of your first milestones, you get another 25%. Likewise, when he hits all 5 of his first milestones, he gets another 25%. If he has to complete one of your milestones, he gets that 5%.
 

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applying to Y-combinator next month (...) my level of commitment will be contingent upon whether or not it is accepted (...) If it is funded I drop everything and commit 100 percent. I understand that due to this contingency we are both assuming different levels of risk - and he also came up with the original idea - so it makes sense to me that we would not split equally.

Since you dont care about this business anyway and dont think it has potential, you should simply quit. If you cared, you would work your a$$ off, funding or not. This also solves the equity discussion. I wouldn't want to be in this business with you based on this.

Apart from the equity discussion and your level of commitment, this sounds like a lot of entrepreneurial masturbation from both of you. Stop it and get to work.
 
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MitchM

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Since you dont care about this business anyway and dont think it has potential, you should simply quit. If you cared, you would work your a$$ off, funding or not. This also solves the equity discussion. I wouldn't want to be in this business with you based on this.

Apart from the equity discussion and your level of commitment, this sounds like a lot of entrepreneurial masturbation from both of you. Stop it and get to work.

I do care about the business and I do think it has potential. We talked in the earlier stages and I gave the best advice I could. Eventually he asked me and I told him that in order for me to drop all of my pursuits the business would have to get a little bit further first. How is that unreasonable?

Also, as far as entrepreneurial masturbation - I would say this is a very important decision.
 
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MitchM

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If this is true, I would start there. Will you take a salary?

A salary wouldn't really be viable until further down the line. I think we are definitely going to go with equity split.

Create a set of heuristics that allocates equity based on time, effort and/or milestones committed. So, it might look like:

- After 6 months, 50% of the equity is split based on the proportion of hours each of you worked
- Each of you get 5% equity for each hitting your first 5 milestones

So, as an example, if in the first 6 months, you work an average of 70 hours per week and he works an average of 30 hours per week, you get 35% equity and he gets 15% equity. When you hit all 5 of your first milestones, you get another 25%. Likewise, when he hits all 5 of his first milestones, he gets another 25%. If he has to complete one of your milestones, he gets that 5%.

I like this because it relies on time investment and I will keep the structure in mind. Thank you.
 

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Create a set of heuristics that allocates equity based on time, effort and/or milestones committed. So, it might look like:

- After 6 months, 50% of the equity is split based on the proportion of hours each of you worked
- Each of you get 5% equity for each hitting your first 5 milestones

So, as an example, if in the first 6 months, you work an average of 70 hours per week and he works an average of 30 hours per week, you get 35% equity and he gets 15% equity. When you hit all 5 of your first milestones, you get another 25%. Likewise, when he hits all 5 of his first milestones, he gets another 25%. If he has to complete one of your milestones, he gets that 5%.
This is an interesting method of allocating equity, thanks for that.

I usually try to deter folks that talk of taking on a partner, but I wonder if a method such as this could be made to work. Has anyone used a method such as this, and if so, did it drive the partners to commit and take actionable steps?
 

JScott

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This is an interesting method of allocating equity, thanks for that.

I usually try to deter folks that talk of taking on a partner, but I wonder if a method such as this could be made to work. Has anyone used a method such as this, and if so, did it drive the partners to commit and take actionable steps?

This is really nothing more than a vesting schedule for founders. While we often think about employees having to hit milestones (time frames, deliverables, etc) to vest equity, we often assume that founders just start with equity and don't need to vest it. It doesn't have to be that way.
 

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Listen to @JScott It can be sophisticated or simple. You can literally keep a time card with a pro-forma hourly rate and accrue it into an equity table on a monthly/quarterly/yearly basis - or use some other basis if it tickles your fancy.

I do the hourly thing accrued to equity in my day job and it's super simple.
 

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I don't think time equates to value. There is a risk/reward ratio that needs to be determined to set the equity split. The most important thing however is the vesting of stock. If either of you pull out the company can claim back the shares. A typical vesting period is 1/3 after one year, and each remaining 1/24 vested each month thereafter. So if either don't work at least a year, you get nothing. VCs won't invest in a company that has a large percentage of equity given to a co-founder that is now no longer interested but will benefit of the work of others.
 

JScott

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A typical vesting period is 1/3 after one year, and each remaining 1/24 vested each month thereafter. So if either don't work at least a year, you get nothing. VCs won't invest in a company that has a large percentage of equity given to a co-founder that is now no longer interested but will benefit of the work of others.

Yup, though it's typically (at least in the tech world) a bit more complicated. Startup founders will vest *until* they raise their seed round. At that point, there's a good chance that the investors will require the founders to re-vest part or all of their equity to ensure the founders stick around for some minimum period (a vesting "cliff") after investment is made. Depending on how "founder friendly" the investors are, they may give accelerated schedules. But, in theory, this could happen in multiple rounds of raises, and founders may be required to stick with the company for long periods of time to fully vest (perhaps up until a liquidity event in some cases).
 

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G-Man

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Yup, though it's typically (at least in the tech world) a bit more complicated. Startup founders will vest *until* they raise their seed round. At that point, there's a good chance that the investors will require the founders to re-vest part or all of their equity to ensure the founders stick around for some minimum period (a vesting "cliff") after investment is made. Depending on how "founder friendly" the investors are, they may give accelerated schedules. But, in theory, this could happen in multiple rounds of raises, and founders may be required to stick with the company for long periods of time to fully vest (perhaps up until a liquidity event in some cases).

It's why we put off PE until later. If you're gonna be somebody's bitch, you gotta make sure the space between you and a major buyout is 18 months or less
 

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You said yourself, "If it is funded I drop everything and commit 100 percent". Doesn't that mean you should try and get every single percentage of equity possible? I mean, if you truly believe in the business and you're willing to commit that much...

Sounds like the tech industry might be different, so I don't know. Also, I checked out Y-Combinator and it sounds like they take at least 7% equity for at least $125k investment. If my "Shark Tank" math is correct, Mr. Wonderful would value your business at $1.78 Million.

Honestly though, if you are as motivated in the business as your co-founder, I really don't see why you wouldn't take as much as possible.
 

Solrac

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Founders work on things because it is an itch, not because the money is there or not. Dosen't really seem like you are onboard unless certain parameters are met. If it's like that, it's not important enough for you to work on. Y-Combinator would probably reject you. They want people who are obsessed.

To answer your question, I think 50-50 if your both grinding. If not give more to whoever is putting in the real work. A lot more.
 

mgrowan

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Yup, though it's typically (at least in the tech world) a bit more complicated. Startup founders will vest *until* they raise their seed round. At that point, there's a good chance that the investors will require the founders to re-vest part or all of their equity to ensure the founders stick around for some minimum period (a vesting "cliff") after investment is made. Depending on how "founder friendly" the investors are, they may give accelerated schedules. But, in theory, this could happen in multiple rounds of raises, and founders may be required to stick with the company for long periods of time to fully vest (perhaps up until a liquidity event in some cases).

Totally agree, something to be aware of. Not that @MrSterlock is there yet.
 

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Jscott sounds a lot more experienced than myself so maybe he can clarify further but I've also heard it's a good idea to keep a % in mind for future investors. If you start with a 25/75 split, and you take on an investor who wants equity, where is that dilution coming from? Will you go down to 15% and he'll go down to 65% so the investor can take 20%? You may want to think about this now instead of having an argument over it later. Maybe you'll want to plan something like a 25/55/20 split where you get 25%, he gets 55%, and 20% is reserved for investors. Build the dilution into the plan from the get-go.

(I'd love to hear more about this from those with experience though)
 

mgrowan

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Jscott sounds a lot more experienced than myself so maybe he can clarify further but I've also heard it's a good idea to keep a % in mind for future investors. If you start with a 25/75 split, and you take on an investor who wants equity, where is that dilution coming from? Will you go down to 15% and he'll go down to 65% so the investor can take 20%? You may want to think about this now instead of having an argument over it later. Maybe you'll want to plan something like a 25/55/20 split where you get 25%, he gets 55%, and 20% is reserved for investors. Build the dilution into the plan from the get-go.

(I'd love to hear more about this from those with experience though)
Dilution doesn't typically work like that. It isn't you selling your shares which would adjust the percentages like that and have tax implications. It is issuing more shares which causes the dilution. So if you have 25 shares and the other 75, if you want to issue an investor 20, there is now 120 shares of which you have 25/120 which is 20.8% down from 25% (25/100 originally) and the investor has 16.6% (20/120) and the other 75/120 (62.5%). That's my understanding after going through an accelerator. Does that make sense?
 

JScott

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Jscott sounds a lot more experienced than myself so maybe he can clarify further but I've also heard it's a good idea to keep a % in mind for future investors. If you start with a 25/75 split, and you take on an investor who wants equity, where is that dilution coming from? Will you go down to 15% and he'll go down to 65% so the investor can take 20%? You may want to think about this now instead of having an argument over it later. Maybe you'll want to plan something like a 25/55/20 split where you get 25%, he gets 55%, and 20% is reserved for investors. Build the dilution into the plan from the get-go.

(I'd love to hear more about this from those with experience though)

Typically, equity investments are accomplished through dilution, not setting aside shares (since without knowing the valuation at the time of the investment, it's impossible to know how many shares to set aside).

And, just like mgrowan said above, when stock is "diluted," that means that your number of shares stays the same, but your percentage of equity goes down. So, for example, you own 1000 shares of a company and that comprises 100% of the company. If you want to sell 50% of the equity in the company through dilution, you issue 1000 more shares (that go to the equity investor), you keep the same 1000 shares, but now you only own 50% of the company.

Setting aside shares is more common when you want to maintain a pool of equity for early employees and management...
 

Bottomsouth

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I do care about the business and I do think it has potential. We talked in the earlier stages and I gave the best advice I could. Eventually he asked me and I told him that in order for me to drop all of my pursuits the business would have to get a little bit further first. How is that unreasonable?

Also, as far as entrepreneurial masturbation - I would say this is a very important decision.

Don't take a partnership then.
 

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