The Two Basic Approaches
There are many ways to divide the equity of a startup, but broadly speaking there are two approaches: (1) go with what’s “fair”; or (2) try to ascertain the market value of the founders’ present and future conduct.
The “Fair” Approach
The basic premise of this approach is that founders putting in equal time should have equal ownership interests. The main benefit is to the relationship between the founders. When they are equal owners, they need to act with greater consensus. When one founder doesn’t get his or her way, they don’t feel like they were cheated by the company structure: there’s at least a fairness of process. In contrast, a minority founder may feel hopelessly at odds with majority founders, and this can tear apart startups.
The Market Value Approach
The basic idea with this approach is that you try to put a number on the value of each founders’ contributions. For each founder the value of cash, assets, and services contributed is contemplated and percentage ownership interests are divvied up accordingly. Another way of determining the market value is by estimating the replacement value of each founder. Is one founder more easily replaced than the other(s)? If so, the less replaceable founder would receive a greater interest in the company. One of the main benefits of this approach is that it addresses any inequalities between the founders head on. Sometimes the “fair” approach doesn’t seem “fair” down the road when one person realizes his or her value is much greater than is currently being realized.
The best approach for any given situation depends on the nature of the people involved, and the particularities of the startup.
Details to Consider
Who came up with the original idea? Usually this isn’t highly valued. As a general rule 99% of the value lies in execution.
Who is ironing out the initial details and making things happen? Who is preparing the business plan? Who is getting a prototype out there? A good business plan might be worth a hint more equity if one party is primarily responsible. But if one party can execute an early version of the product, that has much more value.
Who is the CEO? Generally, along with the title comes additional work and responsibility, and usually a little more equity.
Who is the field expert? Is one person more of an expert in the industry? This gets to the market value of the founders; how replaceable is your expertise? If you can’t be easily replaced you should get a greater cut of the equity. If you are just going to be doing work that anyone could do, you should get a lesser cut of the equity.
Who has the reputation to get the company noticed or trusted? If one of the founders is well-known either in the particular industry or in the funding community, that could make or break a company. Accordingly that founder might get a larger chunk of the equity.
Who is committed? Is one founder watching the other jump off a cliff, only to see how deep the water is? If one founder quit their job and is working full time for the startup while the other founder has a steady job and does startup work on the side, the full-time founders need to have a greater chunk of equity.