The Founder Equity Split

Michael Siebel of Y-Combinator wrote an excellent blog on equity splits among founders.  I love some of the points he made and they cannot be underestimated.  The conversation about splitting equity will help you have a conversation that helps founders learn about each other.

I find the “priced round” versus the SAFE or Convertible Debt round conversation is similar with entrepreneurs.

Brad Feld also has a nice post up about how to split equity and why.  In his book, Do More Faster, they talk about how to split founder equity. The post I linked to from Brad is from 2011.  Nothing has changed and it still can be a thorny issue.  I think Brad’s advice is right.  Invest the time needed to get the founder’s documents right.  It might be frustrating, and you might try and avoid it.  But, it’s important because it’s part of the foundation of the company.

For those that absolutely have to have a numbers based way to divide up equity, Professor Mike Moyer has a way.  He wrote a book called, “Slicing Pie”.  The book is a universal model that creates a fair equity split in an early-stage, bootstrapped start-up company.  It’s based on a formula he created that can be put on an Excel spreadsheet.  When he demonstrates it in class, it’s fun to see the numbers change.  Professor Moyer teaches entrepreneurship at Chicago Booth and Northwestern.  Many of the founding teams he advised have won the New Venture Challenge at Booth.

One theme that ties together all their thoughts is the word “fair”.  What is fair?  This is a theme that runs through a lot of public discourse these days so it’s no surprise that it affects founder equity too.   No one in the world can decide what’s fair when it comes to your company, except the founders of the company.  Remember, it’s your company.  What’s fair to you might not be fair to me.

I think Michael Seibel hits the nail on the head when he says that More Equity=More Motivation. Milton Friedman would give you the same advice.  People respond to economic incentives.  If a founder doesn’t have enough equity, they might be open to doing a lot of side projects or something else.  Startups need 100% focus.  Having ownership sharpens that focus.

One fear founders have is that they will never get equity again.  They also fear dilution over the life of the company.  Dilution will happen unless you want to be a sole proprietorship.  As long as you execute, dilution will take place at a higher and higher price which makes up for it. There is also the potential to add back equity via outright grants, or via options/warrants.  Investors at certain stages of the company will want to incent founders by putting a cherry on top.  An example of this, Evan Spiegel made an extra $800M by taking Snapchat public.

This is also another reason why you want to do some diligence on the people investing in you.  It’s a partnership.  Investors that treat you badly or see their role as judge and jury rather than a side by side partner are tough to deal with.

The way Professor Moyer puts it, “The person’s a person’s % share of the rewards should always be equal to that person’s share of the at-risk contributions.”  Here is a video he put together that talks about his model.

Another important point.  Once you decide, it’s done.  Don’t continually mull it over in your mind.  Don’t continue to talk about it.  What’s done is done and move on.  Focus on building the company.  If you are really peeved about it, the match might not be the right match for you.  Or, you need to revisit it in the next equity round.  Grumbling and dissonance in day to day operations can take down a company.  Startups are hard enough to execute without that.

6 thoughts on “The Founder Equity Split

  1. Regarding the SAFE, or any other convertible instrument, I see it best suited as a bridge to the priced round. Seems that fundraising always takes longer than one would expect. It may be that the entrepreneur needs just a bit more to get over the hump. A team worth backing can see how to get there and be clear about what is required. A couple of points:

    1) There is only one bridge. No stacking, or stringing, or nesting, or whatever, of convertible instruments. The bridge should lead to a priced round that is already visible in the distance.

    2) The convertible instrument should be capped with a maximum amount of capital to be raised. Any entrepreneur worth their salt should be able to put a figure on what they require. Investors on that eventual priced round will prefer the certainty of a maximum to be raised, and one should seek to honor those preferences.

    Along the lines of “equity split” and “priced vs. convertible” conversations, what is your point of view regarding Participating Preferred (PP) vs. Preferred, non-paticipating (PNP)? This may be a moot point when considering seed stage investment, but one hopes to eventually realize a Series A (or beyond) where this conversation will eventually manifest.

    The best justification I can figure in a VC asking for Participating Preferred is “because we can”. Which is totally understandable. The reason I dislike is “because we always do it this way”.

    Once PP is in place, one would expect any subsequent financing to demand the same, more senior to boot. So the VC who starts this trend opens a door to getting squeezed out themselves. It appears, then, that a VC who wants PP must consider that juicing the return is worth this risk.

    To my point of view, it seems like having PNP across all stages is cleaner, less complicated, keeps all investor classes feeling “treated the same”.

    1. A 1x liquidation preference isn’t a bad thing to have in the term sheet. I totally agree on your point about “bridge to a priced round”. How many deals have you seen that are extremely messy because an entrepreneur just kept raising on one or two notes? You wind up with 20-50 investors and a spaghetti bowl to make sense of. If you are going to raise on a SAFE/note, spend the money to create an LLC and dump investors into it as you go. Then, it consumes one line on the cap table with a lot of transparency for next round investors.

  2. Interesting discussion Jeffrey. I just had Mike Moyer on my Game Changer podcast two weeks ago and Brad Feld will be my guest on April 14th. Sounds like I need to put together a panel discussion!

  3. We need lawyers and other advisors to startup founders to come up to speed on Slicing Pie concepts and dynamic equity, which is, quite literally, the only rational solution I have seen to counteract the absolutely ridiculous practice of fixing equity on Day 1 of a startup. As Steve Blank says, “A startup is a temporary organizing hunting for a sustainable and repeatable business model.” The founders have no idea who will contribute over the temporary process of nailing a business model, so why fix the equity on Day 1?

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