One of the hardest things to do in early stage startups is dividing up the equity. I have been asked for advice on this from time to time but I never had a good answer. Mike Moyer, who teaches entrepreneurship at Chicago Booth wrote a book about it Slicing Pie. I like it because it gives you some theoretical basis to begin thinking about dividing up equity.
When things come across my desk, the equity has already been split. When we look at cap tables, we look at who previous investors are and who controls most of the equity in the startup. We also game out the cap table to make sure there will be enough equity for everyone so they have an incentive to go for the stars. It turns out upon exit, most founders own roughly 17% of the company they started.
Yesterday I came across a post by Professor Waverly Deutsch. She also teaches entrepreneurship at Chicago Booth. She differs from Mike’s approach slightly and she did some rigorous research to get there. She shows her math.
These can be uncomfortable discussions. Waverly writes that there are 4 things you need to talk about.
- You will overvalue your contribution and undervalue the contribution of others. So will your fellow team members.
- You need to have this discussion early in your founding process. If you cannot wrestle with this really hard and important decision while your company is basically worthless, it will only get more difficult when there is meaningful value at stake.
- You have reached success when everyone is equally unhappy but feels that the process and outcome is “fair” to all.
- If you cannot get to agreement, that is a strong red flag that these team members will have problems working together on this company in the future.
Numbers 3 and 4 are interesting. Everyone is equally unhappy-sort of like Satisfy. You got some pie, but you’d like a bigger piece. If 4 happens, the startup is guaranteed to fail.
I am speaking at Northwestern’s Law School today so I expect there will be some questions about this topic.