You have developed a promising startup concept after extensive customer interviews and building a prototype. When seeking funding from angel investors, they advised you to bring on a business co-founder. Fortunately, your MBA classmate is interested and wants to join as a founder for equity.

Deciding on the equity split can be challenging as you deserve credit for initiating the idea and putting in the initial work. In this situation, how much equity should you offer your co-founder to incentivize their commitment and effort towards the company’s success?

While there is no set formula, I can provide you with principles to consider when determining an equitable founder equity split for negotiation with your co-founder.

Employee Option Pool

Prior to dividing equity with your co-founder(s), it is crucial to establish an Employee Option Pool for future hires. Generally, VCs recommend setting aside 15 to 20 per cent of the company’s equity for this purpose.

To determine the percentage, create a budget outlining the number of employees you plan to hire in the next two years and allocate appropriate equity to each position, such as 2 to 3 per cent for management team members and 0.1 to 0.2 per cent for entry-level employees.

Also Read: SEA tech founders playbook: A to Z of becoming a fundraising legend (Part 2)

Cash Investment

If you or your co-founder(s) plan to invest cash into the company, treat it as an external investment. Determine a valuation for the company based on the cash injection and divide the resulting equity accordingly.

Consult with local angel investors to gauge the company’s valuation considering the team and progress. For example, if you invest S$50,000 and value the company at S$1 million, you would receive around five per cent of the equity. Distribute the remaining equity as outlined below.

Idea Development

While ideas are abundant, validating an idea or developing intellectual property (IP) can warrant additional equity. Spending time on validating the idea or creating a prototype should earn a premium ranging from 5 to 25 per cent based on the effort put in.

CEO’s Role

In a two-founder scenario, avoid a 50/50 equity split as it may lead to decision-making deadlocks. Since the CEO holds the final decision-making power, they should receive a larger share of equity.

Investors value the CEO position and may allocate more equity to a CEO, especially if they are an external hire. Consider giving the CEO a five per cent premium for assuming the role.

Calculations

Using the example provided, divide the equity based on contributions and investments. Considering factors like CEO role, idea validation, and cash investment, distribute the equity in a fair and motivating manner.

It is advisable to involve a neutral arbiter, such as an experienced founder or investor, to help determine an equitable split to avoid conflicts and ensure a smooth decision-making process among co-founders.

–

Editor’s note: e27 aims to foster thought leadership by publishing views from the community. Share your opinion by submitting an article, video, podcast, or infographic

Join our e27 Telegram group, FB community, or like the e27 Facebook page

Image credit: kanghj103

The article was first published on October 8, 2021

The post How to split founder equity without splitting up appeared first on e27.