In many cases, founders split their share ownership during the company’s inception without considering future eventualities. This can pose risks for the company if one or more founders decide to leave.
The fundamental principle for splitting shares should consider crucial aspects such as allocating the appropriate amount of shares based on the founders’ contributions to the venture over time, their duration of service, and the risks they undertake. This plan should also account for future parties who may join the venture and the need to have a pool of shares available to attract and retain them.
Planning and executing the founder equity split is a crucial process for the lead founder. To ensure fairness, alignment, and future growth, the lead founder should follow these steps:
- Define the Founders’ Roles and Contributions: Clearly outline the roles, responsibilities, specific expertise, experience, and contributions of each founder. This evaluation will serve as the basis for determining the equity split. One approach to assess value is by estimating the opportunity cost the founder has to bear, calculated based on market value, along with a risk premium to negotiate the value.
- Assess the Founders’ Commitment: Evaluate the level of commitment and long-term dedication of each founder. Consider factors such as their willingness to take risks, ability to persevere during challenging times, and their intention to actively contribute to the venture’s growth.
- Determine the Initial Equity Split: Propose an initial equity split that reflects the relative value of each founder to the venture at the outset. This split should align with their expectations, fostering a sense of fairness and motivation among the founding team.
- Vesting Schedule: Implement a vesting schedule that outlines the timeline and milestones for founders to earn their allocated equity. This schedule ensures that founders continue to contribute to the venture and reduces the risk of founders leaving early while still retaining significant equity. Common vesting schedules are typically four years with a one-year cliff, meaning that founders must stay with the venture for at least one year before any equity vests.
- Share Pool for Future Employees: Reserve a portion of the equity, typically in the form of an employee stock option pool, to allocate to key employees or future hires. This ensures the venture can attract and incentivise top talent as it grows.
- Share Buyback or Repurchase Rights: Incorporate mechanisms such as share buyback or repurchase rights in case a founder voluntarily leaves the venture or underperforms. These mechanisms allow remaining founders to repurchase the departing founder’s shares at a predetermined price, minimising any potential unfair advantages gained upon exit.
- Shareholder Agreements and Legal Documentation: Document the equity split plan in a shareholder agreement or a similar legal document that outlines the rights, responsibilities, and ownership of each founder. Seek professional legal counsel to ensure compliance with applicable laws and regulations.
- Regular Review and Reassessment: Periodically review the equity split plan to ensure alignment with the evolving dynamics of the venture, the contributions of each founder, and any new team members joining the company. This flexibility allows for adjustments as the venture progresses.
While applying these criteria to determine the share allocation, the lead founder or founding group should also consider future possible dilution and the majority shareholding necessary to maintain control over the board and company.
It is crucial for the lead founder to foster open communication, transparency, and trust among the founding team throughout the equity split planning process. Additionally, involving legal and financial professionals experienced in startup equity can provide valuable guidance to ensure the plan is fair, legally sound, and aligned with the venture’s long-term goals.
A J Balasubramanian is a serial entrepreneur, with over three decades of startup experience in founding companies, mentoring / incubating startups and writes regularly on topics of interest to startups.