How To Determine Founder Equity Splits

Tech Industry

How does one determine founder equity splits at the outset? originally appeared on Quora: the place to gain and share knowledge, empowering people to learn from others and better understand the world.

Answer by Kunal Lunawat, Investor and Operator, Managing Partner at Agya Ventures, on Quora:

Here’s one good framework to determine founder equity splits at the outset:

  1. First divide the equity allocation between initial contributions and future contributions.
  2. For instance, if you’re commercializing a patent / IP that is now being brought into the company, the founder behind the IP is making a significant initial contribution.
  3. In another instance, if a non-technical founder is bringing an idea, and the technical co-founder will be building out that idea over the next few years, the latter’s future contributions are more significant.
  4. Let’s assume we allocate 30% towards initial contributions and 70% for future contributions. From this allocation, make equity splits across co-founders.
  5. To build on the example, let’s say there are 2 co-founders (A and B) and both get the same split for their initial contribution: 30%/2 = 15% each.
  6. However, co-founder A is expected to make greater future contributions than co-founder B down the road. Therefore, it is mutually decided, that A will get 2/3rds of the equity split for future contributions and B will get 1/3rd. Therefore, A gets: 70%*(2/3)=47% for future contribution and B gets 23% for future contributions.
  7. Summing 3 and 4, we get the following:
  8. A gets 62% and B gets 38% from the math above
  9. Now, step back and see if this equity allocation feels right and factor in any adjustments that we need to make. Typically, adjustments are made:
  10. For initial capital contribution to the business before it raises external capital.
  11. To account for opportunity cost of each founder.
  12. Any idea premium.
  13. Let us say co-founder B,
  14. Has put in initial cash in the business that warrants an additional 3% of equity.
  15. Is letting go of a high paying job because he believes in the startup and deserves an additional 2% of equity in the company.
  16. And let us say co-founder A,
  17. Initially had the idea, which makes the company unique and reckons the idea premium is worth 2%.
  18. Now netting out, A gives 300 bps of equity to B for these adjustments, with the net equity allocation yielding:
  19. A gets 59% of equity in the company and B gets 41% of equity in the company.

Final pointers:

  1. This is a simple framework to illustrate some parameters to consider while determining equity splits: a) initial contributions b) future contributions c) adjustments for initial cash, idea premium and opportunity cost.
  2. While the framework gives some analytical rigor, the guiding principle behind this discussion should be: what keeps the relationship thriving between the co-founders? As investors, we have seen this go both ways: equity splits create friction and disincentivize; fair equity splits do the opposite.
  3. Note: equal equity splits are the default outcome but not always the best outcome. It is worth doing the exercise above and having a candid discussion with your co-founder at the outset.
  4. Vesting matters, even for founder equity allocations.
  5. Baking in a process to keep certain % of the future equity allocations dynamic may work in some occasions. You trade certainty with flexibility.
  6. Worth reiterating: one should not miss the forest for the trees. How the other co-founder feels about their ownership in the company is more important than getting the precise bps right on the equity allocation.

To read more on this, we know Harvard Business Review has a ton of good content on this and Harvard Business School has a dedicated class on Founders’ Dilemmas that talks about such issues.

This question originally appeared on Quora – the place to gain and share knowledge, empowering people to learn from others and better understand the world.


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