How much should the cofounder equity be – Split the pie

How much should the cofounder equity be – Split the pie

Cofounder Equity – Learn to split the Pie

When you come up with a profitable and marketable idea, it’s high time for you as a founder to realise that ‘Two heads are better than One’. At this point of time, you search for a co-founder. If you are lucky enough to find someone of your preferred mentality, things are going to be challenging.

One of the most important Challenge is splitting the equity among the founders. This is a crucial step in your startup, and believe me, this discussion room has shut down much more startup firms than you can imagine. The discussion room must be filled with a verbal, mental and emotional conscience.

Assuming you are the founder, with a mind-blowing marketable idea. Your co-founder is going to take care of the technical aspects of developing the software you need. According to your co-founder, he’s taking up a high-end task of developing the whole software, you would need to run the business. He’s the one going to burn the midnight oil to make your business run at the initial stages. At the same time, just because you came up with a profitable idea, doesn’t mean you have a grant for 90% equity. So here comes the splitting of the pie.

Cofounder Equity : What should you think about 50/50 equity split?

A 50-50 equity split might be one of the worst decision you may take as a founder. A 50-50 equity split just signifies your low confidence level as a founder of a firm. Always remember, a technical co-founder might burn the midnight oil to prepare the software in the initial months, and you as a founder would be waiting simply for the software to get ready. So, the activities of a co-founder get bestowed as a higher one at that instant. In fact, coming down to reality, after months of preparation of the technical part, the founder’s task of marketing, user acquisition and other non-tech aspects takes a huge effort. Also, you always have the option to hire some other technical guy to complete your software.

So now, think a fast-forward of 2 years from the present. Is a 50-50 equity split reasonable?
Well, definitely not. The biggest deal now is to make the co-founder understand this with all mental, emotional and verbal conscience.

Also, it’s worth noting that your firm is expected to run for several upcoming years. Will the co-founder stay in your firm for such long time? You cannot allow a co-founder to quit the company and also carry a huge share in the firm. That’s where the vesting of equity comes into the role. The discussion of splitting the pie goes incomplete without mentioning the vesting period.

What to consider while splitting the equity ?

I would recommend you to go via a logical framework that would eventually evaluate the co-founder’s or any employee’s contribution to the success of the firm. The logical value of Input, Risk that was taken and dynamic changes in input with time should be considered in the allocation of equity.

Also, now we need another logical framework to recover the equity when a co-founder or employee leaves the company. A good framework will look into the contribution of a person as well as the nature of separation. If the contributor separates due to his/her own fault (may be failing to work for the firm) or if the firm decides to layoff some of its employees (may be due to some restraint) – At these situations, the framework should support and benefit both the company and the contributor.

Characteristics for splitting the cofounder equity:

1. The First time experience of working in a startup environment before.
2. The Achievement of the previous startup the co-founder had worked in regards to his/her contribution alone.
3. Activity of the person with regards to the firm (CTO / COO/ CMO/ other)
4. Willingness to work full time only when the firm gets funded
5. All Monetary contribution to the firm till current time.
6. An Estimate of rate per hour that can be expected for the contribution of the co-founder to the firm
7. Number of hours the co-founder spent working on this project (e.g. average number of hours worked per week x number of weeks worked)

Splitting the cofounder equity – Bottom Line

Based on the evaluation above, splitting of equity can be evaluated. Also, a co-founder equity of maximum 40% can be suggested, but remember, it’s always subject to evaluation. If you believe he could be the only person in the whole world who you crave to do this activity, you can go with 50% equity sharing.

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Should you consider equity share over salary in a startup?

Should you consider equity share over salary in a startup?

Equity share :

If you are on the verge of joining a startup, ‘equity compensation’ would be the single most incentive a firm would attract you towards. Startups are known for their bankrupt bank accounts and their needs to develop the product with the existing cash. This renders the employees an incomplete or a cut-down salary or in a more raw stage null salary incentive.

Since your salary cash is going to be less than the market rates, the startup firms assure you a little stake in the situation. Equity compensation helps the firm save some cash and improve the product and operations. Now, hands down to those who are weighing an equity – Keep in mind equity has it’s own risk and benefits.

Risk and Benefits of Equity share over salary:

1. Equity share is not hot-cash but a steady walk to money:

The main risk of equity compensation is that you are not guaranteed to benefit from the stakes. There are a lot of factors that affects the stock price and in-turn your equity benefit values. Firstly, your startup has to succeed and remain in operations. In case your startup shuts down, despite your efforts, your stake value flows down to zero. Contrarily, assuming your startup succeeds and acquires enough consumers, there is a high chance for your stock price to riseup.

Let us look at an example,

When amazon entered IPO initially, it’s stock rate was $15 on an average which is same as the stock owned via equity by employees. Coming down to 2016, each stock of amazon worth $713. That’s a huge increment and thus, the employees who had worked for amazon intially with equity compensation would be able to gain a lot. That is how equity compensation works and benefits you.

Also Read: Amazon Founder and CEO Jeff Bezos gets richer by $2 billion in an instant after stock price surge

2. Varying Equity share Structure and Tax hurdles:

You can be compensated with equity either in form of ‘Incentive Stock Option’ (ISO) or in the form of ‘Restricted Stock Units’ (RSU). Each form of equity compensation packages a different tax consequence. It’s always good to listen from the firm about the type of compensation offered.

Jumping onto explaining the tax hurdles, let me tell you, equity defines your net worth. You will be stuffed with the tax burden even though your stock value falls. Thus, it’s real important to know when to cash-out your equity for cash and when to save it in form of equity itself.

Final Statement:

Equity share payments allow startup to manage financial struggles, when the firm could not afford to pay its employees. While Equity compensation lures the eyes in the form of huge cash tomorrow, it is badly subject to higher risk factors. Equity Compensation is a very strong platform for startup firms to keep their employees motivated with less payouts.