Starting a business with a group of co-founders always sounds like a good idea. You can bounce ideas off each other, make sure each and every single decision you make is sound, and find investors for your up-and-coming company.
It’s exciting to be working with people who pretty much share the same values, ideas, and ideals as you do. However, as with all relationships, it also comes with its fair share of challenges.
One of the most crucial decisions you’ll make as a group is how to split equity amongst yourselves. This can be a tricky and sensitive issue to navigate, but getting it right is essential for the long-term success of your company.
In this guide, we’ll take a look at how to split equity among co-founders and provide some best practices for creating an equity split agreement that works for everyone.
So buckle up, grab a cup of coffee (or two!), and let’s dive in!
What Does Equity Split Even Mean?
Co-founders typically split equity when starting a new company. Equity represents ownership in the company, and it’s typically divided among the co-founders based on their contributions to the business.
Now, equity split refers to the division of ownership in a company among its owners. This is typically represented by shares of stock, which entitle the owner to a percentage of the company’s assets and profits.
What are the Factors to Consider when Splitting Equity?
Here are a few of the most important factors you should think about when you’re about to split equity among your co-founders:
Contributions
One of the most important considerations when splitting equity is each co-founder’s contributions to the company. This includes things like:
- Time and effort spent on the company
- Expertise and experience brought to the table
- Financial investments made in the company
Ideally, each co-founder’s equity stake should reflect their contributions to the company. For example, if one co-founder has put in significantly more time and effort than the others, they may be entitled to a larger equity stake.
Roles and Responsibilities
Another factor to consider is each co-founder’s role and responsibility within the company. So ask yourselves:
- Who is responsible for day-to-day operations?
- Who is responsible for long-term strategy?
- Who is responsible for fundraising and investor relations?
Just like your contributions, each co-founder’s role within the company should be reflected in their equity stake. For example, if one co-founder is responsible for day-to-day operations, they may be entitled to a larger equity stake than someone who is more focused on long-term strategy.
Future Contributions
Lastly, it’s also important to consider each co-founder’s future contributions to the company when splitting equity. This includes:
- Future time and effort spent on the company
- Additional financial investments made in the company
- The potential value of any intellectual property or other assets that they bring to the company in the future
While it’s impossible to predict the future, it’s crucial to make sure that each co-founder’s equity stake reflects their potential future contributions to the company.
What are the Best Practices for Creating an Equity Split Agreement?
Once you’ve considered all the factors listed above, it’s time to create an equity split agreement. These are the best practices you should keep in mind:
Get Everything in Writing
We cannot stress this enough: Make sure every little detail you’ll discuss with your co-founders about your equity split agreement is in writing. This ensures that everyone is on the same page and that there are no misunderstandings down the line.
Consult with a Lawyer
When creating an equity split agreement, don’t forget to consult a lawyer. They can help ensure that everything is legally sound and that there are no loopholes or issues that could cause problems in the future.
Be Flexible
Having an equity split agreement in place is great, but it’s also important to be flexible. As your company grows and evolves, it may be necessary to adjust the equity split to reflect changes in contributions, roles, and responsibilities.
Consider Vesting Schedules
A vesting schedule is a way to ensure that each co-founder’s equity stake is tied to their continued involvement in the company. This can help prevent situations where a co-founder leaves the company but still retains a large equity stake.
Under a vesting schedule, each co-founder’s equity stake would “vest” over time, meaning they would earn a larger percentage of their equity over a set period (usually three to four years). If a co-founder were to leave the company before their equity fully vested, they would only be entitled to a portion of their equity.
How Can I Protect Myself?
While it’s important to be fair and transparent when splitting equity among co-founders, you also need to know where to draw the line and protect yourself and your interests. Here are some things to consider.
Non-Compete and Non-Disclosure Agreements: To protect confidential company information, have all co-founders sign non-compete and non-disclosure agreements.
Buy-Sell Agreements: Consider a legal contract outlining how shares in the company can be bought or sold if a co-founder decides to leave or if there is a disagreement.
Intellectual Property Ownership: Determine early on who owns the company’s intellectual property, including patents, trademarks, and copyrights.
Consult with a Lawyer: A business lawyer can help draft an equity split agreement, review legal documents, and provide guidance in protecting your interests.
By taking these steps, you can ensure that your equity split agreement is fair, transparent, and legally sound.
Conclusion
Splitting equity among co-founders is a critical aspect of starting and building a successful company. It sounds complex and daunting, but fortunately, there are several best practices and factors to consider that can make the process smoother and more transparent.
So take time to get your equity split agreement right, consult with experts when needed, and enjoy the exciting journey of building your business together!
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