This guest post in the What Startups Need to Know series comes from Charlie Sommers, a startup attorney at Founders Law. Charlie works closely with early-stage founders to navigate everything from formation to fundraising, and brings a sharp, founder-first perspective to the topic of splitting equity.
There are many benefits to working with a co-founder while trying to launch and scale a startup. You may find that you work better in a team, and believe that the combination of your skill sets will lead to faster traction or a better reception from customers. Additionally, you may want to be attractive to VCs and angel investors, who often prefer to invest in co-founder-led teams.
It is important to remember that co-founder relationships are nuanced. While co-founders should have a shared goal of growing their startup, each has individual interests that can either advance or hinder the business mission. In my experience, co-founder disputes are the number-one reason that early-stage startups fail.
In Harvard Business School professor Noam Wasserman’s book The Founder’s Dilemma, Wasserman writes that 65% of high-potential startups fail due to co-founder conflict. The high-stress nature of a co-founder relationship can turn combustible, with high-profile founder disputes driving headlines at companies from Snapchat to Facebook.
One topic that co-founders need to agree on is how to split equity. The decision on how to split equity is stressful, as it is both very personal and can have significant implications for each founder individually. But having complete faith in a mutual decision is essential for the long-term health of the co-founder relationship.
All else being held equal, I often advise co-founders to split equity equally (e.g., in the case of two co-founders, 50/50). Giving each founder half of the pie allows them to be true co-adventurers while working together to achieve their business goals. This seems to be the most agreeable outcome for most founders in the long run. This view is shared by many, especially VCs, who consider uneven splits a diligence red flag, absent extraordinary circumstances. The equal split approach limits the chances of a disruptive dispute later because it’s less likely that one founder will feel slighted as the company scales.
That said, there are still plenty of instances when an unequal distribution of equity actually makes more sense:
When to Consider an Uneven Distribution of Equity
1) Full-time vs. Part-time
Startups with full-time founders tend to have greater success. If one co-founder is working on the startup full-time, and the other is only working nights and weekends, I tend to recommend a majority-minority equity split. This is intuitive; each founder’s consideration is different, and the one who is putting forth the most effort should have a higher percentage of the cap table.
2) Intellectual Property (“IP”) Contributions
If one co-founder contributes their own crucial intellectual property into the business, and the other co-founder does not make a similar contribution, the co-founders may agree on an unequal equity split. This allows the IP contributor to have higher financial upside upon exit in exchange for the IP sacrifice.
This makes sense when you think about what each founder gives up for equity in the business: If Founder 1 decides to trade future time, and Founder 2 trades both future time and preexisting IP that provides the startup with a competitive advantage, Founder 2 deserves more shares on paper.
An alternative to the above is an equal share of equity, complete with a slightly more complex IP licensing and/or royalty arrangement. That’s outside the scope of this article, but best discussed with your startup’s attorney at incorporation.
3) Differences in Monetary Investment
Sometimes, one founder contributes more money into the venture than another at incorporation, and expects to be compensated through outsized equity ownership in the startup. This is actually a structure that I tell my clients to avoid, because it can get particularly confusing.
For example, founders may justify the equity split by making an arbitrary valuation at their company’s incorporation stage, before any operations have begun. Instead, in these cases, I tell clients to split equity equally and have the investing founder(s) invest the additional capital through a Simple Agreement for Future Equity (SAFE), like any other institutional or angel investor would. This, in my opinion, is the more equitable way of handling these situations. It also pre-prices the equity appropriately, shows “skin in the game” to future investors, and allows at least one founder a seat at the preferred stock table when the SAFE converts.
Equity isn’t just compensation—it’s commitment. And a powerful motivator and a founder’s best way of capturing outsized returns.
Therefore, splitting equity is often the first serious conversation that co-founders have, setting the tone for what’s next together; it may even be the first time founders disagree. Splitting equity fairly, in a way that makes each co-founder happy, should be a startup’s first order of business.
About the author: Charlie Sommersis a startup and venture capital attorney at Founders Law, based in Chicago, IL. He represents founders, startups, and venture capital funds in a wide variety of corporate transactions, including raising capital and navigating issues associated with rapidly growing startups. He can be reached at csommers@founderslaw.com.