One of the biggest questions facing startups is how to divide up equity between the founders. Research indicates founders often don't spend enough time thinking about this question.
Dr. Jones, Mr. Black, and Ms. Smith created a digital health company. Dr. Jones came up with the idea, Mr. Black invested most of the money, and Ms. Smith put in most of the sweat equity to get it going. How should the founders’ equity be divided?
a) According to who invested the most
b) Divided equally
c) Depends on the results of a negotiation between the parties
d) Depends on future contributions, and in what form, in the future.
If you guessed any answer but (b), you are on the right track.
How to split equity is one of the most important decisions a founding team will make. Noam Wasserman, a Harvard Business School professor who has spent 15 years studying high-stakes decisions at more than 6,000 startups, says entrepreneurs too often split equity with what he calls a “quick handshake.” Nearly 40% of startup teams spend a day or less hammering out an agreement, he says. A large subset of those go the even-steven route. An even split may be the best answer, but if you land there by default rather than after a thorough discussion of expectations and contributions, your team will probably suffer.
Recent research also indicates that startups with even splits are less likely to attract investors, and end up with lower valuations.
Splitting founders’ equity is just the beginning of several future crucial conversations. The factors that come mostly into play have to do with who thought of the idea, who reduced it to practice, who invested and how much and who put in the most sweat equity.
Of course, other emotional factors come into play when dividing up the pie that might drive the final decision. However you do it, however, you will be sending a signal to many inside and outside of your team how you deal with conflict and make tough decisions. Spend the time and effort to get it right from the start.