How to Split Equity Between Co-Founders (and Stay Friends)
Starting a company with someone is like entering into a high-stakes relationship that blends money, vision and emotions. Like any relationship, it requires trust, communication and clear boundaries to thrive, and one of the earliest and most critical conversations you will need to have is how to split the equity ownership of the company between the founders.
While it might seem like a simple question, a hasty decision (i.e., “let’s just go 50/50”) can cause deep problems down the road. In his 2012 book, The Founder’s Dilemmas, Noam Wasserman estimated that around 65% of high-potential startups fail due to conflict among co-founders, and though more than a decade has passed since Wasserman’s book, the dilemmas remain. This article explores key questions and frameworks to help you navigate equity splits thoughtfully and avoid common mistakes that can lead to co-founder conflict.
Why You Cannot Wing It
Founders often delay conversations about equity because they are uncomfortable or assume things will “work themselves out.” However, equity is not just a legal formality. It is a blueprint that defines how ownership, control and accountability are structured within the company. Avoiding this discussion can have detrimental consequences in the long run.
Equity determines:
A lack of clear communication can turn into misunderstandings and messy splits, which in turn may lead to resentment, failed fundraising or even lawsuits. Clear, transparent agreements help avoid these pitfalls by laying a strong foundation for the future.
What Really Drives a Fair Split?
There is no magic formula, but here are five core factors to guide your discussion along with basic examples that illustrate how each factor can play out when determining a fair equity distribution:
3. Risk Tolerance
Who is quitting their job, self-funding the company or going without pay? Founders undertaking the most risk should be compensated accordingly.
4. Experience & Network
Who has previously launched a company, raised capital or built key relationships? A founder with startup experience or investor connections can significantly increase the company’s odds of success. Such advantages should be reflected in the equity percentages.
5. Vision and Commitment
Are all co-founders equally invested in the long-term journey, or is one eyeing an exit in 12 months? It is important to ensure that future goals are aligned to help avoid conflicts down the line.
Tools and Tactics That Help
Ask These Questions Up Front
These are not easy conversations. However, having them now can save your startup and your friendships down the line by building trust and commitment.
Conclusion
Equity is much more than just a number. It is a reflection of the roles, commitment and unique value each co-founder brings to the partnership. The “fairest” split is not the most symmetrical or convenient, but the one that is honest, documented and built for the long haul.
As a result, taking the time to get equity right is an essential part of building your company. The time and effort you invest today will pay off for your company and relationships tomorrow. That said, don’t wait too long because granting equity once value has been created introduces its own tax complications, including a delay in starting the clock for your Qualified Small Business Stock (QSBS) holding period.
While it might seem like a simple question, a hasty decision (i.e., “let’s just go 50/50”) can cause deep problems down the road. In his 2012 book, The Founder’s Dilemmas, Noam Wasserman estimated that around 65% of high-potential startups fail due to conflict among co-founders, and though more than a decade has passed since Wasserman’s book, the dilemmas remain. This article explores key questions and frameworks to help you navigate equity splits thoughtfully and avoid common mistakes that can lead to co-founder conflict.
Why You Cannot Wing It
Founders often delay conversations about equity because they are uncomfortable or assume things will “work themselves out.” However, equity is not just a legal formality. It is a blueprint that defines how ownership, control and accountability are structured within the company. Avoiding this discussion can have detrimental consequences in the long run.
Equity determines:
- Who controls the company?
- Who gets rewarded if things go well?
- Who bears the loss if things fall apart?
A lack of clear communication can turn into misunderstandings and messy splits, which in turn may lead to resentment, failed fundraising or even lawsuits. Clear, transparent agreements help avoid these pitfalls by laying a strong foundation for the future.
What Really Drives a Fair Split?
There is no magic formula, but here are five core factors to guide your discussion along with basic examples that illustrate how each factor can play out when determining a fair equity distribution:
1. Time Commitment
Is everyone full-time from day one? If someone is part-time or joining later, that should likely impact their equity. Time is one of the most measurable commitments, especially in the early stages.
Is everyone full-time from day one? If someone is part-time or joining later, that should likely impact their equity. Time is one of the most measurable commitments, especially in the early stages.
Example: A and B co-found a blockchain startup. A quits her job immediately and commits to the company full-time. B remains employed and plans to work for the startup only on evenings and weekends for the first six months. Rather than a 50/50 split, they agree on an initial equity split giving a larger stake to A, which can be revisited once B commits full-time as well.
(For additional considerations on “moonlighting” click here.)
2. Role and Contribution
Who is writing the code, designing the product or closing the deals (including financing)? Future responsibilities matter as much as past work. Evaluate each person’s short-term and long-term value to the company.
2. Role and Contribution
Who is writing the code, designing the product or closing the deals (including financing)? Future responsibilities matter as much as past work. Evaluate each person’s short-term and long-term value to the company.
Example: A and B co-found a software company. A handles the technical side of things, responsible for coding and building the platform from scratch. B is in charge of branding and marketing strategy. While both roles are important, they agree to give A a greater share in the equity split, acknowledging that A’s initial contribution is more time-consuming and critical for the company’s launch.
3. Risk Tolerance
Who is quitting their job, self-funding the company or going without pay? Founders undertaking the most risk should be compensated accordingly.
Example: A and B are launching a wellness app. A turns down a job offer to work on the app full-time and takes out a loan. B works for the startup on evenings and weekends but retains her employment. Recognizing this disparity in risk, they agree on giving a larger stake in the equity split to A.
4. Experience & Network
Who has previously launched a company, raised capital or built key relationships? A founder with startup experience or investor connections can significantly increase the company’s odds of success. Such advantages should be reflected in the equity percentages.
Example: A and B co-found an AI startup. A brings immense startup experience and a powerful network of investor connections. B is newer to the field with less experience and fewer contacts. Accounting for the strategic value and leverage that A adds to the startup, they agree on an equity split that gives a larger share to A.
5. Vision and Commitment
Are all co-founders equally invested in the long-term journey, or is one eyeing an exit in 12 months? It is important to ensure that future goals are aligned to help avoid conflicts down the line.
Example: A and B start a media platform. A plans to exit in a few years to pursue other interests, while B is dedicated to the company long-term. They adjust their equity split accordingly, giving B a larger share corresponding with her greater commitment.
Tools and Tactics That Help
- Start with a conversation. Before diving into a formal agreement, spend time discussing each co-founder’s goals and visions for the company. Misaligned expectations are at the root of most co-founder conflicts. Clear and timely communication helps iron out misunderstandings before they become serious disagreements.
- Use a framework. Instinct is not enough when there is equity involved. Utilize structured tools and models to quantify each founder’s equity based on their contributions. Using an established framework allows for clear documentation of how the split was determined and can also help co-founders avoid vague or emotional negotiations.
- Set vesting terms. A standard vesting schedule consists of four-year vesting with a one-year cliff. A cliff requires a co-founder to stay with the company for a minimum time period to earn and retain any equity, protecting the company from situations where a co-founder leaves the company early but keeps the equity.
- File the 83(b) election. When a vesting structure is used for Founder’s Stock, it is almost always a good idea to file an 83(b) election with the IRS within 30 days of issuance. Promptly filing this election can lead to significant future tax savings. (See our Post-Incorporation Checklist for Startups.)
- Put it in writing. Drafting a written founders’ agreement is essential. A simple founders’ agreement might include provisions addressing clear roles, ownership, voting rights and what happens if someone exits early.
- Revisit your agreements as your company grows. As the business evolves, so do individual roles and contributions. An equity split should reflect and adapt to these changes.
Ask These Questions Up Front
- What happens if one of us decides to leave the company? It is critical to establish what happens to their equity if that occurs.
- How will we make major decisions? Defining how decision-making processes and voting rights are affected by each founder’s equity share can help avoid future conflicts.
- Do we agree on growth vs. exit strategy? If one founder is committed to taking on the responsibilities and risks of scaling the company while the other only sees the company as a short-term opportunity, equity split should be distributed accordingly.
These are not easy conversations. However, having them now can save your startup and your friendships down the line by building trust and commitment.
Conclusion
Equity is much more than just a number. It is a reflection of the roles, commitment and unique value each co-founder brings to the partnership. The “fairest” split is not the most symmetrical or convenient, but the one that is honest, documented and built for the long haul.
As a result, taking the time to get equity right is an essential part of building your company. The time and effort you invest today will pay off for your company and relationships tomorrow. That said, don’t wait too long because granting equity once value has been created introduces its own tax complications, including a delay in starting the clock for your Qualified Small Business Stock (QSBS) holding period.