-How to divide ownership of a company?
[Below is my answer to the question How to Divide Ownership of a Company in a Startup? on Quora.]
When considering this issue , many people will focus on incentivizing the founders as well as issues of equality and equity. I would recommend a deep understanding how roles and responsibilities will be divided prior to discussing the equity split.
You need to tackle:
- Decision Making
- Vesting Schedule
Even on day one, the team needs to understand who will be making decisions on which issues and trust each other. If all team members take an “equal” share, then there is a tacit presumption that the team will be making critical decisions together. If not addressed, that could lead to issues down the line as everyone begins to interpret “critical” decisions differently.
If the CTO and the CEO disagree on a strategy, will the CTO go along with the CEOs vision? Will the CEO accept whatever technology solution the CTO proposes to back his plan?
Discussing these issues early on can not only save a lot of grief when decision time about “how to divide ownership of a company” comes, but it should quickly become clearer as to who is taking more responsibility and who will be burning the midnight oil.
I am a big fan of balance of power, in government and in business. For a four person group, a deadlock should not be possible with equity voting. A deadlock is the death of company.
A CEO has to be able to make decisions and have everyone back him up even if they disagree, but no CEO should be able to make decisions for the entire company arbitrarily with any recourse. A vote of the owners should be able to remove the CEO if there is a lack of confidence in his / her vision and management abilities.
The CEO should never own >51%. While there is nothing “wrong” with that… but if he / she does, it should be understood that there is one founder and three employees.
(CEOs…feel free to disagree.)
Definitely have a vesting schedule. A good four year vesting schedule should keep everyone honest.
If a co-founder was entitled to 30% and is putting in 10% of the effort, then a vesting schedule allows the group to come together, be honest about the situation, and adjust the free rider’s %. If the free rider doesn’t agree, then lucky for you, their shares haven’t vested yet!
Kick ’em out with only 2% vested and call it a win.
You should also seriously consider having a shotgun clause such that the other members can buy out the free rider.
A shotgun clause essentially states that the company (or perhaps another founder) can offer to buy the free rider out. If the free rider doesn’t like the deal, he / she can offer the same terms to buy everyone else out. This is risky and has very debatable merits…but it’s worth considering and discussing.
Lastly, it’s worth considering whether ANY shares should vest before the first year. There are many pros and cons to this which I won’t go into. Just consider whether or not someone who works for only the first three months should get anything at all. After all, they could just be slowing you down.
Once it’s clear who is doing what and how decisions are handled, the haggling can begin…
…but wait? Is there haggling? Personally, I like to work with people I respect and who respect me. I’m not too unusual in that regard.
If your discussion devolves into haggling, it’s a bad sign. Everybody in the team should be looking for a win-win solution. The CEO should be insisting that the CEO gets his fair share so that the CTO works hard, same thing for the CTO.
Many people will disagree with this, but I like to take the first equity offer given to me and undercut the offer. If my ‘partner’ says, “Yes…you’re right. You should only get 10%.” It’s not someone I’m going to work well with. Best to find that out early and back out of the deal.
“If you offer me 1% of the equity, I’ll do 1% of the work. If you offer me 25% percent, I’ll do 25%. If you offer me 60%, I’ll insist on only taking 25% and I’ll work 24/7 for you.” – http://grasshopperherder.com/tha…
Investors are great at dealing with equity while talking about how to divide ownership of a company. Learn from them.
An angel of VC has done it all before and know all the tricks with vesting schedules, what shares the founders should get and so forth. It would be very valuable to bring an investor in very early as an advisor to help show you how things are split up and under what conditions.
Not only will they give you great advice and help you set up the company in a structure that won’t have to be completely redone if you go for funding, but they may turn out to be your first investor.
Failing that, read VentureHacks.com They offer great advice on dealing with vesting, equity splits, and so forth.