Questions

I'm bringing on a co-founder, how do I determine a fair equity split?

The new co-founder is willing to invest an equal amount of cash to what I am willing to invest, but I've spent 2 years already buidling up the business, following, & customer base. This is a B2C business. Assuming I can value what I've already built, how do I factor that into a future equity share?

4answers

Much like negotiating a salary or company valuation, your objective is not necessarily to assign the perfect value. Your objective is to add a highly motivated partner to your business, feel great about it, and get to work on the important stuff. You want to mitigate the possibility for resentment or the need to revisit this in the future.

There are so many things to consider, how can you find the perfect number, anyway? What is their target salary? What is yours? You've put in two years, but are they super charged up and going to bring new energy into the company that you badly need? What about their professional network? Will they bring future customers, team members or investors to the table? Was the investment you put in chump change for your situation while the new person is investing their kids' college fund?

If you try to solve this problem from the standpoint of determining the perfect value, you could spend weeks crunching the numbers. To Assaf Ben-David's point, this is a psychological problem of how to motivate two people and create a relationship that both people value. Today's company value has little bearing on that unless it's super important to your own motivation and sense of fairness. You could be fine with 60/40 and so could your new partner, and you're off to the races without all the headache.

Just try to find the number and vesting terms you can both live with no matter what happens. If you're both happy and motivated, you've achieved the objective. If you pick the perfect value but neither of you is very happy, you've failed.

There is a lot that goes into picking a co-founder. If you want to chat about this, please reach out.


Answered 4 months ago

Hi,
Both a good and tough question. As someone who has heard this question hundreds of time before (from startups that I worked with), I think that I can help:
There are 2 options / solutions to calculate the value/equity: the financial solution (cold numbers) one, and the psychological one.
From a financial aspect, you can calculate the current value of the business (if need be, I'm happy to explain how this is commonly done). This is the value/worth of your hard work over the last 2 years. Once you've added a number to it, you can now know (more or less) how much equity/shares your new partner 'should' get in return for his/her investment.
The problem with this option, is that we are not robots - we have feelings, egos and independent thoughts. This means that no matter how accurate your calculations might be, your partner might still value the business differently (if higher - then no problem. If less = arguments arise). This leads me to the second option: the psychological calculation.
You are taking on board a partner. Assuming you're not only bringing this person into the business for his/her investment, this means that you have reached the conclusion that you want this person with you, and/or or that you need them for their skills. If so, this means that your future partner has value - in addition to the money he/she is bringing in. In which case, the best option is to decide with yourself how much you are willing to give for this 'value'. Then, invite the person for coffee, and ask them how much they would expect in return: if they say a lower number than you thought of - great (you'll both be happy). If they ask for more than you thought, explain and pursued why you are offering that specific amount. There are numerous methods to reaching 'middle ground' - usually through means of vesting. For example: your partner would get X% equity, and every Y months/years they would get Z% more (alternatively he/she could get more only if they achieve certain milestones or goals).
2 last tips:
1. It is better having 50% (for example) of a bigger cake, than having 100% of no cake (or 70% of a much smaller cake).
2. whatever you do, make sure that you have a decent founders agreement. Fall outs between founders/business partners is one of the top 3 reasons that startups/businesses fail.
I am happy to prepare you for the meeting, help you analyze the percentage you should offer, and/or draft the founders agreement should you need one.
Best of luck.


Answered 4 months ago

Be careful! The vast majority of founders and those who advise founders attempt to solve this problem with fundamentally flawed logic. The primary mistake is basing the equity split on unknowable, future events such as a founder's expected commitment to the company or the creation of future value.

There is, however, a way to get this right every time.

Startups are unique in that they don't pay for inputs that more established companies are expected to pay for such as salaries and expenses. The amount that most companies are expected to pay is known as the fair market value.

If the company does not pay, the unpaid amount is essentially a bet on the future value of the company. It's impossible to determine the future value of any company, but it's easy to observe the fair market value of the bets.

For two years you have placed bets equal to the unpaid portion of your fair market salary and any expenses covered by your personal or investment dollars.

The new guy will join you and he, too, will place bets in the form of unpaid compensation, etc.

The betting will continue until the company has enough money to start paying at breakeven or Series A investment. When this happens, you can calculate each persons bet relative to every other person.

A person's share of the equity, therefore, should be based on that person's bet. This is literally the only logical way to divide up equity.

This is the basis of the Slicing Pie model for equity splits. It's the only equity model based on observable facts and it is used by startups all over the world.

You can learn all about it at www.SlicingPie.com or by setting up a call with me here on Clarity.fm. As of this writing, I've done almost 800 calls on exactly this topic with hundreds of 5-star reviews.

There are lots of ways to split equity, but only one way that makes it fair.


Answered 4 months ago

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