Intro

So here we are - just a few co-founders with a big idea for our new startup and it's time to figure out how to split up the equity. This shouldn't be too hard - there are 3 of us, so we all get a third of the pie right? After today we can settle this discussion and get back to the fun part which is building our giant world-changing startup.

(Cue haunting music suggesting a foreboding moment!)

If we're like most startups, we're about to rush through one of the most important and expensive decisions we will ever make. We'll make it without really understanding the consequences of our decision now and the brutal pain of it later.

Splitting equity quickly is like getting married the moment you go on your first date. It sounds great to get things moving, but it's damn near impossible to unwind. Actually, getting divorced is way easier than breaking up a bad equity split! In either case, let’s figure out how to avoid that outcome!

Who I am and why am I so Anxious about Splitting Equity?

Before I go onto a nonstop rant about why splitting equity is such a big deal, let me tell you a bit about who I am and why this subject freaks me out so much I wrote a whole book about it!

I’m Wil Schroter, the Founder + CEO of Startups.com which helps over 1 million startups launch and grow. I’m a serial Founder myself, having built 9 companies over a few decades (which just means I’m old). In that time I’ve advised hundreds of startups of all sizes through the entire journey, and if all of that experience has taught me one thing, it’s this - Founders have no flipping idea how to properly split equity in a startup!

What you’ll read here is the summation of decades of conversations with Founders in guiding them through these decisions, but also my own personal experience in watching me and my co-Founders wrestle with equity challenges time and time again.

My goal with this course is to help my fellow Founders get the benefit of all of these experiences by not having to go through any of those experiences!

Why We Mess This Up

There are lots of reasons we mess this up, but it really comes down to just two that matter.

First, we don't really know what we're doing. None of us has started a company before, and if we have, we probably just did a quick split and moved on. No one was an "expert" in how to split up equity so we just went with the playground rules of "let’s split equity equally, fairly", regardless of whether that was the right way to do it. We just didn't know any better.

We simply don't know what questions we should be asking.

Second, we weren't ready to have a super uncomfortable discussion. Just about everything we need to discuss is really awkward. We have to ask tough questions like "How is my contribution potentially worth more than yours?" or "What happens if you leave - do I get your equity?" In some cases we may not even know each other that well, so broaching these discussions gets tabled for fear of creating an early rift.

We're about to avoid the most important discussions just because it’s uncomfortable.

Let's use the marriage analogy again. Imagine that we just met each other, and we are just both crazy about the show Stranger Things. Our passion for camp 80’s sci-fi is so strong we both think it's a great idea to get married. But before we do, shouldn't we ask some basic "big" questions about all of this? Thinks like "Do you want kids?" or “Do you really want to be married”, or the all-important "Did you think The Phantom Menace was a worthy follow-up to the original Star Wars trilogy?". These are probably some important questions we want to clear now versus waiting til our honeymoon to get the answers.

This is the very nature of splitting equity. Asking all the important questions before we commit to getting married. The good news is that there is a fairly specific formula we can use to walk through the big questions and come to some reasonable answers.

All we have to do is understand the fundamentals. Those fundamentals are based on helping avoid the 3 most costly mistakes in splitting equity.

We Want to Avoid 3 Colossal Mistakes

While our intentions are good - we just want to get on to building the business - that doesn't change the fact that if we motor through this too quickly, we're likely to make three giant mistakes in the process.

  1. We won't split equity based on actual contributions. By dividing the equity into equal splits, the freshman college student will get the same equity as the seasoned veteran with 20 years of experience. The person who put in $0 will get the same equity as the person who gave up their life savings. That's going to become a real problem when we start to actually build the business and notice the contributions definitely aren't equal – but the equity split is!
  2. There won't be any incentive for anyone to work harder. If we do a quick split of equity, and everyone has exactly what they "earned" before they did any work, what's the incentive to work any harder than anyone else? What if one of us works 10x harder than the others? All of a sudden our "fair split" seems like a bum deal.
  3. We won't have a provision to handle major change. There's a fairly good chance that at least one co-founder will run into a life situation where they have to leave the company. What do we do if they leave? How does that equity return to us? If it doesn't, do they just get paid for life? We need a plan that anticipates inevitable changes and makes it clear what happens next.

What this Course is Not

The focus of this course is to present all of the most salient challenges and options involved in getting a company formed and splitting equity. It’s not a Mad Libs-style walkthrough to supplement needing legal counsel or having our legal docs crafted.

Think of this more like a primer on what we might face – so that we know how to approach the legal docs.

Whether we decide to download some free form off of the Internet or enlist the services of the most expensive lawyer out there (please don’t), the most important part of this process is understanding the handful of major decisions we need to make, and why to make them. That’s what this course is all about. Actually crafting the docs – that approach is up to you.

The Goal

Our goal is to truly understand the major challenges and decisions we’ll need to make and walk through those issues methodically. What we’re most concerned about is isolating each issue where we may not have consensus so that we can focus all of our time and attention on just those items versus “the entire plan”.

When we’re through with this exercise, we’ll have a few critical elements to our Equity Plan in place:

We’ll have a stock structure setup so that we can award equity to current and future participants.

We’ll settle on a fair way to split the company’s equity

We’ll have a plan in place to account for changes to the stock as participants are added or removed

With that, let’s get this equity party started!

Next
Key Issues
  • Identify the 3 biggest pitfalls of handing out early equity
  • Come to a basic consensus on equity decisions among the team
  • Formalize each step of our equity arrangements before bringing in the lawyers


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