First things first.
When you’re planning to start a company with someone, it’s important you establish the ownership split from the beginning. Dividing the company between co-founders can be a contentious issue. Sometimes it’s contentious from the start but, if it’s not addressed, it often becomes extremely contentious later on. You should determine ownership as early as possible after a proper discussion, because you don’t want to discover you disagree when the stakes are high.
But how do you split the company? You do it through ‘equity’. When you start a company, you create shares in your company. These shares are commonly called equity. While you’re running the company, the equity split – meaning the percentage of shares you have – determines which governance decisions you can vote on and other rights as a shareholder. And when the company is sold, the equity split determines how much your stake in the company is worth. If you have 10% of the company and the company sells for $10million, excepting some details, you’d expect to get around $1million.
Equity is forward looking
We recommend an equal split of ownership for co-founding teams where you’re starting from scratch. In a startup, you’re assuming that almost all the value of that equity will be created in the future. On Day One, the shares are worth zero. Value is created by what you do together. If you’re joining a business that already exists, or if you’re exploiting the previous work of one co-founder, you might reach a different agreement, but the principle here is that equity is forward-looking. It’s not based on intellectual property created in the past.
Imagine you agree to a 60/40 split today. Fast forward ten years and the company is worth a billion dollars. Do you really feel that the difference in what you started with was worth $200 million after working side-by-side for ten years? Almost certainly not. Everything that happened prior to the birth of the company is essentially a rounding error compared to the amount of value that you’ll create together if you succeed.
This is why we recommend a 50/50 split. If you create a situation where one person resents that they own 20 per cent less or 15 per cent less of the company than the other person, even though they’ve been there for 99 per cent of the company’s life relative to the other person, you’re eventually going to be in a situation where that resentment poses more problems than having had an equal split from the start.
Equity does not make decisions
Split also factors into operations and governance. We’re often asked who gets to make the final decision in a co-founder relationship. If ownership of the company is split equally, how do you settle disputes when there’s no ultimate leader? We’ve been fortunate to be involved in over 300 companies, and we’ve never seen a company that makes voting decisions based on the number of shares each person holds.
This is why it’s important to separate how the company operates versus how the company governs. People overestimate the importance of voting and underestimate the importance of influence. ‘The most existential decisions (e.g., whether to sell the business) should be taken genuinely with equal weight to the views and aspirations of both founders, assuming an equal equity split, which I usually advocate,’ said investor Chris Mairs.
Even if the equity split was uneven, the person holding the higher share would get nowhere by using their larger share to trump the other person. That kind of power move builds resentment between co-founders, and resentment can kill a partnership. If you want to have a healthy partnership, it’s best to have an equal split from the start, and to discuss early on how you will make decisions when there is a difference of opinion. Chris Mairs said, ‘At the day-to-day level, while the CEO needs to seek consensus from the other founder – and indeed from all stakeholders – the non-CEO founder equally needs to give the CEO the freedom to execute efficiently.’
Agree up front
In a startup, the ability to make a quick decision is important. The majority of business decisions are matters of judgement – if you make the wrong choice, you can fix it later. When it comes to company ownership, however, a lack of clear agreement often creates a dysfunctional relationship between the cofounders. So when your co-founder relationship determines the outcome of your company, it’s best to agree your equity split fair and fast.