By Fernando Berrocal

Co-founder disputes are the main reason for the failure of new businesses, according to a Harvard study, they account for up to 65% of all startup failures. Disagreements over startup ownership distribution can turn into a real problem between co-founders and pull them apart at a rapid rate. Despite this fact, according to Harvard Business Professor Noam Wasserman's assessment of over 6,000 businesses, roughly 40% of them spent less than a day considering the equity split between members of the founding team.

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Is Equal the Same as Equitable?

It's easy to see why co-founders, particularly first-time entrepreneurs, would brush over such an emotionally and financially significant issue at such an early point in their partnership. Saying "Let's split 50/50" in the context of a typical startup equity structure provides an easy solution to the problem and the appearance of justice in the distribution of founder shares. However, it's uncommon for founders to split the work that makes a business work equally, a fact that Venture Capitalists (VCs) are well aware of: the same Harvard study indicated that businesses with equal equity splits had a harder time raising funds than their immediate competitors. In some circumstances, having no "deciding" vote can lead to a conflict among the founders.

The Madness' Methods:

Doing your homework, like everything else in the early phases, is key to splitting equity shares equally. However, this isn't always as straightforward as it seems. Despite inevitable complaints to the contrary, the "original idea" founder of your business isn't usually as significant as the technical founder who makes it happen, and the most experienced founder isn't always the most valuable professional in that business. There have been numerous rubrics, algorithms, and matrices dedicated to establishing this split and ensuring its fairness, but most businesses discover that it comes down to an assessment of each startup founder's capabilities, availability, and value generated. At this point, you could ask the following questions:

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• Do they intend to work part or full time?
• Are they mostly technical or sales-oriented?
• Do they have control over the business's finances?
• Will they be the main driver of the business's success?
• Are they putting their own money into it?
• Is there any Intellectual Property (IP) they're bringing to the business?

Good equity allocation decisions will take time, and they will most likely begin with clear dialogues about each founder's duties and roles, which will likely vary as the organization grows. Since equity numbers are not written in stone, your equity image may alter when your responsibilities change.  It's a good idea to think about your business plan, specifically your plans for the following four years: How much of the organization's success will they be responsible for if everyone performs as expected? You might even discover that a 50-50 split is the best distribution for your organization after thorough analysis. In situations like this, many businesses may split 51/49 to avoid bottlenecks.  The most important thing is that you make a well-thought-out decision.

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Dynamic Split:

This is a method of allocating equity based on how much each founder contributes. The goal is to determine the worth of individual contributions such as time in comparison to other team members. Cash, important relationships with potential customers and investors, and time are just a few of the variables. They all have a monetary value and the dynamic model assigns a relative value to each team member's various contributions. By dividing the contributions of one individual by the contributions of all team members, this equitable method of splitting equity ownership determines the right percentages. This gives an exact ownership calculation based on a person's actual influence on the business. Unlike a fixed-split model, a dynamic model will alter over time as additional contributions are made.

The dynamic split approach is guaranteed to be fair for all participants because all values are relative, and it awards equity stakes based on the level of involvement. A vesting schedule for founder stock should be established. An accurate vesting schedule prohibits a founder from walking away with a full equity grant after the first year in business. If a founder's shares have a vesting timetable, they could lose a lot of money if they leave the business early. It's also your best protection against a failed partnership damaging your business because it allows you to purchase back any unvested shares from departing founders and re-allocate them. The vesting schedule is generally, but not always, the same for all founders, if not all workers, in the interest of fairness.

Inking the Documents:

The parameters of co-founder equity are usually wrapped into the "Articles of Incorporation" (also known as the "Charter") and the "Stock Vesting Agreement" once all of the tasks are completed.  These agreements will define not just the amount of equity obtained by each founder and the vesting schedule in the documentation, but also other conditions such as “Rights of First Refusal”, which permits founders to buy back shares from departing founders. These options will be reflected in your cap table thanks to a built-in equity calculator.

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Free-Riders & Good Reason:

A "free-riding" founder or co-founder can obstruct your growth and cause bad will, just like having a partner who doesn't pull their weight in any kind of entrepreneurship. A new startup is a highly dynamic entity, thus it's in your best interest to address any concerns like these as soon as possible.  Since all vested shares contain voting rights at the founder level, it's critical to get rid of dead weight as soon as feasible to keep your business on track.

This is why most "Founder Stock Purchase Agreements" include provisions for the pre-authorization of unvested share buybacks. These clauses enable the business to repurchase the unvested common stock options of an employee who is fired or left so that it can be allocated to a new employee, founder, advisor, or wherever else it is needed. Employees sometimes depart for what is referred to as a "good reason." Any combination of changing employment duties, changing corporate needs, and/or relocation concerns, as well as a few other no-fault issues, constitutes a good reason in legalese. If an employee is dismissed or departs for a valid reason, their options may be accelerated, resulting in partial or full vesting.

Ready to bring your startup to the next level? Apply to MassLight’s next batch. MassLight supplies capital and a dedicated tech team. We take equity in return. Have questions? Refer to our FAQ page.

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