Startups and Equity is often a complicated yet simple discussion that must take place before moving forward on a deal to come on board with equity in the compensation mix. It’s even harder when you are the 1st hire or a co-founder. The topic has definitely been debated a lot and there are many varying opinions online. Having been through this process before a few, I want to put this into simple so you don’t have to spend reading through every one resource and be left confused more than ever.
I will assume you are coming on board as a co-founder. Just the fact that you are at this point of the discussion with your co-founder is superb. Since this part only requires working out a “fair value” you both can be comfortable with.
Question 1 – are you both starting from ground zero?
An idea is still ground 0. If one of you have already executed an MVP then this is not ground 0.
If YES, Then Joel Spolsky’s advice nails it well. Split equity 50/50. Done.
- Ideas are dime a dozen. It’s all about the execution of this idea. Both of you will work together to make it fly.
- “Fairness, and the perception of fairness, is much more valuable than owning a large stake.” ~ Joel Spolsky
- x3 the last point. I will expand on this in the next question.
If NO, then Question 2 – how much value has your co-founder already created?
There is no right or wrong here. Seriously. There is only 1 thing here. What was said above about “Fairness, and the perception of fairness”. Speak freely with your co-founder about this. Get external advice from advisors, friends, partner etc… You really need to be comfortable with whatever you finalize.
At this point you and your co-founder have to work out what is fair. For BOTH of you. There is no room for lies. Or cheating each other to gain the upper hand. This is NOT an employment contract. Successful founders are successful because they trust each other and are fair to each other. Angels / Investors invest in people. For this solid reason. Ethics are everything.
Remember that the journey ahead is long and so even if the company has already got traction you still will be adding a lot of value. What has been done to date will change. What has been done to date is the confirmation of something there which can turn into a successful business. Startup companies pivot frequently to find a business model that sticks. Most successful startups in the valley are not famous for what they started off. They are famous for their last pivot. Read FoundersatWork by JessicaLivingston (YC partner) to get a feel for this.
Start from the back
It is easiest to just start from the back. The back meaning “how much ownership do you want after 3 rounds of dilution.”. The dilution comes from rounds of investments (A, B and C). It helps if you already have a feel for the equity value you believe is fair.
A typical funding round dilutions look something like this:
Round A – 20 to 40%
Round B – 10 to 30%
Round C – 5 to 20%
A great Infographic produced by BothSidesofTheTable.com and visual.ly explains dilution in alot more detail here.
Bingo. You are done!
Now start the discussion with your co-founder explaining how you got to this number. Remember, the outcome has to be that the both of you are comfortable and that it is fair.