Startup101: How Do I Divide Equity Among My Cofounders And Employees?

So you have just spent six months building a prototype with an early team, punting the question on how to divide the company. Now you are looking to raise external capital essentially forcing you to formalize structure and ownership, generating heated debates. Sound familiar? Having a hard time deciding on how to divvy the startup is the rule rather than the exception. While every situation is unique and ultimately a negotiation, here is an actionable framework to help. With due caveat that small pieces of a large pie are often worth more than large pieces of a small pie.

1) The Standard — Options with 4 year vesting, 1 year cliff, vesting monthly have become the norm among startups. There are obviously myriad variations. Some issue options based on achieving milestones. Some issue shares outright. Some have different vesting schedules — recently 5 years of vesting or non-linear vesting (an extreme example: 10% year 1, 20% year 2, 30% year 3, 40% years 4) have become a bit more common. Depending on who you are, these may be looked as a reward or a punishment for employees to stay around longer. Finally, a company may change an existing employee’s vesting schedule — these are rare circumstances and typically limited to the demands of an acquirer or of an investor.

2) Solo Founder — If you are a solo founder then you will naturally start with 100% of the equity until you bring in other investors and employees. If you are the business lead chances are your first hire will be technical, else vice versa, and in either case that person is extremely valuable and a quasi-founder. As such, giving a substantial stake, close to 10%, happens commonly. Else the typical framework is logarithmic — give your first 10 employees single digits of equity (e.g., employee #5 gets 1%) and your subsequent 10 employees percentages of a point of equity (e.g., employee #16 gets 0.2%).

3) Multiple Founders, With Symmetry  — Chances are you are two cofounders or maybe three, all of which are quite active. Then you have an argument to divide the equity roughly equally. Co-CEOs is a bad idea generally but cofounders being similar in equity works as long as there is a clear understanding on how decisions will be made. After all, there are plenty of cases where a CEO actually owns less than the founder but has the ultimate say — it’s really a difference between political power versus economic gain from the company.

4) Multiple Founders, With Asymmetry — If some founders have brought considerably less to the table, say because they are still part-time, then you obviously should give a haircut on their equity. What most startups make a mistake though is valuing the work so far rather than contributions moving forward. If that same part-time founder is expected to generate say half of the value for the next four years then you want to reward them accordingly. Finally, in cases with more than three cofounders almost always there is a main founder who commands the lion’s share of influence. When there isn’t a main founder it’s usually a messy negotiation.

5) Employee Stock Option Pool aka ESOP — The standard is to allocate 10-15% for future employees in the series A. If you have less the lead investor will usually require it in the term sheet, which means dilution for existing employees and investors. So seed investors will often enforce the 10-15% ESOP itself in the seed in anticipation. Employees looking to calculate their eventual ownership should also factor they will likely get diluted 20-30% in the seed, similarly in the A, 15-20% in the B, and 10-15% in subsequent rounds.

Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.