How to Split Equity Without Giving Away the Company
Splitting equity with your co-founders and early employees is an art, not a science. Here is a list of suggestions for splitting up the pie with early team members that will save you headaches, time and money.
1. Vesting equity is smarter than static equity. Just about every company starts out with the “idea guy” who convinces his college buddy or co-worker to join the startup. Because it was his idea, he usually keeps most of the equity but gives a gigantic chunk to the second person. Together, they set down the long-term path that is entrepreneurship. They have no idea who will be providing how much value, or when.
Equity-based compensation is best saved for long-term propositions. Giving percentages of your company to unproven team members, without linking equity to the value of their work or how long they stay with you, is called “static equity.’’ It’s not subject to change until the next round of negotiation. Every day that passes before said round is another notch of negotiating power you, the founder, are losing.
Vesting is the simplest way to meet halfway between giving it all away before a person has proven themselves and not giving them anything at all (which obviously risks losing a good team member). Consider the example of Bob and John
Bob wants 25 percent to work for John. John agrees that, if the job gets done, Bob is well worth that percentage. To protect himself, John puts Bob on a five-year vesting schedule. Every year that Bob is working for the company, another 5 percent is set in stone. After the second year, Bob gets a job at Google and quits the startup. Two of his years, a total of 10 percent, have vested. Bob keeps the 10 percent but the balance remains with the company.
2. Compensate value, not time. You want hard workers but value is the only thing that matters. Getting stuff done is far more important than working hard. Consider, for another example, imaginary entrepreneurs Ashley and Sarah.
Ashley works for two straight months, eight hours a day. She drinks 75 cups of coffee, pulls four all-nighters, breaks up with her boyfriend to work and signs two major clients. Great! Sarah barely hits two hours a day, doesn’t look the part, drinks no coffee, pulls no all-nighters but signs four clients in a single month. Way better!
As good as two clients are, four is twice as good. Who worked more hours is moot. What matters is four is better than two. Emphasizing value over effort will help your team prioritize how they spend their time. Don’t let them get away with complaining about time at work but, instead, reward them for value provided. There is a big difference.
Related: When to Share a Piece of the Pie
3. Be transparent about what the job is. Often, when a founder invites their first or second team member onboard, the new member falls for the myth that entrepreneurship is brainstorming, internet research, business planning, networking, etc.
Those things take up a lot of time but are worthless relative to actual work. It’s your job, as the founder and leader, to recognize what you actually need them for. Ambiguity for the sake of covering your bases is weak and a mistake. Decide what, specifically, is the work you need done. If you need sales, tell them. If you need programming, tell them. Communicate sternly, at the start, that nothing else counts as time worked. Yes, I know there are a lot of other duties but guess who should be doing those? You.
4. Calm your worries. The biggest mistake you can make when splitting up equity is worrying about making mistakes. Entrepreneurs likely make more mistakes-per-hour than any other profession. Get used to it.
It’s impossible to prevent worrying altogether but all it’s going to do is slow you down. Equity-splits with the wrong person are an avoidable mistake but never getting off the ground in the first place is a company killer. Your team, their compensation and the contracts that protect everyone are an iterative process. Striving for perfection from the get-go is a rookie mistake. Make it clear what you are paying for and how it is earned. Things are going to change so much that long-term legal decisions are a waste.