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One of the most valuable assets of a startup in its early stages is its equity. Equity refers to a non-cash, partial ownership of a business. Often, you will divide equity in a startup into three categories:

  • founders;
  • investors; and 
  • (sometimes) employees.

Dividing equity in a startup in a fair way for all parties can be very challenging. In particular, deciding how to split equity amongst startup founders can be emotionally taxing and difficult to navigate. To help you tackle this, this article will take you through one way to divide equity in a startup, based on entrepreneur Frank Demmler’s widely used ‘Founder’s Pie Calculator’.

Idea 

When dividing an equity split amongst co-founders, the first thing you should consider will be whose idea the startup was. The original idea will be the company’s foundation and should therefore be taken into account when dividing startup equity. However, it is generally recommended that only a small amount of weight be given to the original idea. This is because the idea is only a minor component of the startup’s overall success.

Despite this, in certain circumstances, you may wish to give more weight to the initial idea, such as where the company is a technology company, and the initial idea is novel.

Preparation

Secondly, when dividing startup equity amongst co-founders, you should consider those who have worked to develop the initial business plan. In the early stages, a business plan lays the foundation for the company’s future. Therefore, the time and effort that goes into this process should be rewarded. Further, you will present the business plan to banks and investors when requesting financial support for your startup, making this a critical element in raising capital.

Finally, those involved in the business plan execution will play a significant role in the startup’s success, which should also be considered when dividing startup equity. 

Expertise

The success of your startup will depend on the knowledge of its people. Therefore, having knowledge and experience in your startup’s domain will play a significant role in your startup’s success.

For example, suppose you have a tech startup. The founding team responsible for developing the technology itself as a new company will be equally important as those with business expertise. Consequently, both parties should be considered when dividing equity.

Risk

In its earliest stages, those involved with the company will inevitably take on the most risk and should be rewarded to reflect this. 

For instance, startup founders who quit their stable jobs to work for an early-stage startup might be given more equity than those who later join the company as employees and earn a fixed salary. 

Similarly, investors who put up large amounts of capital in the startup’s earliest stages will not be considered equal to those who invest small amounts at later stages when the business is more secure.

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Responsibility  

The responsibilities of each party should also be considered when dividing equity. Those who will be primarily responsible for the startup’s success and carry the burden of any failures should be entitled to more equity. Generally, these will be the founding members who have the most pressure to satisfy investors and pay their employees.

Example of an Equity Split

When dividing equity, you should consider that funding rarely occurs in one round and room should be left for additional funding rounds. Similarly, founding members of the company might join at a later date. It is important to remember that it takes years to build a successful startup, requiring you to leave plenty of room for future equity division.

The below table outlines an example of an equity split in a startup, noting that the best division of equity for your startup will depend on your unique business structure, goals and principles of fairness.

Category

Phase one of investment

Secondary phases of investments 

Founders

60%

25%

Investors

25%

60%

Employees

15%

15%

Total

100%

100%

Key Takeaways 

The division of equity in a startup will depend on various factors. This includes the nature of your startup, your ideas about fairness as a principle and how you will fund the startup. Considering the Founder’s Pie Calculator, some key things to consider when dividing equity in a startup include who has the:

  • initial idea for the company;
  • responsibility for the planning of the business;
  • business and domain expertise;
  • greatest degree of risk; and
  • largest amount of responsibility.

If you need help dividing equity in your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

What is equity in a startup?

Equity refers to a non-cash, partial ownership of a business. It is a crucial incentive for encouraging people to join a startup, particularly in its early stages. Equity in a company consists of more than shares. It will include the shares themselves and associated rights, such as preferred shares, common shares and warrant rights.

How do I divide equity in a startup?

The division of equity in a startup will depend on various factors. This includes the nature of your startup, your idea of fairness as a principle and how you will fund the startup. According to the Founder’s Pie Calculator, some key things to consider when dividing equity in a startup include who has the initial idea, the responsibility for business planning, business expertise and the highest degree of risk and responsibility for the startup’s success.

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