How To Distribute Startup Equity Fairly for Founders

0:00in this video i'm going to cover how to distribute startup equity fairly for founders if you stick around until the end of the video i'll share a resource you can lean on if your situation is more complex than what i discuss in this video i'm rob walling i'm a startup founder with multiple exits author of three books on building startups and an investor in more than 100 companies i want to be clear from the top that this video is about founder equity which is different than employee equity which maybe is a topic we'll cover in a future video but think about equity distribution for the founders of a

0:29company to begin everyone even founders should vest their equity that means they don't get it all up front because there's a huge risk with a founder taking their equity on day one stopping work on the company and now you have a problem on your cap table standard vesting is a four-year vesting period for equity with a one-year cliff meaning no one gets any equity for the first year after 12 months you get 25 and then subsequent years you get the remaining you know three-quarters of the equity basically you don't have to stick to that script it's just a typical vesting schedule i've seen founders invest their equity in less time like

1:03having a three year equity vesting period with a one year cliff or three years with no cliff there's different ways to do it i want to be clear at the top of this video that none of this is legal tax or accounting advice it's just the opinion of someone on the internet who has been around startups for a long time and invested in a lot of them and so i have some battle scars to uh to prove it and i've seen cap tables that are well structured and then i've seen some that have been decimated by unfortunate distribution of founder equity i want to say something that

1:31maybe is a little bit controversial that in all honesty most companies should probably not split equity evenly between the founders and that's because founders bring different things to the table depending on their experience where they are in their career how hard they're going to work on the company there's so many factors and the default i think is to kind of be harmonious and just so if there's three founders we each get equal split right if there's two founders which get equal split and i think in a lot of cases that maybe shouldn't be the case so let's dive in to maybe some formulas that we can look at on how to

2:06better distribute equity i want to introduce you to the talk framework for calculating equity it's toc which is time opportunity cost and cash contributions and those are the three factors that you have to weigh as to what each founder brings to the company so let's start with t which is how many hours per week do you plan to work how many hours per week does each founder plan to work in this company so once we have our time commitment we look at the opportunity cost and this is how much would you each make working at the same company in the same location so you can't say well i make x and you make y

2:42if you live in new york city and i live in alabama because the costs of living are different or you work at facebook and i work at general mills because the salaries are different so you have to give it some thought right and work it out like if we both work for the same company in the same location how much do we think each of us would make and so maybe one founder is more senior they're a cto or their vp of engineering and they would make 160 000 working at a company in minneapolis versus a junior dev who might make 80 000 working in minneapolis so now i want to look at two

3:14examples to kind of run through numbers because look it's we're doing math on the internet in a video which is not the most riveting thing but this is just to get the point across that this stuff is pretty complicated and we're trying to quantify or simplify it such that you have some type of formula to look at this is not going to cover every edge case or be perfect but as i mentioned at the top of the video anything that falls outside of here any extenuating circumstances you can look at the resource that i name at the end of this video so for example one let's take

3:41founder one who as we said above would make eighty thousand dollars if they worked at the same company as founder two so eighty thousand dollars divided by two thousand equals forty dollars an hour founder two makes a hundred and sixty thousand dollars divided by two thousand and that equals eighty dollars an hour so it's twice as much if they're both going to work full time then really we just add all the rates together 80 plus 40 equals 120 and then we find out the percentage that each hourly rate gives us so the 80 an hour employee is at 66 and two-thirds percent and the 40 an hour employee is at 33 and

4:13a third so it's a two-thirds to one-third split now that may seem crazy to you know only take a third of the company when you're both going to be working full-time but what this is trying to capture is the idea that opportunity costs are different for different people that someone making hundred sixty thousand dollars is probably seven to ten years into their career they have a lot that they are putting on the line by starting this startup versus the person who is a year or two in their career they have less to risk and so whether you look at this and say well maybe 60 40 seems more fair or

4:41whether you know one founder takes compensation and you adjust this formula or whether one founder buys in with cash contributions as we'll look at below that can also adjust this so this is not something to take as gospel for your equity again not legal advice but it is a way to start getting to a point where you have some number other than just the default well we're gonna split it evenly now let's look at example two so in this example i'm gonna mix up the salaries so founder one let's say they make a hundred thousand dollars a year and you divide by two thousand you get fifty

5:10dollars an hour founder two hundred fifty thousand dollars a year divided by two thousand they get seventy five both gonna work full time but founder two is going to take twenty five dollars an hour out of the company so you subtract that from their 75 and now we have 50 an hour each and the hourly rate basically are equal and since the hours are equal as well because they're going full time this would be more of an equal split and so again is this approach perfect i don't think so but i do think it's better than two founders splitting it 50 50 just because that's the default assumption so

5:43in our talk framework t-o-c t was time o was the opportunity cost and c is cash contributions what if one founder has money in the bank and they want to put fifty thousand a hundred thousand dollars into the company what you have to do here is decide on a company valuation and then you figure out how much of the company the cash contribution purchases so if you decide well two people with an idea is worth 450 000 and one founder wants to put in 50 000 then that would give a post-money valuation of 10 right you take 450 plus 50 and now 50 is 10 of 500 000 post

6:18money valuations are a whole topic under themselves i won't go into here but 10 would basically come pro rata from each of the other founders who did not match this contribution the challenge of splitting up equity in your startup is that different people come with different things to the table they might come with experience and skills that are more valued in the market they might come with more time available to commit to the startup they might come with money what i'm trying to do is take these numbers and put them into some type of framework that can give you a general direction of where you should

6:48head with deciding on equity because i have seen founder teams kind of screw this up where someone's only going to work 10 hours a week and they're working a day job and they're not super focused and maybe they're a mid-level developer and they get an equal share of someone who is working full-time on the company and has sacrificed a lot and so those numbers shouldn't be the same but what we hear founders say is but i don't i don't want to get the argument you know or i don't know how to do this isn't there a formula and while there is no exact a perfect formula you know as i've

7:17said a few times i do think this starts to get us towards a rough number or a rough estimate of how we could divide equity now the problem with everything i've said so far in the video is it assumes that everyone starts working at the same time everyone works the hours that they say they're going to work which doesn't always happen so there is a more i'll say it's a more thorough but a more complex approach that would actually be really cumbersome to go through in a video but it handles the edge cases that i've mentioned hands a lot of edge cases and i'm going to tell

7:45you about it in a second before i do that i want to tell you about our community for bootstrapped and mostly bootstrap sas founders it's called microconf connect it's free it's heavily moderated it's an amazing community of more than 3 000 founders head to microconfconnect.com if you want to be part of the community and you get support you can ask questions it's a fun and knowledgeable place to hang out and to ask people questions about sas and to share your wins and your victories and your failures that's microconf connect.com so i mentioned a more thorough approach to handling equity splits and there's an entire book it's called the slicing pie

8:20handbook it's available for purchase on amazon but it is an entire book devoted to this topic and it goes even deeper than what i've been able to cover in this video so if you enjoyed this video i'd love it if you hit the like button subscribe to the channel we have new videos like this coming out every week educational videos on detailed sas topics sometimes i interview folks sometimes i answer listener questions live and we have talk videos from all of our in-person events eventually make to the channel hope you enjoy this video i'll see you in the next one [Music]

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