McStartup

It's been a little while since I've gotten to the questions.  Being in the process of launching my own startup, Scale Computing.  If you need scalable data storage systems at low cost, I'm your man. But, the world of the startup takes a lot of time, and I've been slow getting to these questions. Nevertheless, I do have a couple of questions I'll be addressing over the next few days.  Here's the first:

Bob Writes:

My questions are around what makes the most sense on splitting equity. I'm starting a business in an adjacent space to one I just left but I'm not sure how the stock should be split. I'm the original idea person and will be President and CEO. I've tapped into two former colleagues and I'm in touch with another former CFO who may get involved. Most of us will put money in for long enough for the business to get to real revenue, maybe break even.  While I want to do the right thing for everyone, I also want it to be appropriate. At this point, I am the only one "out there" pitching. That is likely to be the case for the next 3 months, at which point, we should be through beta and have some actual, paying customers. I would say that my importance in this venture at least 60% of the value. Am I answering my own question or do you have other good methods of determining founder share splits? 

When I think about splitting up equity among a founding team there are a number of considerations.  First is the time at which the people involved make a commitment and start working.  Generally, I would consider a commitment to be the point at which someone is embarking on the startup on a full-time basis.  If no one is doing this, then it's a bit harder to decide when someone "starts" - but, for example, you are full-time on this project, then the date at which you went full-time is your start date.

Another factor to consider -- and this one is obvious -- is any capital contributed to the startup.  I don't give much credit for "soft dollars" - meaning someone brings a rolodex, expertise, or intellectual property to the table.  Cash is king, and you get credit as such.  Intellectual property can have some merit if it's already patented or has otherwise established real value, otherwise it's not worth much.

The third factor to consider is stage of the company relative to when someone starts.  This is similar to my first point, however in a startup there are certain key milestones at which time the value of the company jumps considerably.  For the early stages, I'd look at these as:

• Idea validation stage
• Product development stage
• Beta launch of the product or service
• Actual launch
• Initial paying customers
• Any sources of funding secured
• Addition of key team members (which can happen at any point in this list, multiple times)

All three of these factors boil down to one simple thing:  Risk.  In any investment, the reason for providing compensation in the form of equity is in exchange for taking risk.  Someone puts their money at risk, they get equity.  Someone puts their time at risk, they get equity.

This is why things like rolodexes and intellectual property don't get much credit in my book.  There's no real risk in bringing those things into the business.  If you call on your great rolodex and the company doesn't work, you can just call on those people again next time.  There's little risk there.  

Likewise, each of the stages I've listed above are points at which the risk profile changes.  If you have a product, there's less risk than when you didn't.  If you have funding, there's less risk than when you didn't.  If you have convinced others to join the team, there's less risk for those that come afterwards.

In your email to me you called out that you were the original idea person.  Here again, I give very little (probably none at all, actually) credit to the idea.  The idea carries no risk in and of itself, and therefore, gets no meaningful equity credit.  If you and some buddies have an idea and decide to simultaneously jump into business together on a full-time basis, my inclination would be to split the equity evenly.  If you each put in different amounts of capital to start, then you'd split based on a combination of going full-time and the cash involved.

So all that said - if what you say is correct, that you are out there for 3 months, and that before anyone else joins up that you'll have real paying customers then I'm assuming your partners won't join until after you've already hit the revenue stage.  There difference between the risk you took vs. the risk they would be taking is tremendous.  

For purposes of illustration, here's a way to think about it.  Let's say you are each going to put up some cash, and that your partners are going to put in some capital along side you right from the beginning.  Let's also say that you are going to be out there working the business from day one, where they are going to wait for customers before joining.

You might consider that 50% of the equity be split based on capital contributed, and 50% be based on "sweat" equity.  So, if you each put in equal amounts and there were three of you, then you'd each get one-third of that first 50%.  Second, if you are going to do all the meaningful work before customers and revenue, and it's going to take 3-6 months to get there, then I'd say you are probably taking 4x the risk they are.  So you'll get 4/6 of the second 50% and they'll each get 1/6th.  

If I blend those two things together, you'll get a total thats right at 50% (1/3 * 50% + 4/6 * 50%), and your two partners would each get 25%.  (1/3 * 50% + 1/6 * 50%, for each)

That's just a starting point to help you think this through.  If it only takes you 2-3 months to get to revenue and they join, that's quite a bit different than if it takes 6-9 months to reach the same point, for example.  If you get just one customer and they join that's different than if you have a pipeline full of promising deals and a handful of real customers when they do.   

There's really no right way or wrong way to do this exercise, but I would encourage you to focus on only the risk, and not the dozens of other factors that people tend to start thinking about when trying to determine these splits.