United States: Allocating Founder Equity

Last Updated: March 17 2016
Article by Gary R. Schall

There's no legal definition for "founder," but it is one of the most important roles in a startup. Designating someone a founder means a lot for the long-term future of the company and for that individual; it is the founders who define and shape the vision for the company. Usually, a startup will name two to four founders.

According to the 2015 CompStudy survey of technology companies in the US, it varies as to whether or not certain roles are given founder status. For instance, survey respondents indicated that the CEO role is given founder status in 72.3% of instances whereas CFO or Head of Finance roles only 9%. (View the full data as a chart generated via CompStudy's online reporting platform using 2015 data.)

Allocating equity among this group is one of the first things that needs to be done when a startup is incorporated. Often times, the questions that come up in deciding whether or not someone is a founder are the same questions that the team will discuss in deciding how much equity to allocate.

The easy route is to split the pie equally, so that each founder gets the same number of shares. This approach, however, is not always in the best interest of the company. Allocating too little equity to a founder whose role will be key creates an obvious challenge since that founder may not have enough of an incentive to stay on and build the company. Allocating too much equity to a founder who will make a less significant contribution can have equally devastating consequences, creating ill will over time as other founders begin to think, "I have more responsibility than he does, so it isn't fair that he has the same ownership stake as me." It is important to think through these allocations very carefully, and to have tough conversations early in the process.

When deciding on a fair allocation, consider what each founder brings to the table. Did one of the founders develop the idea and devote a significant amount of time to it before forming the company? If so, that essential contribution should be recognized—but not overvalued. Investors care much more about the contributions team members will make over the several years it typically takes to build a great company, and so should you.

Initially, everyone will have lots of different responsibilities—that's the nature of a startup. Over time, however, people will generally fall into specific roles. Consider the importance of those roles as you determine your equity allocations. For example, the person who will run the venture (whether as the CEO or under another title) should typically receive more equity than the person who will oversee a single function, such as marketing or sales.

Of course, titles are often not dispositive, and—especially at technology companies—founders who code, design or mastermind the science might not be the face of a company, but may be equally, if not more, important to its success. When allocating equity, seriously consider how severely an individual founder's departure from the company would impact development schedules, fundraising chances and other critical issues.

Also consider how much time each person is devoting to the company. Is one founder only joining part-time, while the others are working full-time? Not only might that reflect a lack of commitment, it can also lead to discord if the other founders feel it is unfair for the part-timer to get the same or more equity than they do.

Many times, one of the founders will put in the initial cash required for the company, which raises the question of whether this founder should get more equity to compensate. The short answer is, not always. Often, it's best to consider the cash contribution separately from the allocation of equity. Maybe the individual who contributed cash is not really a founder, but is instead is an investor. In that scenario, you can allocate equity without factoring in the investment, and then issue a convertible note for the cash as you would in a normal round of funding.

In the end, there's a lot of variability when it comes to founder equity allocations. Every company, every situation and every group of founders will look at this issue differently. Calibrating all of the factors is a difficult exercise and may need to be ongoing. It is, therefore, important that the allocations are discussed early enough to obtain input from all co-founders. Once the founding team generally agrees on allocations, counsel can help fine-tune exact equity holdings by implementing vesting requirements, such as vesting cliffs and vesting commencement dates.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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