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Forming a new alliance with a potential partner: How do you allocate equity among yourselves?

Gladwyn Lewis

By Gladwyn Lewis, co-founder of Dubai-based Pixel Vector Media and regional partner of Oriel Capital.

December 2, 2013 12:33 by

As a digital media agency, we see value in getting engaged with start-ups and offering a combination of reduced fees or (very rarely) no fees at all, in exchange for equity ownership. As a start-up investment firm, we see partners that are often confused about how to distribute equity ownership. The truth is, there is no hard and fast rule on how equity should be shared, but the most important principle is fairness. Fairness in any business or any equity ownership exchange is more valuable than owning a large stake. Remember, in any start-up, your idea is worth naught and to argue on the get-go about equity ownership is ultimately dooming your start-up to failure.

Being “more experienced” or claiming “it was my idea”, does not give you the right to ask for a higher share, it ultimately has to be fair to all parties involved and must be based on the committed effort and actual effort that each partner puts in to grow the business. Let’s be frank, asking us, as potential investors, to sign an NDA is not something we usually do, because NDAs don’t protect your idea (if not executed) in any mature court of law. Look at the Winklevoss twins and Mark Zuckerberg. In the same way, a partner that exits after a couple of months and comes back to claim his “fair share”, even though he wasn’t fully involved in the business, is pure foolishness.

So let’s get down to it. For the sake of simplicity, I am going to assume that in the initial term, you are not going to raise venture capital and you don’t have outside investors. In the follow-up article to this, I will explain how to go about calculating venture capital in the mix, but for now, let’s just leave it out. Let’s just assume that all founders quit their jobs, forego current commitments and completely focus on their start-up. I will explain how to factor in founders who do not start at the same time, in the follow-up article.

In layman’s terms, you need to add your people in as “layers” as the company grows.

– The top most layer is the first founder or co-founders. This could be one or more than ten, but everyone must start working at the exact same time and need to take equal risks moving forward by quitting your current jobs to work for a new and unproven idea/business model/start-up.

– The second layer is the first set of employees. Of course, by the time you hire this layer, you have cash or investment coming in from somewhere, be it from investors or customers. Now remember, these people don’t take much risk because they got a salary from day one. Let’s be real, they didn’t start the company, they just got another job.

– The third and subsequent layers are later employees. By the time they join your team, your company is already well established and gaining revenue fairly regularly. You are, somewhat, self-sufficient.

Each layer, for the most part, is measured as one year long. By the time your company is ready to sell to Google, go public, or whatever, you might have anywhere between six to ten layers. Each successive layer pool is larger. There could be three founders, five early employees in layer two, 30 employees in layer three, 300 employees in layer four, and so on. However, the underlying pattern is clear, the later layers took a significantly lesser risk than the layers before them.

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