Forming a new alliance with a potential partner: How do you allocate equity among yourselves?
By Gladwyn Lewis, co-founder of Dubai-based Pixel Vector Media and regional partner of Oriel Capital.
December 2, 2013 12:33 by kippreport
So, how do you use that information to deciding a fair equity split?
The founders should start with dividing 50 per cent of the company and each subsequent layer should ideally end up with approximately ten per cent of the company, split equally among the number of employees in each layer. Also don’t forget, you haven’t got an investor in this scenario.
So, as an illustrated example:
- Three founders start the company. Each gets approximately 1,666 shares and there are 5,000 shares at level one.
- These guys move forward and, at a certain point, hire approximately eight employees in year one. These eight employees take 125 shares each. Now you have a cumulative total of 6,000 shares, with an additional 1,000 shares at level two.
- They go ahead and hire 40 employees at year two. Giving each one 25 shares. These chaps get fewer shares, because they took less risk and they get 25 shares, because you are giving each layer 1,000 shares to divide up.
- By the time the company has six layers, you have given out 10,000 shares. Each founder ends up owning 16.66 per cent of the company and each employee layer owns ten per cent collectively. The earliest employees that took the most risk owns the most shares in the employee pool.
Am I making sense now? You don’t need to follow the exact numbers, but the base idea of setting up “stripes” of seniority serves the company and its earliest employees well by rewarding your earlier employees with more shares, thus ensuring their loyalty.
A slightly different way to utilise the stripes system is in terms of seniority. Your top stripe is the founders, below that you could reserve a single stripe for your C-level team, below that is for early employees and top managers, and so on. However, you organise it, it should be simple and clear, just to avoid arguments later down the line.
Now that this semi-fair system is laid out for everyone to use, there is one absolutely essential principle. You must have vesting, preferably for four to five years. Nobody gets their “promised” shares, unless they have completed a minimum of one year. A good vesting schedule is 25 per cent in the first year and two per cent provided for each additional month after that, otherwise, you are going to have a co-founder who jumps from pasture to pasture and he could quit after three months and come back five years later at the point of your exit to demand his 25 per cent stake. It never makes sense to give away equity without vesting.
Finally, if you’re asking, shouldn’t you get more equity because it was your idea? My answer is a no. Ideas are worthless and placing great emphasis on an idea is like writing a contract on toilet paper, then using it (for what toilet paper is usually used for) and expecting the contract to hold. Working on the company is what creates value, pushing forward during an uncertain future is what brings an exit or an IPO possibility. Not thinking up some crazy invention while you’re on the loo.
Next week I will explain more clearly about dilution of shares, with concerns to an investor coming on board and how to factor in the salary/equity exchange for those founders that don’t take a salary and do not work full time. I will also touch upon the balance of effort put in by the co-founding team and how this should be appropriately split between its members, based on their tasks and respective responsibilities.
Gladwyn Lewis is the co-founder of Pixel Vector Media (Digital Media Agency Dubai), dedicated to helping start-ups establish themselves in the online world, and regional partner of Oriel Capital (Seed Incubator Dubai), a hybrid VC firm that specialises in seed stage investing.
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