How to Split Equity In a Startup Without Conflicts – Equity Distribution

Here we are, with yet another smaaalll issue that can become a catastrophe. This one comes up at the very beginning.

But later, if you don’t deal with it well – it can become a source of major conflicts in the project or business. Like, it can cost you millions of dollars.

I’m talking about the very important question: “How to split the equity in a startup without getting into pointless arguments?”

“I mean, just split it 50/50, no? Problem solved…”, you blurt out, confused.

… but not really.

Sure, sometimes you can. But there are countless scenarios (which are very likely) where the story is NOT that simple.

I’ll show you how to split the equity in a startup where the contributions are not equal, how to communicate it, and how to make sure your agreement is respected.

Keep in mind: I won’t give you any set-in-stone recommendations.

I’ll just outline how it can be done, and how some people approach it. You decide for yourself; this is your project.

Once again, your responsibility, your problems. You are an adult, you can make these decisions 😀

Equal Shares: Simplicity, Motivation… And Where It Falls Short

As I already said, the simplest solution is to just split the shares equally.

50/50 for two co-founders, 33/33/33 for three co-founders (you can give me the remaining 1%, thanks)…

And so on.

This is a really good option for mutual motivation. You get the same feeling of responsibility and you all feel like you’re equally important partners.

Aside from responsibility, you also bear equal costs. and bring equally significant results to the project.

You don’t need to think a lot or discuss extensively about who owns what share of the project.

This option is great if both participants in the project are equally qualified in their fields.

For example, let’s say you’re amazing at building products and your co-founder is a killer marketer. A project needs both good implementation AND promotion… so you’re equally valuable.

It’s also easier to split it 50/50 if you guys have approximately equal financial capabilities.

Oh, and if you have the same time to invest in the project…

… as you can see, lots of things need to align for the 50/50 split to work. Don’t get me wrong it can happen – but it doesn’t HAVE to happen.

There’s a high likelihood that you’ll just say “Ahhh let’s just split the shares 50/50 and not overthink it. Beer later today?”

But in a couple of years, the actual inequality will become more evident.

So if you just move forward without discussing, resolving, or documenting potential inequalities… you are planting the seeds for future conflict.

Discuss very honestly and transparently who brings what to the table. Time, money, expertise, connections, etc.

When the business makes $50k a year, it doesn’t seem like you’d make significantly more money if you owned an extra 5% of the business.

And so, you might rather avoid a conflict… but trust me, it will be very painful and unpleasant for you in 2, 3, or 5 years when, hopefully, this project will be worth millions of dollars.

A difference of 5% or 10% will be REALLY costly, and you’ll think very differently than you do now.

You will be a different person with different financial scales, and you will view the project differently.

The difference in shares will become extremely significant.

The Risk of Unequal Contributions: Addressing Future Conflicts

There are also risks of unequal contributions. If you decide to go this route, you have to do it well.

Very well.

Seriously, I have been in situations where different parties felt their contributions were undervalued and that their role in the project was much bigger than the other party’s.

But then, people are different, right?

Someone might be more sensitive to this risk and they might value every piece of their share very highly.

For someone else, a few percentage points in a project might not be of enormous value, especially if the project is just one of several or not a primary source of income.

So you have to explicitly discuss these issues of share inequality and each co-founder’s EXACT contribution.

Do this well and you’ll avoid major conflicts and possibly even legal disputes (and no one will call you mean).

Let’s consider a few simple scenarios for addressing these risks. We won’t necessarily solve them entirely right now, but we’ll outline the paths to resolution.

Many people think it’s impossible, but in reality, many smart people, businessmen, and financiers have already come up with solutions.

You can get it here:

Back to the unequal shares!

Scenario 1: Unequal Time Commitment

A classic: You and your co-founder agreed to split 50/50 because you thought you’d put the same amount of time into it.

Six months later, it turns out that you are regularly, month after month, working full-time on this project.

But your co-founder sits idle. Their area of expertise is not needed yet.

The project is in a stage where, for example – you are still developing the product – and you have been constantly busy for several months. You’re working day and night and the product is still not ready. You don’t see an end in sight.

So you feel resentful when, month after month, you work on this project… unable to earn money elsewhere. I mean, you have no time to earn since you’re fully occupied with this startup.

But still… your co-founder sits idle… waiting… doing very little in the project.

This is SO frustrating.

You see that you are spending time, and the other person is not, and you feel a sense of injustice.

And you (rightfully so) think:

“We both have 50% shares, we both should be equally contributing time. Why should I work for free, or for minimal money, to allow my partner to have their 50%? They are not working for my share, but I am working for theirs. This shouldn’t happen!”

Again, this should NOT happen. The issue should be discussed in advance. Luckily, the solution is pretty straightforward.

Just separate your roles in this project.

Basically, every startup has two types of roles:

• Managerial roles: Meetings, calls, developing plans, brainstorming sessions, strategy, outlining business plans, attracting investors…
• Operational roles: Development, sales, marketing, customer support…

If you have divided the shares 50/50, you will likely spend equal time on managerial decisions, energy, and dedication to these tasks.

I actually don’t recommend you track your hours for these roles, since managerial decisions are of a creative nature, and tracking hours hinders that.

Also, managerial work can’t really be paid based on hours. If you get an idea in 3 minutes because you’re amazing – you don’t want to get paid LESS than if it took you 3 months.

But for operational roles… track your time and work. Pay yourself a salary for the extra work you did.

Just imagine that you’re a temporary employee at your startup.

Agree with your co-founders that if you’re a developer writing code and building the product, you should be compensated for your work.

For instance, agree on a salary of 50% of your time, maybe $3,000 a month (this is just an example; salaries may vary in different countries, and your agreements might differ).

Agree on a salary that is somewhat competitive and fair to you and your partners.

And you don’t have to withdraw these funds physically.

They can only exist as records in spreadsheets if you want. View this symbolic $3,000 a month as your monetary investment in the project. If you work this way for a year, you can consider that you have invested $36,000 into the project over the year. These funds can be counted as your contribution, your costs, your stake in the project

Discuss this with your partner now to avoid feelings of injustice later and to make future processes smoother and with fewer conflicts.

Scenario 2: Unequal Financial Investment

Classic situation number 2… you invest more than your co-founder because they can’t match the investment (haha you get to call them broke).

But why should you invest more and risk more? Shouldn’t the share distribution be reconsidered then?

Yes, it should.

Agree in advance with your partner that after six months you can review the shares, reassess the situation, and reconsider the monetary and time contributions to the project from each side.

For example, if one side needs to invest more money, change the distribution from 50/50 to 60/40.

Agree roughly on what amount of money corresponds to what percentage of the share, even if only broadly and approximately. You will likely need to negotiate the specifics later, but if you outline your position and comfortable solutions at the very beginning, it will be much easier later. You will spend less time negotiating this issue, woohooo!!🥳

I STRONGLY recommend recording these agreements somewhere, in a letter, document, or an Agreement of Intent.

A letter like that doesn’t legally bind you but indicates that you have agreed to proceed in a certain way.

Takeaways

Equity distribution can be a very touchy and sensitive topic, so most people like to ignore it. Not at Eightception though!

Trust me, the discomfort required to communicate with your co-founder is definitely, definitely worth it. Especially if we’re talking about an important topic like this.

There are multiple methods to split shares among co-founders and each one has its pros and cons. But luckily we also talked about mitigating the cons (pat pat)! 

Here’s the summary:

• The simplest solution is to just split the shares equally (50/50, 33/33/33, and so on). You get the same feeling of responsibility and you all feel like you’re equally important partners.
• However, lots of stars need to align for the 50/50 method to be the best method. Time and money are the main stars.
• If you opt for unequal distribution, do it very well and transparently to avoid conflicts in the future.
• If one partner puts more time into the project, divide roles into managerial and operational roles.
• You’ll probably both have the same managerial roles and inputs, but if one puts way more hours in – it’s probably because of operational roles.
• Simply pay yourself a (discounted) salary for the operational roles you do (such as sales, marketing, product development, customer support, etc.)
• The paid salary doesn’t have to be actual money, it can also be a record in a spreadsheet as evidence of your stakes in the business.
• If the financial investment is different, adjust the shares accordingly and fairly.
• Agree with your partner in advance that in 6 months, you’ll review the shares and adjust if needed.
• Record these decisions in a Letter of intent.