When co-founding a business, a major question that the co-founders face is how to divide equity. It can be difficult to discuss this especially when co-founders are friends, which is very common. Having the discussion with co-founders is very important. These discussions are normally about past contributions of the business partners, the involvement of the business partners towards the business in the future or whatever is typical for the market (i.e. equal division of equity). Some discussions center on how much risk the individual partners are taking or they can be simple negotiations with each partner negotiating for his own cause. All these discussions can be guidelines in deciding on equity should be divided To divide equity properly and efficiently, the 4D’s approach should be considered:
- Decision: this includes not only decision on how equity is going to be divided but also decisions on who is going to have the final say, who will be on the Board of Directors and how are things (assets, work, etc.) going to be decided.
- Divorce: can be of two types in this context. First, is when business partners decide to fire one of the business partners. The problem lies in how this should be done. Second, is when one of the business partners asked to leave. The problem lies in how much of the equity should he be given or that should he be allowed to leave at all.
- Death: this implies the circumstances when one of the business partners dies. A major decision is whether his/her family should be allowed to own the equity or will the equity be given to the person who is hired in the position. This is a major dilemma: because the person has passed, they are not contributing to the business while others contribute and put in a lot of work. This can lead business partners to believe that his family should not be allowed to keep their former partner’s part of equity, rather, the equity should be re-distributed. However, the family may be dependent on that equity for their living with no other source of income. This is where a major problem is encountered and thus, it is better if this question is answered before the start of the business.
- Dissolving the company: this entails deciding how the equity will be divided when the business is dissolved. Businesses can be dissolved once they start making revenue or sometimes when they haven’t started making any revenue yet. In such and many other cases, it is very difficult to decide which partner should get how much part of the equity. Sometimes, when the business is dissolved only one partner may be actively working for the business and so he may demand the entire equity because nobody else worked for the business until then. Therefore, it is always a problem deciding how to divide equity and deciding this question first is a very good idea for co-founders.
These are the major considerations that the co-founders should keep in mind while dividing equity. Dividing equity is not as simple a task as it seems and something that entrepreneurs normally err on. Using the 4D’s approach as guidelines will make the process easier for all parties and will reduce the possibility of disputes in the future.
Posted in Babson Entrepreneurs