How 2 Divide Equity
For the Blank Center’s first How 2 Tuesday event of the semester, Senior Lecturer Les Charm hosted a workshop on approaches and important topics to consider when dividing equity among the founders of a new business. He calls this the “kitchen table discussion” because it often takes place at an informal location, such as a founder’s kitchen table.
Part of the reason this discussion is so difficult is because each founder has to agree to the amount of equity they receive. To demonstrate this point, the event’s attendees were split into small groups and given a scenario in which 5 people were starting a biotech company. Their job was to determine how much equity each co-founder should receive. The groups were given fifteen minutes, but in reality this conversation can last for months. Although the discussions started off light-hearted, they became more serious as tensions rose. Charm assured the attendees that this is very realistic because each founder wants their share of equity to reflect their value to the company.
After the fifteen minutes was up, Charm asked each group to share how it came to a consensus. As it turned out, they each approached the situation completely differently! This led to the first main takeaway of the session: any way you decide to split the equity is correct if everyone agrees to it.
When evaluating the appropriate amount of equity to give everyone, possible criteria include past contributions, possible future contributions, the industry standard for dividing equity, who is taking on the most risk, and who is putting in the most money. Charm is a proponent of “negotiation for its own sake,” meaning that even if the founders will split the equity evenly in the end, they should still have the kitchen table discussion. Doing so builds trust and helps them understand their own and their co-founders’ value to the company. Having this discussion is also helpful for avoiding future conflict because the founders know what to expect from each other.
A word of advice from Charm is to deliberately decide who is invited to the kitchen table discussion. Once someone is at the table, they will likely believe that they deserve equity. If this is not necessarily the case, it would be wise not to invite them at first.
In addition to the kitchen table discussion, other items founders should discuss include decision-making, divorce, death, and dissolution- what Charm refers to as the “four D’s”. Who will be making decisions, including taking on loans and hiring new people? If a founder leaves the business, gets a divorce, or passes away, what will happen to their equity? Who will vote on whether the company is ever sold? While these are difficult and slightly uncomfortable scenarios to think about, agreeing on how to approach them early on is best.
Although co-founders may be inclined to equally divide equity, it is worth having a kitchen table discussion as soon as possible to recognize everyone’s expectations moving forward.