Equity Splits

“Lets all split it equally”. There are many people who agree with this and quite a few who don’t. I am with the latter group. I have been part and am still part of ventures where equity has been split equally from the word go. If there is one reason why this is done so widely it is, ‘lets not ruffle any feathers’. The other train of thought is that since the company is only an idea right , lets see how it develops. I used to think that way too, until some of the companies I was with got reasonably big or some partners became way too complacent. Thats when I realized this doesn’t work.

Since we are creating a culture of being candid I think it should start from the word go. When looking at splitting equity there are a couple of factors to consider when doing the split:

1. Money to be invested

2. Time to be invested

3. Experience of the partner

So lets take an example:

Three partners are setting up a consultancy. The business requires substantial experience and industry knowledge as well as a large amount of time commitment. Looking at all the factors, they come to the conclusion that each factor should get a certain weightage; Money (18%) Time (48%) Experience (34%). All partners decide that they should split the investment money equally. Time wise the split would be 50/30/20 and experience wise it would be 55/25/20.

Thus you would get:

Partner A ( 6% + 24% + 18.8%) = 48.6%

Partner B ( 6% +14.5% + 8.5%) = 29%

Partner C ( 6% + 9.6% + 6.8%) = 22.4%

Allocating weightage to each of the factors can be mutually decided by all partners to be set equally or using a range of values. I feel this brings more fairness into an equity split and puts pressure on those individuals with greater shares, to deliver more to the team.

There are many permutations which could be added to bring a greater level of equality among the shareholding when time is being spent equally by the partners.

This model should provide a starting point to bring more objectivity into the equity splitting process. If you have any questions please let me know.

Related Posts:

Vesting Schedules

14 Comments Equity Splits

  1. LK

    I need your assistance in the Remodelling business that we are doing within our family ( my dad and husband).I am desperately in need of advice, as I foresee some troubles coming. Could you pls helo ? I will email you the details,seeing your response.

  2. Usman Sheikh

    Hi Jorge,

    The calculation for the figures in the parenthesis is listed below:

    1. Money: Partners decided to allocate this component a 18% weightage and split it equally among themselves. Thus ( 18% x 0.33 = 6% ) . This is the first figure in the parenthesis for all partners.

    2. Time: Partners decided to allocate this component a 48% weightage and split it 50/30/20. Thus you get ( 48% x 0.5 = 24% ) This is second figure for Partner A. Likewise for Partner B and C it would be ( 48% x 0.33 = 14.5%) & (48% x 0.2 = 9.6%)

    3. Experience: The partners decide to allocate this component 34% weightage and split it 55/25/20. Thus you get ( 34% x 0.55 = 18.8%) This is the third figure for Partner A. Likewise for Partner B & C it would be ( 34% x 0.25 = 8.5%) & ( 34% x 0.2 = 6.8%)

    Allocating weights to the key components of the equity split is subjective. This would wary depending on the type of project that you are undertaking . In the example above a consultancy will allocate greater weightages to time and experience since it doesn’t take a lot of money to start one. However the figures could be skewed the other way for a capital intensive project.

    I hope this was of some assistance. If you require further clarification or advise for your particular example please either email me or contact me on twitter @usmansheikh. Thanks

  3. Wahini

    This is a fascinating formula and I am trying to figure out how it might work for my firm. I am trying to find a fair “equity” split for a start up renewable energy firm, that is seeking an investor to invest ~ 1 Million dollars so we can commercialize our product. 4 Partners are in this “team” with two partners being the “founding fathers” Partner #1 (Founding father) has the patent on the technology and is very “hands on” and has also put in the most “seed” dollars towards the effort, he contributes and works in the company daily- despite holding down a FT job. Partner #2 was more hands on in the beginning, and just offered “intellectual” capital from a Business Development /finance perspective, but is not active on a daily basis- He has a FT job and will just act as an advisory equity partner moving forward as he has a FT job apart from this venture . Partner #3 (another founding father) was active early, on- hands on in manufacturing R&D etc, and has contributed some funds but is not involved on a daily basis. Partner #4 (me) has been working Full time in the company moving the company forward since October 2009- building infrastructure, connecting and networking, building web strategies, implementing PR efforts etc. Preparing Business Plans, etc moving the company towards the point that we can actually market the product. I intend to continue to work in the company FT as it grows. We are currently looking at an equity split for the 4 partners, taking into consideration the need for an extra investing partner (partner #5), which is why we need to finalize this split process as we will start seeking investors. Partner #1 wants to have a salary so he can continue FT in the company and further the R&D on the product. Partner #2 also wants a salary so she can work FT in the company and continue to build it out and generate sales/revenue for the investor. So I was thinking we needed a split structure that addressed all 4 being “equity partners” as well as a Split to allow for partner 1 & 4 to draw salaries. Any suggestions are highly appreciated.

  4. Manish

    Nice post;

    One small question:
    Once the equity share of the partners is decided, what happens next?

    -> Are profits to be shared on the Equity Split basis?
    -> What about existing liabilities of the company? Is that also split accordingly?
    -> In case of a takeover/ merger, the equity shares remain or is there priority share allocation etc?

    Thanks,
    Manish

  5. Pingback: Quora

  6. Daniel from Costa Rica

    As a former mathematics teacher, I too was facinated by use of a formula. My wife and I have a cafe in costa rica and have been approached by a customer to ┬┤partner┬┤in a project. The project is to develop a kind of community market center. We are being asked to run/develop/own the 3 or 4 eatery options invisioned. I am curious the key factors and the weighting of each factor for a food business. It seems to me that time $ and experience will apply to most businesses. Any thoughts or suggestions will be appreciated.

  7. Usman Sheikh

    It is still unclear about what input the ‘customer’ who approached you will have in this project. Will he/she be providing the capital to setup the community market center? How many eateries will there be in total? Will you be able to manage such an expansion without impacting your current cafe? I guess there are a lot of variables that need to be taken into account here. Being familiar with the owner and operator food business model, I like it very much. However unless it is in a high traffic area you always want to be in the owner position, renting out the eateries to other vendors.

    Hope that was helpful. I can be reached at blog@usmansheikh.com if you have further questions.

  8. Daniel from Costa Rica

    thanks usman for your quick reply. the customer is the chief capital provider. He has a property that sits just off the freeway where lots of comuters and truckers travel. the physical structure is just a shell, as the original building burn down years ago. His vision is to offer 3 or 4 eating options, like a bbq pit, a bakery and a grill for hotdogs & burger. In the long term coffee roasting, tortilla making are to be part of the other activities taking place at this center. We are in the middle of putting in a new kitchen at our cafe and so we have very limited funds to contribute at this early stage. When i was thinking about your formula, i then wondered about food, service and management of the eatery options. My wife has experience in project management from her 1st career. In addition to cooking skills my wife is excelllent at overall food managent. My strength is in customer service and the customer wants me to provide some daily supervision of quality, etc. We all are involved in other things a therefore have constraints of time investment. Your formula got me wondering about additional key factors beyond time, $ and experience. For example food and service and the weights for each.

  9. Usman Sheikh

    The basic formula provides a basis for extrapolation. For example you could easily breakdown experience in further sub categories to take into account the additional factors you mentioned. If you do think that it is a critical element of the business, then I would assign a higher weight age to the category as well. As the investor though, I am looking for the working partner to put in substantial amount of time into the venture to make a success. Thus it becomes a balancing act between the three components to find the correct outcome.

  10. jacopo

    Great post Usman,
    it really help to get ideas clearer.

    I still have one doubt thou:
    While Money investment is fixed, TIME could be endless.

    So, one angel investor invests 100k for 15% of the equity. Fine.
    How about the CEO who reduces his salary to the basics?
    According to a healthy financial plan a CEO should get, let’s say, 100k/yr.
    Our CEO gets 15% of equity (same as the Angel Investor) , and he reduces his salary to 30k (can we say then that he is investing 70k of his own pocket? 100-30=70).

    But should we fix a time limit to this?
    If the company takes longer then expected to breakeven, and the CEO keeps working for for example 3 yrs at 30k … it is like he invested 210k of his own money, double the amount invested by the AC, but still getting a mere 15% of equity.

    So when one of the partner is investing TIME, should it be fixed a time limit, after which either he switches to a full salary, or otherwise continuing working underpaid after the time limit should be considered a re-investments, that should be supported
    by all partners?

    thank you so much!
    Jacopo

  11. Usman Sheikh

    Hi Jacopo,

    Usually the trade off for a salary sacrifice is compensated by a higher equity percentage. Usually the CEO is also the founder, not the biggest fan of brining in an external CEO from the very beginning. However this depends on the business.

    For example if we have a new venture with a solo founder and he raises $100k from an Angel Investor for 15%. Which does leave 85% in the company, if the founder had more partners they would divide this equity based on the formula in the post above. Secondly the founder(s) would not get their equity upfront as it would be vested (http://www.usmansheikh.com/strategy/vesting-schedules) over a 3 or 4 year period.

    The CEO/Founder should not be looking to optimize for salary rather the emphasis should be on building the business rather than getting his/her salary back to the $100k mark.

    If you hire an external CEO and pay him $30k/year and 15% equity. That equity is split among the 3 or 4 years. Usually if the business doesn’t start to show some traction within that time frame he/she will leave.

    Thus in conclusion the Angel Investor has taken the biggest risk and salary and equity discussions should be secondary.

    Get in touch if you have more questions that I could potentially assist with. All the best.

    Usman

  12. Wess

    Hey Usman Sheikh, I found your post really interesting and appealing to me at the same time. Could you just break it down for me in my case. In your opinion that is.
    I am intending to come up with a website just to increase productivity and hope to make money out of it. Details are as follows:
    I have came up with this simple idea to generate revenue through this platform and I am looking for investors to assist in the funding of this project. We will only need approximately 70k to generate an estimated profit of 800k per annum after the first year. Now, this project is relatively simple. Work done can be outsourced to anyone by just paying them a salary and no specialty is required. Experience required is not much, experience need has been inputted into the idea itself. In this case, would you put money as probably 80% of the total project, 10% into the idea and another 10% into the work done. Please let me know what you think.

    Many thanks.
    Wess

  13. Usman Sheikh

    Sounds a little too good to be true. If the idea is very simple then more than the money the level of execution will ultimately be the deciding factor in the businesses success. I would bump up the numbers in the work to be done part. Also if the idea is original and has some level proprietary defensibility it should be given more as well.

    This equation depicts a situation where an investor is asking to take unnecessary control of a project. Given that 70k nets over a 10x increase in value in a year, I would pay a lot more attention to developing the idea further and the team which is going to execute it.

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