Equity allocation is a crucial but frequently contentious issue among startup founding teams. Allocating founder equity can be more art than science. This post helps you decide, in relative terms, how to divide ownership of a new company among co-founders based on the co-founders’ expected contributions to the company. You will end up with percentage allocations like 50%/50%, 60%/40%, or 33%/33%/33%. To put these allocations into practice in a corporation, check out the post How Many Shares Should Startup Founders Have?

An Approach to Startup Founder Equity Allocations

An appropriate equity allocation incentivizes future contributions from co-founders and encourages their long-term commitment to the company. 

To start, think about what each co-founder will contribute to the company’s future growth. Contributions can come in many forms, such as the ability to code, sell, manage people, execute a plan, operate a company, etc. Carefully weigh these potential contributions and allocate percentage stakes in the company to reflect proportionate rewards for the expected future work. Co-founders often have drastically different but complementary skills. For example, one co-founder may have technical skills, while the other has business acumen and experience. Each can be essential to getting the company off the ground. If the co-founders’ expected contributions are equally important, ownership should be allocated equally, like 50%/50% or 33%/33%/33%. Uneven equity allocations need to be justifiable, perhaps based on the relative importance of expected contributions, and agreed upon by the founding team.

Once future contributions are adequately incentivized, adjust the equity allocations around the margins for any disproportionate past contributions to the business. For example, one of the co-founders may have paid for most of the company’s early expenses, another may have built the original code base, and another may have come up with the business idea. However, do not let these past contributions affect equity allocations too much. Instead, consider what the co-founder’s past contributions mean for their ability to contribute to future success. If the company needs money in the future, will the co-founder help to raise more? If the code needs to change, will the co-founder do it herself or lead the development team? If the original business idea doesn’t catch on, can the co-founder invent and execute new products or services?

Notice how the sample equity allocations assume two or three co-founders. A founding team of more than two or three individuals can make it difficult for a young company to make the swift and impactful decisions at the founder level needed for a startup to survive, and later, thrive. Also, be aware that future outside investments will dilute the founders’ initial equity allocations. If the founding team’s initial equity allocation is spread too thin, outside investment may cause the founders to lose voting control over the company sooner.

Don’t Forget to Impose Vesting on Founders’ Shares

No matter how the founding team allocates the company’s equity, make it clear that each co-founder must earn their shares over time through vesting. Co-founders leave their startups all the time for any number of reasons. They might have a falling out with the rest of the founding team. They might need an actual paycheck to pay their bills. They might fall in love and move away. Life happens. The best time to impose vesting is at the company’s start when everyone is on good terms and excited to build a business together. If you need to ask a co-founder to leave the company, you don’t want to be in the weak position of negotiating the repurchase of their shares at the same time because you didn’t think to set up vesting at the start.

Standard Silicon Valley vesting requires someone to earn their shares monthly over four years, with a one-year “cliff” before any shares are vested. In the absence of vesting, a co-founder can leave a company early, keep all their shares, and not contribute anything more to its growth. When economic interests are misaligned like this, keeping the remaining co-founders and the startup’s employees motivated can be challenging. With vesting, if a co-founder leaves, they are only entitled to retain the shares they have earned through their contributions to the company over time.