Profit 101 #8: Not All Cofounders Are Created Equal
Aug 18, 2023
But Don't be Stingy, Quantify
Cofounders and Equity Sharing
In my first startup, I spread equity too thin across the team, and had we grown the company I would have struggled mightily under rapid dilution (we got lucky and sold the company in the 2000 boom instead). I overcorrected in the opposite direction with my second startup - I tried to do everything myself, thinking I could wear all the hats to get the startup off the ground.
With startup #3 I found a reasonable middle ground, compensating myself fairly while still appropriately compensating my co-founder, without whom success would have been impossible.
In my conversations with founders, I've seen that there are a lot of questions around how to divide equity fairly. If two cofounders meet or join early on, then perhaps 50/50 works - but that rarely matches reality. What about when one founder brings the idea? Or when a founder brings initial capital? How about when one founder had the idea and handles sales, marketing, customer success, and all other aspects of the business, while the other founder just writes code?
I've sketched out below what I think cofounders deserve for bringing different capabilities to the table. The essence of a startup is to deliver a product (or service), and to market and sell that product. As a result those two areas earn the lion's share of value - the idea itself isn't worth that much without execution.
Proposed Allocation of Equity By Capability:
Initial customer discovery
Engineering / Writing Code
10% Customer Success
Internal Operations 5%
HR / Payroll
Corporate / Admin
Finance / Tax / Accounting
Ideation: < 5%
the idea itself
Note that there's no specific carveout here for being "CEO" or for any other specific role - I believe that you contribute by what you do, not what title you carry. In the early stages management falls into the Internal Operations category (worth 5%), but as a company grows a CEO (or other C-level) role could receive options to compensate them appropriately.
Concrete Examples with Two and Three Cofounders
A Non-technical Cofounder needs someone to help build: I'm cofounder 1, and I've been working on my idea for 6 months. I've done the market research, done initial customer discovery with 10 prospects, and even mocked up wireframes of what I need built. I handled all of the corporate and legal structuring, and will handle all of sales, marketing, product thinking, and internal operations in the early stages - I just need a technical cofounder to build the product for me! I'll likely split customer success with my cofounder, as they will need to be close to customers in the early days as well. In this example, perhaps I deserve all 40% from Sales, 20% from Product, 5% from Customer Success, 5% from Internal Operations, and 5% from Ideation - that's 75% of the company. In this example, which is not far from many real-life scenarios, I'd say that the non-technical cofounder is likely to cede more of Product to their cofounder than they realize. Perhaps 65%, with the technical cofounder earning 35% via 30% from Product and 5% from Customer Success, is more realistic.
Two technical cofounders find a sales cofounder: Two technical cofounders have poured their efforts into building an excellent SaaS product - except it has no customers and no prospects at all! They think they have something, but don't really know. They meet a non-technical cofounder who thinks she can take them to market. Does she deserve 40% of the company if she handles all of sales, marketing, and customer discovery, even though it wasn't her idea and she didn't build anything? In my opinion, YES! I've seen so many examples of "shelfware" in my life - software that has never been and will never be used by anyone, for lack of any form of marketing or distribution. Perhaps one of the technical cofounders can step up to help do SEO, outbound email, and other marketing work, thus taking on some of the marketing effort. But absent that, I think that technical founders should be prepared to cede a lot of equity if they haven't got a clue on how to get to market.
A non-technical founder recruits a CTO after paying for product build: Many non-technical founders I've spoken with are roughly in this place - they've stood up all aspects of a business, and invested their own money in getting a product built, but now realize they really need a technical cofounder to get anywhere real. Paying for dev gets expensive in a hurry! In my experience it can take 1-2 years of iterative development, with real customer feedback, to achieve any semblance of product-market fit. In this scenario, assuming that the founder has a running business with Sales, Customer Success, Internal Operations, and Ideation covered, and is also handling Product Design and Product Management, then a technical cofounder (or non-founder CTO) might be hired with a lower equity stake. But here's the trouble. The CTO you want, if you are offering only cash compensation, is worth $300k+ per year. That's probably not the CTO you can afford, which may explain your predicament! If you can't pay a salary, be prepared to take up to half of the Product allocation, or 15-20% of company equity, to solve this problem. That may feel expensive, but that's what it will take if you want founder-level technical talent. Why else would someone who can make $300k per year decide to work with you for zero? It's worth noting that if you are able to pay a salary, equity needed drops rapidly and non-linearly. 20% equity with zero salary might equate to 3-5% equity and a 150k salary, for instance.
What about Capital?
When one founder brings capital to the table, they should be treated as an investor for those purposes. For instance, let's say a technical cofounder is handling all aspects of product and customer success, and had the original idea, giving them 55% of the company (based on the above). If they also bring 100k to the party, they should buy a SAFE note from the startup with those funds. Let's say that a post-money SAFE has a valuation cap of $2M - then they will get 5% of the company for 100k (or more if the next round valuation is lower!) plus 55% of the balance (from their founder contributions) for a total of 57.25% of the company.
I've tried to provide some guidance on early-stage equity splits here based on my own experience across four of my own startups, plus observations of dozens more. You may attribute different equity values to each capability that a startup needs - my opinions above are simply based on my experience. But however you decide to divvy up equity, I think what's important is that you attempt to use a quantifiable approach, in which equity is distributed based on actual capabilities provided and work done. No approach is perfect, but taking this approach at least gives you a framework to start, and a framework for measurement as the startup evolves.
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