

Ask HN: How to split equity? - espitia

I am about to ship my second app and I&#x27;d like to bring in a good friend of mine who I believe can contribute a lot in many areas that need to be covered in order to build a succesful app company. How do I go about forming a mutual agreement as to how to split equity?<p>To explain what I&#x27;ve done so far:<p>- Developed and shipped first app.<p>- first app has a few thousand downloads and growing.<p>- put up investment for the development of second app (validated market with customers, great potential).<p>- invested my time for 3 months almost full time (taking care of metrics, marketing, managing developer&#x2F;designer etc.)<p>Any more info that is needed please ask. All comments or helpful links are appreciated.
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patio11
People who are doing this for the first time care a lot about the numerical
split but people who do this professionally care a heck of a lot more about
vesting. Whatever you choose, your outcome will be a lot better with a defined
vesting schedule. The standard one in the Valley is (for both of you!) "four
year vesting with a one year cliff", which means that 25% of the eventual
grant is durably yours on the 366th day and then 75% gets parceled out in
equal increments every month for the next 36 months after that.

I'd be inclined to have the company write you an IOU for your _cash_
contributions so far, and split it 50/50, perhaps with one of you getting a
tie-breaking share. The company can dispose of your IOU like any other short-
term debt of the company at some point in the future when it has the financial
wherewithal to do so. [See below about IOUs.] Your vesting clock starts 3
months ago, your partner's starts as of the day when he becomes full-time.

I cannot emphasize enough that your equity split is not _nearly_ as important
as "Does bringing this guy on uniquely make this business successful and do I
have confidence that we will both be happy with this arrangement 5 years from
now?"

Edit to add: As I get older and wiser, I am coming to appreciate the
discipline of separating one's personal and business finances and explicitly
receiving written acknowledgment for transfers of money into one's company.
These feel like moving money from one pocket to another in the early days, but
they _are not_ , and explicit written confirmation of that fact will make your
life easier in a lot of futures.

For example, I know one entrepreneur who, like many, tightened his belt, ran
up substantial personal debt, and put blood sweat and tears into building a
company. Professional money came into the company. Without documentation that
he had loaned the company money, the best resolution would have been asking
the other stakeholders to approve increasing his salary so that he could cover
his "personal" debts. Had that documentation existed, he would have had ample
authority to extinguish that debt in the ordinary course of business, and it
would have likely had favorable personal tax consequences.

~~~
gwillen
Are you sure that 1-year cliff is a good idea for founders? A lot can happen
in a year, and founder disputes are A Thing; and it sucks for the person with
49.9% to be in a position where any unresolvable disagreement in the first
year means he walks away with nothing.

~~~
patio11
I agree with you that a lot of founders have catastrophic breakups in the
first six months. In most cases, this kills the company, and good riddance. In
the cases where it doesn't kill the company, the cliff minimizes years of
painful conversations of the general flavor "Hello, 10th engineer. We are
happy to offer you 0.2% of the company, which you'll earn over four years with
us. This grant represents 1/250th of what someone who worked with us for two
months once earned." or "Hello, potential acquirer. That certainly sounds like
a very fair offer. Unfortunately, I'll need to run it by someone who I haven't
spoken with in 5 years who you'll be writing a check for several tens of
millions to."

Cliffs are, of course, negotiable. If someone suggested one to me with regards
to my business, I'd accept it contingent on the clock starting at either
launch or incorporation, either of which would result in the cliff being moot.

------
shin_lao
My first advice would be that this friend has to put money into the company.
You need him to show commitment. It doesn't have to be a lot, maybe just $
10,000. If he refuses to put any money into the company, you have an employee,
not a partner.

Trust me on this one, you want to test risk tolerance as soon as possible.

Second question, will he work full time? If he doesn't work full time, you
should give him very little equity, or just relative to the amount he invested
in the company with maybe a little extra relative to the value he brings.

If he doesn't want to work full time and doesn't want to put money, just pay
him by the hour. Pay him by the hour can also be a way to start the business
relationship and build trust.

Third question, how much can you pay him if he works full time? For example,
if he works full time but you can only pay him $ 50,000 instead of $ 100,000
the first year (assuming $ 100,000 is what he could get), he's putting $
50,000 into the company.

Now, the last part: value your company. The best indicator is profit, when you
reach it and how long you hope to sustain it (for ever, possibly). There are
many tools and formulas, your accountant can probably help you. Because you
have an accountant right? And a business plan, right? ;)

Another approach is that if he puts a decent amount of money (enough to give
several months of runway) into the company and works full time for a well
below market salary you can give him 49% (or 50%, up to you).

------
tzury
Joel's Canonical Guide

[http://www.businessinsider.com/how-to-allocate-ownership-
fai...](http://www.businessinsider.com/how-to-allocate-ownership-fairly-when-
forming-a-new-software-startup-2011-4)

------
andreash
Google "Startup Lawyer If I launched a startup 2014", which sums up most legal
questions including equity splits. Founders Dilemma by Wasserman covers the
topic from a scientific research point of view.

tl;dr as far as I remember from that book: Make sure it is fair, and enough
equity for both to be motivated. You have to discuss with each other to find
out. It can be everything between 95/5 to 50/50\. If you value the friendship
more than you value the company, you should go for 50/50\. Otherwise 50/50 is
not a good option according to Wasserman's research.

~~~
sillysaurus3
5% would be absurdly predatory for essentially a cofounder. (If they're
building the company from the ground up rather than merely shaping it, then
they're a cofounder.)

~~~
andreash
I agree. With 95/5 you're more like a first employee. My guess is that more
popular splits are 50/50, 40/60, 70/30, 80/20\. In that order.

------
lukasm
Ask her what, in her mind, is fair. If she says "we should do 50% 50%" and she
won't give you the credit for starting the venture, you should think twice if
you want to establish the partnership with this person. If she says "you did
most of the work. 20% is fair" you should do 50/50 with IOUs and vesting.*

*Partners are working full time on this.

Here is a good summary of how to pick a cofounder
[http://venturehacks.com/articles/pick-
cofounder](http://venturehacks.com/articles/pick-cofounder)

------
kurttheviking
Find someone who you believe to be your equal (strength of skills he/she
brings, intelligence, future potential) and treat them as your equal (50/50,
same vesting schedule) -- you remain CEO. If you don't believe they are your
equal, then find a way to hire them (as an employee, contractor, whatever)
instead. Most other strategies are recipes for resentment in the long-term. As
others have said, weathering the first 4 months will be nothing like what it
takes to deliver a success story in 4 years.

------
alain94040
_I 'd like to bring in a good friend of mine who I believe can contribute_

This is the key sentence. Work together for a month, with no equity. See how
much this potential co-founder actually accomplishes. You'd be amazed by the
gap between what you dream may happen and what actually happens. Success is
hard.

If after a month, you are still super-excited about this co-founder, start
discussing an equity split. Always with vesting. No cliff (or very short, that
was what the 1-month trial period was for).

If a co-founder doesn't receive a salary, then the minimum equity split would
be 90/10, all the way to 50/50\. FYI, at 90/10 I would behave like a super-
adviser, but not a fully committed co-founder. 75/25 is the first "true co-
founder" deal I can think of.

~~~
tptacek
"No cliff" is wishful thinking. Everyone has had the experience of hiring
someone who ended up not working out. It almost always takes more than a month
to come to that conclusion, and a little longer still to act on it. And
finding a viable cofounder is harder than hiring.

Having someone who worked for you for _a couple months_ walk away with tens of
basis points of ownership is a pathological situation, not something you
should deliberately optimize for.

------
samtalks
Funny you ask this here. In 2012, 1 in 4 Y combinator starts up broke apart
due to founder disagreement. You can bet a large part of that was due to
equity distribution issues. Equity issues can get really messy - and easily
damage friendships.

Read the reviews for Slicing Pie. It's about maintaining a dynamic model that
eventually vest into shares (if the company works out). I read it. It's great
quick read. Ideal for your situation, I think. And it may preserve your
friendship.

[http://www.amazon.com/Slicing-Pie-Company-Without-Funds-
eboo...](http://www.amazon.com/Slicing-Pie-Company-Without-Funds-
ebook/dp/B0096EFHBI)

------
onion2k
If I was in your potential business partner's position, I'd ask for 50/50
vested with a schedule of (say) 12 quarters, so every 3 months I'd get 4.1% of
the company, with a cliff of 6 months to test whether the relationship will
actually work (e.g., no equity transfer if the relationship breaks down in
that time) That would recognise the work you've done already, but also
appreciate that if the business lasts a long time the initial work will become
less important. There's no good reason why you should have more equity than
your business partner after a few years - by that point the risk each of you
have taken is effectively the same.

------
danielweber
Here is some advice from 1996: don't have equal partners. Make sure someone
can call the shots or else no one will call the shots:
[http://yesatyale.org/wp-
content/uploads/2014/06/lecture_06-1...](http://yesatyale.org/wp-
content/uploads/2014/06/lecture_06-1.pdf)

 _EDIT_ This moves around so much I uploaded to Scribd:
[http://www.scribd.com/doc/234962516/Entrepeneurial-Death-
Tra...](http://www.scribd.com/doc/234962516/Entrepeneurial-Death-Traps)

------
kephra
Do you plan on an LLC, an S-Corp or a C-Corp?

An LLC would require to define terms of ownership, decission and cashout in
its charter beforehand. A Corp is much more flexible, especially if you do not
know how much your "partner" will contribute in the future. So you might want
to copy the unusual way Wizards of the Coast did: 1 share = 1 hour = $50

So you own already 600 shares, and your partner owns zero. If he invests money
or time he earns share and dilutes you, if you invest money or time you earn
shares and dilute him.

WotC shares later sold to $1400, iirc - so it was a good deal for the artists
who painted those tiny pictures for magic the gathering.

PS: Peter Adkison later wrote that he had no clue how a normal Corp works, and
did not consult a lawyer because he had no money for it, and just handwaved a
way, that sounded fair to him, to pay the artists without having any money. It
worked out, thats all that counts.

~~~
tptacek
I don't think it's true that an LLC requires you to allocate equity statically
at the time of formation. LLCs routinely issue equity to employees long after
formation, and, to the best of my knowledge (I cofounded, co-managed, and
eventually sold an LLC with several tens of employees), without modifying
their charter.

No matter what your corp structure is, this is an issue you need to spend a
few hundred dollars on an attorney on.

------
sauronlord
I wouldn't give any equity away in this case.

Why?

He has not done anything yet.

This sounds like you are afraid of sales/marketing/biz dev/something and you
think he will solve your problems.

I warn you: he will not solve your problems, you will have more on your hands.

------
Alex-Galapagos
it all depends what is he contributing.. You said that you believe "he can
contribute a lot in many areas that need to be covered in order to build a
succesful app company", but what is it exactly? Who's coding the app? You've
already done first app, if he's contributing to marketing of the first app
then he can get less than 30% of profits from that app. If you've already
built second one, the same thing. If he's building the second app with you and
brings more skill you might consider splitting evenly just for the second app,
you don't have to give away equity within the company, you can make an
agreement to split profits just for the second app, since he can decide to
leave.

------
Axsuul
My experience is it should always be evenly distributed at such an early stage
(3 months is still considered early). I've started two companies and it has
never failed me. This eliminates any drama and holds each founder accountable
for the work that is required. If you don't trust this approach, then there
are deep underlying issues that need to be addressed first. This could be not
trusting the incoming founder to make up for the time that has passed while
you were running the company initially.

------
_pius
Joel Spolsky has weighed in on this:
[https://gist.github.com/isaacsanders/1653078](https://gist.github.com/isaacsanders/1653078)

~~~
rahimnathwani
"if someone goes without salary, give them an IOU. Later, .. you'll pay them
back in cash ... when the money comes rolling in ... pay back each founder so
that each founder has taken exactly the same amount of salary from the
company."

This doesn't seem fair. The founder who takes an IOU rather than cash bears
the very real risk that he never gets paid back. There should be an interest
rate attached to the IOU: something like 15-25% to account for the risk.

~~~
jonnathanson
There should be an interest rate, because the value of money changes over
time. There is a difference between the value of $50,000 in hand today, and
the expectation of being paid today's $50,000 a year from today. That
difference is reflected in the interest rate. Risk is also accounted for in
the interest rate, although fundamentally, not all risk can be accounted for.
There is always going to be the risk that the startup goes bust before it can
pay back its IOUs, and it would be silly to expect an interest rate exorbitant
enough to account for all of that risk. A rate of 15-25% is probably fair to
the individual in a nominal sense (more than fair, actually), but it is unfair
to the company. This is a case where the individual will need to bear some of
the risk in the financial interests of having a successful company. He is not
a loan shark, after all.

~~~
rahimnathwani
"A rate of 15-25% is probably fair to the individual in a nominal sense (more
than fair, actually), but it is unfair to the company."

I think we are in agreement on the first part, i.e. that a rate of 15-25%
should adequately compensate the individual for both the time value of money
and for the large risk of default.

I don't agree that it's unfair to the company. Consider:

\- The company has no alternative, cheaper sources of debt financing

\- The capital and interest will be deferred until such time as the company
has money to pay (e.g. from a Series A) so will not cause any hardship by
constraining cash flow

\- These IOU are non-participating, i.e. they don't get any of the upside
should the company do well.

If you think about it, it's similar to an investment by an angel: you want to
compensate for the risk, you don't know when you will be able to return the
cash, you don't have a reliable way to come to consensus on valuation.

Perhaps the right way to structure these IOUs is as a capped note with a low
coupon (2-5%) but a reasonable conversion discount. That way the equity-like
element of the note compensates for the risk, instead of requiring a large
coupon on the debt-like part.

------
mattei
Here's a link to an in depth talk & infographic that'll help you see a more
detailed view of what might impact how you approach equity splitting someone.

[http://blog.saasu.com/2014/03/28/ceo-insights-webinar-
record...](http://blog.saasu.com/2014/03/28/ceo-insights-webinar-recording-
how-to-register-for-upcoming-events/)

 _Disclosure: I work at Saasu but think this is relevant._

------
ABS
I like, a lot, the Grunt Fund idea of Slicing Pie (no affiliation):
[http://www.slicingpie.com/](http://www.slicingpie.com/)

The point is: why split the pie before it gets done or after? why not
dynamically split based on the actual resources (money, time, equipment,
whatever) people put in in the early days?

~~~
gojomo
While I suspect that Professor-of-Entrepreneurship has a lot of the details
worked out in his book, I would be concerned about tax implications (higher-
basis/more-recordkeeping) and the distractions/morale-risks of constant
rolling renegotiation about "latest contributions".

For example, when the company hits a rough spot, it may be best for a team of
N to be thinking, "We all need to work extra hard this month so that our 1/Nth
shares wind up worth something, rather than nothing." Rather than, "I need
some recharge time, I'll let others earn a little more this month, and re-
engage for my increments if and when it gets less crazy."

------
JSeymourATL
> I'd like to bring in a good friend of mine who I believe can contribute...

Work to keep him as a friend. Channeling Steven Covey, it would be helpful to
first understand what he would like to get out of the business arrangement and
what he's committed to invest on his end. Beyond a mutual agreement, find a
win-win scenario.

------
nav
Look into dynamic equity models. eg. Grunt Funds
([http://www.businessweek.com/articles/2012-12-18/grunt-
funds-...](http://www.businessweek.com/articles/2012-12-18/grunt-funds-are-
trending-in-startup-circles) )

------
staunch
What you've done to date is simply what was required. All of the really hard
work is in front of you. If your partner isn't worth an equal share they're
not worth being partners with.

------
woogle
> can contribute a lot in many areas that need to be covered in order to build
> a succesful app company

You told us what you've done until now, but are those "many areas" ?

------
rajacombinator
What is the other person bringing to the table? Just treat them as a first
hire and offer the minimum equity needed to get such a person.

------
polvi
Sounds like a good time to use the equity equation:

    
    
      http://paulgraham.com/equity.html

~~~
munrocape
Neat article. I think OP is trying to discern _how_ to map the friend's
contributions to outcome of the company.

------
adultSwim
Equitably

