DISTRIBUTION OF THE CAPITAL AMONG THE FOUNDING PARTNERS

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HOW SHOULD A NEW COMPANY'S CAPITAL BE DISTRIBUTED AMONG ITS FOUNDERS?

If there is one thing that keeps us entrepreneurs awake at night when we launch our company, it is the issue of sharing capital, or "equity", with our partners. If they make contributions with money it is reasonably easy to decide the percentage of each one but it is not the only thing and there are many things to take into account... do you know what they are? The decision on how to distribute the shareholding or equity percentage of the start-up is one of those extremely important and complicated decisions that must be properly considered, However, will have a very serious impact on the future of the company and, And to top it all off, you have to do it very early on, when everything is a nebula and we don't know what will happen.

But there is one principle that you should be clear about from the outset:

"The 100% of NOTHING is much less than the 20% of a BIG company".

Some important things to keep in mind:

• NEVER GO IN HALF-HEARTEDLY

Perhaps one of the most common things is precisely this, that the partners "so as not to argue" decide that the split will be 50%... something that avoids the problem now but is very likely to generate a much bigger problem in the future, since a 50/50 split is the origin of many situations of deadlock due to dissension between the partners that end up stopping the startup. One of the two should have something more, ideally the one who is going to be the director or CEO.

• EQUITY IS NOT GIVEN AWAY, IT IS EARNED: 

If there is one thing that bothers investors and founders alike, it is when startups give away small percentages of equity to friends who have helped a bit (but are not founders), to mentors or advisors and so on. You have to start from the assumption that your company is (or will be) valuable, and that if, for example, you decide to offer 1% of equity to a mentor or advisor, you must include clauses that oblige them to really "earn" that percentage, either by permanence, effective work for your company... etc.

• TO MAKE DYNAMIC DISTRIBUTIONS: 

One of the things that is done in some countries is to establish dynamic percentage sharing clauses, which is very valuable in the early days. The idea is to establish two types of shareholding distribution: on the one hand the "base" or percentage that we have from the beginning, and on the other hand another percentage that we can earn (or not) depending on whether for example we are x years in the startup (vesting), that we achieve x milestones... etc. (this is a complex issue that requires the legal advice of a good lawyer, whom you should consult). For example, one case would be a startup where the founders of the startup "earn" their full percentage if they stay at least 2 years, but if they leave the startup in year 1 they would lose 50% of their shares.

• MAKE A PARTNERSHIP PACT (+):

It's very uncool at a time when creativity and future potential is celebrated to talk about getting lawyers in... but it's essential. It is very important at this stage to define and sign a good partnership pact: it is a document that will set out your rights, obligations, those of advisors or mentors, dynamic distributions and other clauses. And the time to do it is now, as it is better to regulate now that you get along well how the startup will operate when problems arise... which they will, unfortunately, arise.

• THERE ARE NO MAGIC ANSWERS:

Never rely on templates that magically say what percentage each partner should have, nor try to copy the shareholding distribution of a start-up similar to yours; each company is different.

Tips on how to establish a good division between the founding partners

Establishing the shareholding of a start-up among its founding partners is an important process that requires a lot of consideration and planning.

HERE ARE SOME PRACTICAL TIPS THAT CAN HELP:

1. Set clear objectives: it is important that all founding partners agree on the long-term goals of the company and how the shareholding will be divided to achieve them.
2. Consider inputs: each founding partner should be rewarded in proportion to his or her contribution to the company, whether in terms of time, effort, capital or any other valuable contribution.
3. Define the value of the company: it is important to have a clear idea of the current and potential value of the company before establishing the shareholding. This can be determined by a valuator or through a financing round.
4. Be flexible: shareholding may be difficult to establish at the beginning, so it is important to be flexible and willing to negotiate with other founding partners.
5. Consider the long-term shareholding structure: The shareholding structure must be sustainable in the long term and take into account any future events, such as a financing round, an IPO or the entry of new partners.
6. Document carefully: it is important to document the shareholding distribution in a clear and detailed manner in an partners' agreement (+).

In general, establishing shareholding requires open and honest communication between the founding partners, as well as careful consideration of long-term goals and individual contributions. Consulting a lawyer or financial advisor can be helpful to ensure that the shareholding is established in a fair and sustainable manner.

A FRAMEWORK ON WHICH TO ESTABLISH EQUITY DISTRIBUTION

The great (if somewhat academic) book The Founder's Dilemma sets out a rather interesting framework of things to decide when it comes to establishing a startup's shareholder structure among its founding partners:

"The Founder's Dilemma" is a book written by Noam Wasserman. which looks at the challenges and dilemmas faced by startup founders as they try to balance the growth and success of their company with protecting their ownership and control. The book presents a series of real cases and case studies to illustrate the dilemmas faced by founders, including stock splits, investor entry, hiring management, strategic decision making and transitioning to the next company. The book also offers practical advice and strategies to help founders make informed decisions and minimise risks as they build and grow their businesses. Some of the advice includes the importance of establishing a balanced shareholder structure, having a long-term plan, having open and honest communication with investors and employees, and being mindful of long-term strategic decisions. In short, "The Founder's Dilemma". is a valuable and essential book for any startup founder seeking to understand the challenges and dilemmas they will face as they build and grow their company. It offers a unique perspective and practical guidance to help founders make informed decisions and achieve long-term success.

1. PAST CONTRIBUTIONS

It is possibly the most important, since, are tangible and reasonably objective elements on which to decide how much value each of the founders has contributed to the start-up: 

• Idea: it is common for the founder(s) who have contributed the original idea on which the startup is built to receive a bonus for their unique contribution. 
• Capital Contribution: the initial or seed capital contributed by each of the founding partners is an important factor on which to decide the distribution of equity, and should be proportionate to the money contributed.

2. OPPORTUNITY COST

A key aspect is to understand what each founder is sacrificing to set up the startup. It is easy to understand if we think of three founders, one of whom currently earns a salary of €100,000/year, another who earns only €20,000/year and another who as a freelancer earns €50,000 net per year.

3. FUTURE CONTRIBUTIONS

Although they are extremely difficult to anticipate now, the reality is that most of the contributions that each founder will make to the startup will happen in the future... but we should still try to assess them (and even include them in the partners' agreement with specific clauses). depending on a number of factors:

• Serial entrepreneurs: Founding partners who have previously set up a start-up, especially if it has been successful, can be expected to make a greater contribution to the success of the new start-up, both in terms of experience, connections and relationships with investors, for example.
• Level of commitment: Founders who will work full time are likely to make a much greater contribution to the value of the company than those who will only work part time.
• Positions: The position (and therefore the responsibility) that each member of the founding team will occupy should have an important influence on the distribution of the startup's equity (e.g. the CEO is likely to have more equity because he/she has much more responsibility).

4. MOTIVATIONS AND PREFERENCES OF THE FOUNDERS

In the end, we are all people, and the emotional aspects and relationships between the founding team members will always affect the distribution of capital to a greater or lesser extent.

• If what motivates the founders is the pursuit of wealth, they should split the percentage less and keep more equity (vs. splitting it among more partners, which depends a lot on what we consider to be success in a startup).
• Risk aversion and optimism will affect the founding team's prioritisation of earning better pay or earning more equity (discussed in The Founders' Salary Debate). 
• The level of conflict tolerance of the founders will also affect their ability and inclination to negotiate more or less for the distribution of capital (something we have already discussed, but which in my view is key to make clear from the outset). 
• The prior existence of relationships between the founders may also affect expectations about equity distribution (it is not the same to set up a start-up with a friend or family member as with a former boss or a complete stranger).

This framework is comprehensive enough for you to try to objectify the distribution of capital between the founding partners of a start-up, but don't forget that the important thing is that you all get to a point where you feel comfortable. (which does not mean that you got what you asked for in the beginning, but that you all think the equity distribution among the founders is reasonable).