April 28, 2021

You can be rich, or you can be king, but you can't be both

At 1517 we work with founders on most of their firsts. First hires, first contract negotiations, first real office -- but it starts much earlier than that. One of the things we encounter a lot is first fundraise and first founding team.

When we started working with founders, we didn't ask them about equity splits amongst the team. In part, I think we assumed it would be equal most of the time. But we saw that unequal splits tended to be suboptimal over time, so we started asking as part of our diligence process.

Most often teams are evenly split, especially when they start something together. And that's because each member of the cofounding team ideally brings overlapping and complementary skillsets to start building the company you wan to launch.

Recently I've come across two examples of teams with greatly inequitable splits. Here are the scenarios and why I think it's problematic.

Team A Scenario: 

Team of three cofounders working on a deep tech startup. The team essentially started the company together but the equity splits are 76%, 15%, and 9%. The founder with the largest percent certainly can't build this company himself and shortly after thinking about the idea this founder brought on a friend who is super excited about the work and brings a lot of scientific knowledge.

When I spoke to the majority holder he said, "B & C have never complained about the equity or wanted more."

This type of comment brings up yellow flags for me because it's clear that person A isn't thinking of themselves as a leader. A leader thinks about the long game and how different incentive structures may look 10 years down the line if the company does very well. When we talked about the long game of the company, he could see that his friends would probably be pissed about not negotiating for something more equitable. We further talked about how negotiation isn't about I win and you lose, but win win -- and by setting up the team inequitably from the beginning could cause big problems later on in terms of keeping the team going, frustrations/resentments between cofounders, and overall not contributing to the team being able to band together when the going gets tough (and the going will get tough -- cofounder splits is the number one thing we see that takes a company down -- it's not that the tech isn't working, it's that the team can't hold it together). What surprised me upon talking to this founder was that another investor had coached him that it was ok to be this split. That said, equity splits are an art, not a science, but our view is that equal splits sets up the team for the long and hard game of building a company. 

Team B Scenario:

One founder started the company in 2015, two others joined in the last year. That said, what they are bringing to market was built by the current team of three, but it's predicated on the work that the first founder started years ago. The splits are 54%, 20%, and 3%. The remaining company is owned by previous investors. 

I can see how the initial founder is trying to be good to his past investors and not scrapping the old company and starting a new one as of last year. There are multiple ways to think about whether or not to wind down a past company before starting a new one, but I'm going to focus on the cofounder splits here. I can see how it would make sense for the initial founder to retain more of the company than the other two cofounders but again, because the product their are pitching on was really created by this team of three, I think a more equitable split is justified. Technically the third person is an employee, but they have been on all the pitching calls and truly holds their own like a cofounder would -- so though the other two founders may see this person as an employee, I see this person as an important piece of the company puzzle. 

One of the sayings that we use the most at 1517 is "you can be rich, or you can be king, but you can't be both." So something to consider when forming a team. 

Hope this helps you to think about cofounder splits a little more! Send or tweet me questions about this any time!