Discover more from Flow State by Chris Schultz
Dividing the Pie 🥧🔪
Ever found yourself thinking… 🤔
‘Starting up is lonely. I want to get people involved.’
‘My ‘big idea’ was dreamed up with a friend.’
‘It’s going to be hard to do this alone, so if I give people a piece of it, they’ll help me.’
There are many reasons to contemplate a partnership when starting a company.
After a year of working on my first company, BachelorBlowOut, my partner and best friend arrived at the ‘getting real’ moment where we needed to make an ‘in or out’ commitment. I was all in. He was taking a job as a lawyer. We rationalized that he could make a salary and help fund BachelorBlowOut while I worked on it full-time with no pay.
We started at a 50%-50% ownership division. We agreed he would invest $1000/month for a year and keep his ownership; if he didn’t put the funds in, his ownership would be reduced accordingly, ultimately down to zero if he didn’t put anything in.
This agreement was handwritten on a piece of paper.
After a year, he hadn’t put any money in. I sold the company two years later for $60,000. I was also offered a $60,000/year salary. Combined, this helped me pay off the $120,000 in credit card debt I acquired building the business.
After the sale, he felt screwed. I felt I’d dedicated three years to the company we founded and walked away with nothing. We went without speaking for more than two years. It sucked to struggle to build our company and lose a friend. The handwritten contract did little to assuage hurt feelings on both sides.
What would I have done in hindsight? Maybe nothing more than trying to paper the contract more formally. With experience, I’ve learned that partnerships are challenging, and crystal clarity on agreements upfront goes a long way to avoid someone feeling screwed later. This becomes especially important when things go really well or really poorly.
How to divide the pie in a new company is one of the most frequent questions I get.
I’ve done it every which way over my career and 40+ businesses. There is no foolproof way and I rarely give the “you should do this” kind of advice, but I like to provide guidelines that help a founder to think it through.
Here are some ideas for consideration:
Having “the idea” is basically worthless. The value will be created by those who build the company.
Today is just a moment. Equity should be earned for effort over a period of time, not based on what someone does today.
Investing capital, sweat equity, and opportunity cost are not the same things.
50-50 partnerships are complex to make work. Same for ⅓ and any fully equal divisions.
If you plan to raise capital, learn and utilize standard frameworks. Messed-up cap tables from early stages will tank future investment.
Agree on equity early. Paper it. This avoids confusion and hurt.
Think in terms of motivation. You want to motivate someone else. And you want to stay motivated yourself. Nothing kills motivation more than feeling like something is unfair.
Reduce complexity. It costs money, so make sure anything you agree to will be worth it for legal, accounting, and tax expenses.
Equity grants are valuable and, therefore, can have tax implications; be aware of them.
Taking risk is more valuable than effort because it is harder to come by.
As a company matures and risk is reduced, resultant equity percentages in a company are reduced.
Getting out of a partnership is much harder than getting into it.
Here are frameworks that can help you decide on the right structure for your situation:
Startups have relatively standard equity bands.
Founders - start at 100% divided between the # of founders, and then start to dilute.
Employees - 5-15% pool of ownership for all employees. This is often refreshed when capital is raised, meaning 5% or even 1% may make sense initially, but if a company has hundreds of employees, ownership is a fraction of a %. Always use vesting for anyone earning equity for working.
Investors - 10-20% per round. Typically, you will sell a portion of your company to investors, and each new round will represent dilution to the founders, previous investors, and employees.
Board Members or Advisors - 0%-10% total pool. People who are valuable to the company but not investing or working every day
Companies often morph as they grow into multiple legal entities. Each can have its own ownership makeup, but be careful that this doesn’t create misaligned incentives.
Knowing whether you do or don’t want to sell a company eventually is essential to knowing if you want partners at all. Owning 10% of a $100 million dollar company or 100% of a $10 million dollar company are two very different paths to ending up in a similar spot.
Communicate openly. Be ethical. Document agreements.
Don’t give away something that you won’t get back. Know who and what you need to be successful.
To my friends who are dividing the pie right now, I hope this provokes some helpful thinking. There is no correct answer, it ain't easy. Do your best and keep on rolling.
PS: Want to dive deeper? I recommend this book: Slicing Pie Handbook