When you are launching a business in partnership, you need to determine the ownership of each member. The profits and liabilities are shared between each member on the basis of the profit-sharing ratio. Most people believe splitting profits is as simple as dividing it 50/50. That may be applicable in cases where each partner contributes equally, not only in terms of funding, but in time, knowledge, and overall partnership. If partners do not have an equal contribution to the business, you are going to have to figure out the perfect split ratio that tells the amount that each partner should get. You can use the startup equity calculator to split the amount fairly between each member. This mitigates the risk of conflicts between the partners. Now, you can focus on expanding your business, instead of calculating the rate of return.
Factors to Consider When Splitting Equity
Each founder contributes a specific amount and agrees to get a return based on their investment. However, they might invest funds in different ways. Some invest only money, while others bring skills, knowledge, time, and other things to the table. These factors are also taken into account when splitting equity fairly between the company’s founders. Here’s a list of the types of contributions.
1. Knowledge or Skills
Every company has at least one technical co-founder who brings the latest technology, builds a website and mobile app, uses AI-powered tools to automate most business tasks, and implements other latest technology to speed up the company’s growth. You also need someone with technical expertise. Knowledge of the industry and how to market the product efficiently are key to organizational growth. Likewise, you need someone who specializes in human resource management. They don’t necessarily have to be the co-founders, but a tech-savvy individual having HR management skills is a bonus.
2. Time Commitment
Investing money in a business is one thing and investing your time in nurturing it is another. The more a founder is actively managing the business (from day-to-day management operations to bigger projects), the higher their equity should be. You can divide the equity based on the number of hours each member dedicates to your startup. However, do you want to avoid your people from overworking? It’s advisable to keep a limit. If it is passed, the number of hours spent on the startup won’t be counted.
3. Job Commitment
Another important factor in deciding the cost of equity is the opportunity cost. There’s a difference between time spent on work. Somebody spending 7 hours on a startup will have different productivity. However, someone spending the rest of the time working a part-time job will be different. Also, someone who’s fully dedicated to your business will have a lot more commitment. Check if the co-founder is willing to work full-time for your business. In some cases, the founders go the extra mile to bring the best results. For instance, they might relocate to a place closer to your office just to attend meetings and conferences in person.
4. Equipment and Resources
Lastly, founders contributing equipment and other valuable resources to the business must be compensated for their contribution. You can decide which contribution should be compensated. It can be a fixed asset or a tool that helps in the production of your product. Usually, for small assets like a printer or furniture, the contributor can be reimbursed immediately. It’s often a one-time payment. However, if it’s a valuable and long-term asset, such as a vehicle, it will be added to the contributor’s equity.
Splitting Equity Based on the Startup Idea
You can work with your co-founders to come up with a startup idea. You might also work with one of the founders who already have an idea in mind. However, they just share it with the rest of the team. The question is, should the person who brainstormed the startup idea get more equity? The answer is no. Your business idea is of no use unless you turn it into reality. That’s why everyone who’s involved in executing the business plan should get an equal part of the equity. Likewise, a technical co-founder who builds an application for your business might claim more equity. There are dozens of mobile apps in the market and only a few rank at the top of the search list. So, being a technical co-founder won’t impact equity. Unless you are running an IT business where technical knowledge is of paramount importance.
What Happens If You are Running a Business Solo?
Now, what about sole proprietors? Since you are running a business all by yourself, you don’t have to split the equity. However, it’s better to split the ownership of a business. Even if that means giving away a significant portion of the profit to your co-founder. That’s because a single person can’t have technical knowledge. They can't have all the soft skills, the required capital, marketing expertise, and other skills. The chances of a startup surviving 5-10 years are pretty low. It’s worse for those handling all operations single-handedly. It’s best to have a partner who can see management operations. They are the ones who can contribute to the company’s growth both financially and through their knowledge.
Use the Founder Equity Calculator
If calculating the equity cost manually sounds too difficult, there’s an easier alternative. You can use a startup equity calculator tool to calculate the equity of each founder. It will be based on all factors mentioned above and their monetary contribution to the market. You can also find tools that take all crucial factors into consideration when deciding the equity for all cofounders. Note that each factor has a unique weight when it comes to equity. What percentage of that element contributes to the ownership of an individual can vary significantly from one investor to another. A common question people ask is what if the co-founders have the same skills as you? Moreover, both of you are non-tech-savvy individuals? How should the equity be split in such a case? Well, you don’t have to divide the equity or become cofounders in the first place. Co-founders are people with different skill sets and different areas of expertise. That’s the whole purpose of running a business in partnership.