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Co-Founder Percentages – Key to a Successful Venture

For those who are thinking of starting a new venture in partnership with other co-founders, I am sure one of your biggest concerns is how much share should each co-founder get. The easiest is to say equally, i.e. if there are 2 co-founders then ½  each, if there are 3 then 1/3rd each and so on and so forth. But, equity is the most permanent form of investment and from the company’s perspective also the most costly. Once decided, it is very difficult to change. Being a Gujju, I never had the heart to commit a percentage until I saw the person helping the venture grow. But then, how do you decide the percentages? In any case the worst answer is equal.

I will justify the reasons and give a workaround later in the article, but before that I would like you to spend a little time self-analysing your venture by answering a few questions. If you want, you can skip those and move to the end. But, I highly recommend otherwise.

First Question: Is your business an online or offline business. (Every business has both sides, but the question is whether majority of the business will be online or offline)

Second Question: Is it a delayed cash or instant cash startup. (This is the most important question according to me)

Third Question: Is it a stable startup or a growth startup. (Stable startups are ones which make good money for the founders and a small team, but don’t have a wide application for achieve global scale)

Fourth Question: Does it require massive capex (Capital Expenditures)

Ok Done?

Now the reason I asked you these questions is because they are imperative when deciding equity shares. I’ll elaborate as follows:

First Question: If it’s an online startup, you probably will have to focus on a more technical staff. Getting a good technical team on Equity is a little easier for an online startup than for an offline one. This is because the technical guys will get a lot more exposure for their work and become popular in their community. On the flipside it you want to “Hire” technical staff for an online venture, it’s probably going to be too damn expensive for you.

For offline startups are easier to “Hire” employees for work, but getting technical co-founders for creating a one pager website is obviously foolish. Getting non-technical co-founders with area expertise is a big challenge over here because most of them will be employed in well-paying jobs in a competitive industry. So getting them on board will be a whole lot tougher.

Second Question: Delayed Cash startups are ones which make money after a long development delay, much like my startup Qpeka which is an online reading and publishing platform. Here cash is to be made on large scale, which is very distant. Instant cash start-ups are where you start making money from the word go. That is similar to my other venture My Cute Office which is a cloud office concept for helping freelancers, startups and professionals get an affordable office space close to their homes to start their businesses. Here there is no focus on expensive technology, no long gestation periods and business can be started just through a good network. In fact I just have a one pager website and it’s more than enough (for now at least)

The reason this is important is, when you are looking at a long business development cycle, you have to keep in mind that the team may not remain intact for long. We started Qpeka with 8 co-founders and are currently at 4. So to sustain, you need to have A) more co-founders than you actually need in the beginning, because many will quit, B) agreements in place with the other co-founders to deal with various contingencies such as their leaving.

With Instant Cash Startups, it’s wiser to pay interest to your investors than to give them equity stakes, since you will be making money. Offer them 15% if required + try paying off the principal from your cash flows. (I know easier said than done)

Third Question: Stable Startups are usually those which will make good money (enough to make employees and the founder happy). However, these achieve market saturation early because of the niche which they aim for. In such startups, getting investors is a bit easier, but taking investor capital could be risky as the investor may have hopes of making more money which may drive you away from managing your business.

Growth Startups is where you aim for the Pie in the Sky. They are inherently risky like Qpeka is. But the rewards once you reach there seem big. Best of Luck if you are planning one like this. These are also typically difficult to get funded, and you will usually say to any money you see coming whether from co-founders or investors, no matter what the stake you need to give. But as I mentioned before getting back the shares you let go is not easy. However, if you decide to give any equity because you need the money, ensure you discuss the exit arrangements beforehand. This is because in all probability you are going to require cash in the future as well and if these investors don’t agree to an exit, you may end up seeing yourself as a minority shareholder.

Fourth Question: Capex (Capital Expenditure is one time expenditure that usually burns your pocket and your legs along with it). These are usually the most difficult. Unfortunately most tech start-ups fall in this category, since costs pile up as you have a development period. Do a proper due diligence of the inflows before you start a venture which requires massive Capex. Usually you need really good luck to get a co-founder to put in all the money for the Capex. Also, if you need special expertise for the technology, getting a co-founder becomes even more difficult.

In all the above, always note that when getting a co-founder later is always better. Try to do as much as you can yourself, but don’t think of going solo the whole way. Co-founders always help and big time.

Now once you have got the basics in place, let’s discuss the main part:

DECIDING CO-FOUNDER PERCENTAGES

I can become all philosophical and say some prophecy showed us how we should divide our shares. But I would be lying.

Equal is the worst possible answer, since we all know – Not everyone works equally” and “Not everyone has the same needs”. Also there is “No guarantee about the future”.

So, we actually had to come out with an extremely complicated calculation for deciding the percentages. This helped us a lot during the phase where many co-founders left the venture. (Please note this was for Qpeka – An online, delayed cash, growth start up with large capex costs. This is where most tech-based businesses fall).

Before deciding to allot the shares, we first listed the criteria for us to decide who should get what. We listed it as follows:

  1. Capital – This is the amount of money which is being put in.
  2. Time and Effort – This is the efforts made by the team members and the time they put in.
  3. Opportunity Cost – This is the sacrifice by the team members when choosing to work on Qpeka.
  4. Idea – This is for the ideas and inputs given by the team members in improving the concept.

But, before that we had to decide the length of the project. We decided that it would take us at least 2 years to develop a self-sustaining product. (Currently we are a year and a half through). Such a long period meant that we had to find a way to change equity ratios.

So, there were 2 major challenges in this, 1. To measure the criteria. 2. To be able to change the equity based on the team’s performance.

Before we tackled these problems, we first had to form a company. A company is an ideal form of organisation when you are dealing with 3rd parties, since it has an independent identity from it’s investors and shareholders and also helps build more trust.

Step 1 – Qpeka was a long term project, and we decided to contribute capital quarterly and issue equity too quarterly. This period depends on the start up and how they want to raise money.

Step 2 – To measure the criteria, we first derived relative values of each of these. So let’s say “Effort” was very important and “Money” was secondary. We therefore decided to give, Effort a total value of say 100 and money a total value of say 75 (for the Rs. 100000 being brought in by the partners. Actual figures are obviously different). Now “Idea” according to us was the least important since ideas count for nothing without execution. So we decided to give it a value of 25. “Opportunity Cost” was a special benefit for those who were giving up their day jobs for the venture. We gave it half the value of the time and effort i.e. 50. (This can also be calculated using the salaries foregone by each co-founder and compared with the amount of money being contributed to arrive at the relative value eg. If for the quarter capital raised is Rs. 10000 for a value of 75 and salary foregone by the co-founders is say Rs. 50000, the value can be 37.5.)

So we now had the total values as under:

Capital – 75

Time and Effort – 100

Opportunity Cost – 50

Idea – 25

Total – 250

Step 3 – Now with these figures in mind, we should start dividing each of them between the co-founders. You are free to choose more heads if you want, eg. you may chose to have a portion for the equity for bringing in and managing clients or give different values for each head depending on your preference and situation. Nevertheless, the next step is much more important.

Step 4 – The most important step is to divide these figures among the partners. Assuming there are 4 co-founders A, B, C and D. Of these let’s assume that A and B are contributing to the capital in the ratio of 1: 2 while also doing their day jobs and helping the venture in their part time. C and D are working on the venture full time but do not contribute capital. D withdraws a salary from the venture but C does not. The idea was thought of by A and C. Now with this case in mind the way we divided it was as under:

Capital 75 – In ratio to the amount actually contributed by A and B i.e. 25 and 50 respectively

Time and Effort 100 – A and B are part time and are assumed to put in 1/4th of the time of C and D. Therefore the ratio is 1:1:4:4. So when split the values are 10, 10, 40, 40 for A, B, C and D respectively.

Opportunity Cost 50 – C and D have left their jobs for working full time on this. But D draws a salary equivalent to his last company, so he should not get any benefit, and C shall get the entire benefit from this. Thus 50 is transferred to C

Idea 25 – The major contributions and the structure of the business was designed by A and C, hence they should be given the benefit equally, which is 12.5 and 12.5 respectively.

Total 250 – The total figures for A, B, C and D from the above come to 47.5, 60, 102.5, 40 and in percentages this comes to 19%, 24%, 41% and 16%.

But percentage of what? Now that the company was in place, we had to issue shares. The face value of shares (the price mentioned on the certificate, market value can be substantially higher) we issued was equal to the amount we had contributed. So for the Rs. 100000 we raised we issued equity worth Rs. 100000. But instead of dividing it between the co-founders equally, the ones working their asses off got more stake, which is quite implied.

Now for the next quarter we repeated the same exercise, but to keep the values in proportion to the last issue, we decided to derive the value of the capital first. Since say we had to raise Rs. 2 lakhs in the second quarter which is 2 times the amount raised in the first quarter, the value of capital was now 75 *2. All other values were proportionately determined. If there are no new ideas, then it can be made 0 in the next quarter. Also, if opportunity cost loses its importance or if all full-time co-founders draw salaries, you can accordingly reduce its value. Once you get the percentages for that quarter, issue new shares for the amount you have raised and divide it amongst the co-founders in that percentage.

Rinse and Repeat, till you get a Washing Machine in form of an investor.

So that’s about it. Just keep in mind, that even though you need to determine the percentages at the beginning of the quarter, keep a clause that these can be revised by the board at the end of the quarter depending on actual performance and you should be safe.

If not on a registered document, at least get these details on mail. Oral contracts are hard to prove.

But as time progresses cash becomes more important if you have a high burn rate. At that time however, if your product is not in place, you may have to shell out more equity for the money being put in, since now it’s riskier. But then again that is the co-founders call.

This is how we tried to ensure that the division was equitable among our co-founders and touch wood has had a really great impact in keeping our team together. Even the co-founders who quit keep in touch with us owing to the fact that they accept this equation.

I happen to be a CA too, so if you need any help in your startup don’t hesitate to write to me at abhishekbarari@qpeka.com

You can also find me on Twitter @AbhishekBarari and on Facebook too.

Also don’t forget to check out Qpeka and My Cute Office.

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10 Comments

  1. Nice one Abhishek

    Although the approach is good and effective….the practical application is more difficult i guess…not suitable for most of the startup…will be looking to know others views on this 

  2. My inputs:

    There was a question asked on Quora:

    How do I split equity between my new co-founder and I on a side-project I have been working on for over two years, put money in, and brought initial users for?

    This was my answer:

    Thanks for the interesting question.

    Let me dive directly into the sweet problem:

    – Lets assume that you have invested 400 hours into the project

    – Lets assume that your market value is US$ 25 per hour

    – You state that you have invested 5000 US$ into the project

    Therefore the ‘capital’ invested into the venture by you is = (400*25) + 5000 = US$ 15,000

    – Now lets assume that your friend puts in 500 hours in the next few months

    – His value in the market is US$ 30 per hour

    After he has put in his hours, the ‘capital’ invested by him will be US$ 15,000

    Total Capital of the Company now will = US$ 30,000

    Both of you will therefore own 50% each.

    – Lets assume that you also continue to contribute while he is involved

    – Lets assume that you add another 200 hours

    Your capital invested in round 2 will be = US$ 5000

    Total Capital created will be 15K + 15K + 5K = 35K

    Your share will be 20/35 = 57.15%
    Your friends share will be 15/35 = 42.85

    This formula can be used to add capital to the pool and reward the contributors (be it via cash, effort, employees (the amount they DO NOT take home in cash) etc.

    Tell me if this helps!!

  3. Hi Alok,

    This is indeed very similar to the formula we had used earlier. But we realised, we had a much larger group to deal with and all of them were from diverse fields with highly varied rates for salaries. Also we wanted to consider the risk appetite and value for the idea too. So on similar lines we started using weights instead. But as I said, this may not be the perfect formula. It’s just a guideline.

  4. It depends actually. I don’t say this is the model case, but it’s something of a start. And it helps really well where the co-founders do not know each other for a long time. Also, helps to keep the environment cool and gets everyone who get’s equity to contribute more than they are supposed to, to get more equity.

  5. Here is a Co-Founder Equity Calculator! http://foundrs.com/, personally I didn’t like it and I don’t recommend it to anyone.

    I think we are very fickle, more parameters we look into we burden ourselves with focusing on craters and impurities of others and others work. Which will start making us suspicious and unfriendly with each other.

    As Alok suggested it’s better to keep things simple consider 1. capital 2. effort that’s it. and let each co-founder earn their share of allocated equity in future based on measurements and milestone.

    Lets take learning from elections. When we vote, it’s one vote for one person. We don’t give double weightage to educated people, celebrities or rich guys. It’s possible to do it today but we don’t because we don’t want chaos and we don’t want to create new monster-problem.

  6. With my limited experience, I feel, its best to go solo .. you are not burdened with these things and you are solely responsible for every decision / profit / loss that you make.. 

  7. A very well written article. The best part comes from the fact that such an arrangement keeps co-founders interested in the overall progress of the company and leaves very little room for friction later. Something that becomes important at a later stage once the business is successful or has to be liquidated for some reasons.

    On a completely different note, I failed to understand the purpose of the website. Seems like a free online reading platform, but nowhere is that mentioned explicitly. I think thats important for someone visiting the website for the first time. Also, how are you managing copyright issues?

    Cheers, Laksh

    Co-founder Green Apple Solutions http://www.greenapplesolutions.com

  8. Dear Alok,

    We are currently working on what will be the stake of each founder in the company and currently we are going with one parameter as capital invested by each founder. Please let me know if this is the right method to do? Also tomorrow when the company needs more funds and if one of the partner decides to invest more funds then does his stake in the company increase and that of the other founders decrease?

    For E.g. There are 3 founders A, B & C. Founder A invested 7 Lakhs, B invested 10 Lakhs and C invested 8 Lakhs so their share/partnership in the company would be Founder A-28%, Founder B-40% & Founder C-32%. After 1 year the company needs additional 15 lakhs funds and Founder B decides that he will invest so will Founder B have more stake now i.e. 62.5%  and Founder A and C will have reduced stake 17.5% and 20% respectively?

    Can you please guide us on how this work?

  9. No. Thats not right

    This is the maths

    CURRENT Valuation

    25 lacs

    A = 7 lacs = 28%
    B = 10 lacs = 40%
    C = 8 lacs = 32 %

    After 1 year, the Company WILL GROW IN SOME VALUE by the work you have done. I dunno what that is

    Lets say its another 25 lacs

    So, after 1 year, the company’s value is now 50 lacs

    Founder B puts 15 lacs

    So new value is 50+15 = 65

    NEW SHARES To B = 15/65 = 23% New shares

    So, final cap table will be

    A = 28% old shares – 23% ProRata dilution new round = 21.6 % Shareholding

    B = 40% old shares  – 23% ProRata Dilution new round + 23% new Shares of new round = 53.8 % shareholding

    C = 32 % old shares – 23% ProRata Dilution new round = 24.6 % shareholding

    Hope this helps!

    ***

  10. Dear Alok,

    Thank you for simplifying the calculation, it is clear now.

    Also when we say value of a company, is it the profit the company makes or the over all revenues or the good will it carries in the market (no of customers). How can one define the value of a company?

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