A Theory Of Share Allocation For Startups
This post originally appeared as a response to “Forming a new software startup, how do I allocate ownership fairly? At Answers.OnStartups.com, a member site of the Stack Exchange network.
This is such a common question here and elsewhere, that I will attempt to write the world’s most canonical answer to this question. Hopefully in the future when someone on answers.onstartups asks how to split up the ownership of their new company, you can simply point to this answer.
The most important principle: Fairness, and the perception of fairness, is much more valuable than owning a large stake. Almost everything that can go wrong in a startup will go wrong, and one of the biggest things that can go wrong is huge, angry, shouting matches between the founders as to who worked harder, who owns more, whose idea was it anyway, etc.
That is why I would always rather split a new company 50-50 with a friend than insist on owning 60% because “it was my idea”, or because “I was more experienced” or anything else. Why? Because if a split the company 60-40, the company is going to fail when we argue ourselves to death. And if you just say, “to heck with it, we can NEVER figure out what the correct split is, so let’s just be pals and go 50-50”, you’ll stay friends and the company will survive.
Thus, I present you with Joel’s Totally Fair Method to Divide up the Ownership of Any Startup
For simplicity sake, I’m going to start by assuming that you are not going to raise venture capital and you are not going to have outside investors. Later, I’ll explain how to deal with venture capital, but for now assume no investors.
Also for simplicity sake, let’s temporarily assume that the founders all quit their jobs and start working on the new company full-time at the same time. Later, I’ll explain how to deal with founders who do not start at the same time.
Here’s the principle. As your company grows, you tend to add people in “layers”.
- The top layer is the first founder or founders. There may be 1, 2, 3, or more of you, but you all start working about the same time, and you all take the same risk… quitting your jobs to go work for a new and unproven company.
- The second layer is the first real employees. By the time you hire this layer, you’ve got cash coming in from somewhere (investors or customers doesn’t matter). These people didn’t take as much risk because they got a salary from day one, and honestly, they didn’t start the company, they joined it as a job.
- The third layer is later employees. By the time they joined the company, it was going pretty well.
For many companies, each “layer” will be approximately one year long. By the time your company is big enough to sell to Google or go public or whatever, you probably have about 6 layers: the founders and roughly five layers of employees. Each successive layer is larger. There might be two founders, five early employees in layer 2, 25 employees in layer 3, and 200 employees in layer 4. The later layers took less risk.
OK, now here’s how you use that information:
The founders should end up with about 50% of the company, total. Each of the next five layers should end up with about 10% of the company, split equally among everyone in the layer.
- Two founders start the company. They each take 2,500 shares. There are 5000 outstanding shares outstanding, so each founder owns half.
- They hire four employees in year one. These four employees each take 250 shares. There are 6000 shares outstanding.
- They hire another 20 employees in year two. Each one takes 50 shares. They get fewer shares because they took less risk, and they get 50 shares because we’re giving each layer 1000 shares to divide up.
- By the time the company has six layers; you have given out 10,000 shares. Each founder ends up owning 25%. Each employee layer owns 10% collectively. The earliest employee who took the most risk owns the most shares.
Make sense? You don’t have to follow this exact formula but the basic idea is that you set up “stripes” of seniority, where the top stripe took the most risk and the bottom stripe took the least, and each “stripe” shares an equal number of shares, which magically gives employees more shares for joining early.
A slightly different way to use stripes is for seniority. Your top stripe is the founders, below that you reserve a whole stripe for the fancy CEO that you recruited who insisted on owning 10%, the stripe below that is for the early employees and also the top managers, etc. However you organize the stripes, it should be simple and clear and easy to understand and not prone to arguments.