Founder shares, founder vesting, and co-founder equity split

Founder equity is a kind of equity ownership reserved for the founders of the company and, sometimes, its earliest team members. Equity distribution plays a critical role in determining long-term company health and stability. Getting it wrong can create conflict between co-founders, complicate fundraising, and lead to startup tension, if not complete failure. On the other hand, getting it right aligns founding team incentives, attracts confident investors, and creates a solid foundation for your startup’s growth and success.

When founder equity is thoughtfully structured, it becomes a powerful tool that strengthens partnerships, clarifies decision-making, and properly rewards the risk and contribution each founder brings to the table.

This comprehensive guide covers the essential things you need to know about structuring ownership between co-founders, baking in vesting schedules, adding protective layers to your interests, and avoiding half-baked decisions that lead to startup failure.

What is founder shares

Founder shares, or founder equity, are the equity stakes issued to company founders when establishing a business. These shares represent the founders' ownership percentage in the company and their claim to its assets and future profits.

Founder equity is different from investor equity in that it's acquired often through sweat equity (work and intellectual contribution) rather than financial investment. It also typically comes with different terms regarding voting rights, liquidation preferences, and other protective provisions that investors don't get.

Types of founder shares

Founder shares typically come in different forms, each with its own set of rights and restrictions.

Common stock

Common stock (or common shares) represent the basic ownership units in your startup. As a founder, you'll likely hold common stock, which typically carry voting rights but stand last in line when it comes to asset distribution in case of liquidation.

Preferred stock

While founders usually hold common stock, it's essential to understand preferred stock (or preferred shares) as they'll become relevant when you seek investment. Preferred stock create a different class of ownership with enhanced rights and protections. Many venture capitalists and institutional investors will only invest through preferred stock, making it crucial to understand their implications for your ownership and control.

Restricted stock

Many founders opt to issue restricted stock, which becomes "unrestricted" over time through a process called vesting. This approach protects the company and co-founders if someone leaves prematurely. The key is to structure restricted stock grants in a way that aligns incentives while protecting the company's long-term interests.

Cutting the Cake

Co-founder equity split

Co-founder equity split is simply an agreement among co founders on how much of the company each will own. This should be decided early on, ideally when you first launch your company. This gives everyone involved a clear understanding of their ownership stake and helps set expectations for future growth and success. 

Plus, it can make it easier to attract investors down the line if there’s already an agreement in place about who owns what percentage of the company.

When deciding on co founder equity distribution, the most important thing is to make sure everyone involved has an equal say in how much each person gets.

50/50 equity split

A 50/50 equity split between co-founders might seem like the fairest approach on the surface, but equal equity splits come with important considerations.

On the positive side, an equal split signals true partnership and mutual respect between co founders. It simplifies initial negotiations by avoiding potentially contentious discussions about relative value and creates a foundation of shared ownership where both parties feel equally invested in the company’s success.

However, 50/50 split is not always the most ideal scenario. Let’s say one of you is investing in more money, or one of you is still working part-time, and the other one is working full-time. Make sure you’re really thinking about roles, responsibilities, and contributions, and make a conscious decision about the split. Because there are many factors to consider, a dynamic equity distribution is often more appropriate.

Dynamic equity split

Some startups are now adopting dynamic equity splits that adjust based on ongoing contributions, making the process of splitting equity more transparent and fair. This approach can help address uncertainties about future performance and commitment. Dynamic splits typically consider various factors, such as:

• Idea and IP contribution. Who originated the core concept? Who owns relevant intellectual property?
• Time commitment. Is everyone working full-time? Are some founders keeping their day jobs?
• Capital investment. Has anyone contributed seed funding or personal savings?
• Experience and expertise. What unique skills and industry knowledge does each founder bring?
• Network and relationships. Who brings valuable connections to customers, investors, or partners?
• Future value creation. How will each founder contribute to growth and success moving forward?
• Risk tolerance. Who is taking the biggest personal or professional risks?

A fair equity split is essential for creating long-term relationships among co-founders and ensuring that each founder’s interests are aligned with the company’s growth and success. A well-structured equity split can also help attract top talent, secure funding, and drive strategic decision-making.

Founder vesting

Simply put, founder vesting means founders don't get all their company shares at once. Instead, they earn their ownership over time by staying with the company. Their shares are gradually released to them according to a timeline, typically over several years.

Essentially, vesting protects all stakeholders if a founder leaves prematurely. It ensures founders are committed for a meaningful period, and prevents departing founders from retaining large ownership stakes without ongoing contribution.

• Standard vesting schedule. Founder vesting typically follows a 4-year period with a 1-year "cliff". The cliff means no shares vest until the founder completes their first year, after the cliff, shares usually vest monthly or quarterly for the remaining period.
• Acceleration vesting. Founder equity typically includes provisions for accelerated vesting upon specific events. For example:
  • "Single trigger" acceleration: Vesting accelerates upon acquisition
  • "Double trigger" acceleration: Vesting accelerates if the founder is terminated following an acquisition

Proper vesting arrangements are typically documented in a founders' agreement. Most investors expect to see vesting schedules in place before funding a startup, as it demonstrates the founders' commitment to building the company for the long term.

Founder agreement

We can't stress enough how important documentation is in matters related to startup equity.

Having a clearly documented equity agreement between you and your co-founders establishes a strong foundation for your business partnership. Having a qualified lawyer prepare these documents ensures your shared vision is accurately translated into legal terms that protect everyone's interests and support your company's growth.

Some of the details outlined in your founder agreement are the following:

• Initial ownership percentages
• Vesting schedules and conditions
• Performance expectations
• Adjustment mechanisms (if using dynamic splits)
• Decision-making rights and responsibilities
• Dispute resolution procedures
• Exit and transfer provisions

Remember to review and update these agreements periodically as your startup evolves. What works at the formation stage might need adjustment as the company grows and roles change.

Founder equity dilution

Equity dilution occurs when a company issues new shares, reducing the ownership percentage of existing shareholders, including founders. While often necessary for growth, dilution requires careful management to balance funding needs with founder control.

Dilution typically happens through:

• Funding rounds. Each time a company raises capital by issuing new shares to investors, existing shareholders experience percentage ownership reduction. While founders may own a smaller slice of the company, the hope is that this slice becomes more valuable as the company grows with the new investment.
• Option pools.Creating or expanding employee stock option pools dilutes all shareholders. Sophisticated investors often require these pools to be established before their investment, putting the dilution burden primarily on founders.
• Convertible securities. Instruments like convertible notes or SAFEs eventually convert to equity, causing dilution when conversion occurs, often at a discount to the next funding round's valuation.

Not all dilution is negative. Bringing in the right investors and talent can significantly increase company value, making a smaller percentage of a larger company worth more than a larger percentage of a smaller company.

Founders should model potential dilution scenarios before each funding round to understand how their ownership might evolve through multiple rounds of financing and make intentional decisions about the trade-offs between growth capital and ownership control.

Setting up a cap table software to manage founder equity

It might be very early in your startup journey when you're thinking about co-founder equity distribution. However, even with just founders to start with, there are many benefits to setting up a cap table from day one.

While a simple spreadsheet can work initially, consider upgrading to dedicated cap table software when:

• You're raising your first formal funding round
• You're implementing complex vesting arrangements
• You need to model multiple funding scenarios
• Your legal counsel recommends it for compliance purposes

Starting with a proper cap table early saves significant headaches later. It's much easier to maintain a cap table from the beginning than to reconstruct ownership history when investors or acquirers demand clean records during due diligence.

Quick-fire Q&A

Frequently asked questions on founder equity

What is the standard equity split between co-founders?

There is no universal "standard" split, as each startup's circumstances are unique. While equal splits (50-50 for two founders, or 33-33-33 for three) are common, the most effective splits reflect each founder's relative contributions, experience, and future commitments. Consider factors such as who originated the idea, who brings key technical or business expertise, and who will be working full-time versus part-time.

How does founder vesting work in practice?

Founder vesting typically follows a vesting schedule with a four-year duration and a one-year cliff. During the first year, no equity vests until the cliff date. At the one-year mark, 25% of the shares vest immediately. After that, the remaining shares vest monthly over the next three years. For example, if a founder has 1 million shares, they would receive 250,000 shares at the one-year mark, then approximately 20,833 shares each month thereafter.

Can founder equity be adjusted after company formation?

Yes, founder equity can be adjusted after formation, but it becomes increasingly complex and may have tax implications. Any changes require careful documentation, board approval, and potentially shareholder consent. It's crucial to involve legal counsel in any equity restructuring to ensure compliance with corporate law and to handle tax consequences appropriately.

What happens to founder equity during funding rounds?

During funding rounds, founder equity typically gets diluted as new shares are issued to investors. For example, if founders own 100% and sell 20% to investors, the founders' ownership would decrease to 80% collectively. However, the hope is that the company's increased value makes the smaller percentage worth more in absolute terms. Anti-dilution provisions and pro-rata rights can help protect founder interests during future rounds.

How should founders document their equity arrangements?

Equity arrangements should be documented through several key legal instruments: incorporation documents, founder stock purchase agreements, vesting agreements, and shareholder agreements. These should clearly outline ownership percentages, vesting schedules, transfer restrictions, voting rights, and any special provisions. Additionally, maintain detailed cap tables and keep records of all equity-related board resolutions and decisions.

What are the tax implications of founder equity?

The tax implications and treatment of founder equity can be complex and varies by jurisdiction. Early filing of an 83(b) election in the US can be crucial for favorable tax treatment. This election allows founders to pay taxes on the fair market value of their shares at the time of grant rather than when they vest, which can result in significant tax savings if the company increases in value. Consult with tax professionals to understand your specific situation.

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