When and How Should Equity Splits Between Co-Founders Be Formalized?

According to Harvard Business School professor Noam Wasserman, 65% of startups fail due to partner conflicts. Going into business with partners offers many benefits, but when you disagree on critical business decisions, it can result in some very negative consequences, including the dissolution of the partnership.

 

When to Formalize Co-Founder Equity Splits

As soon as the business is up and running, you could face problems with your partner(s). Therefore, you should formalize any co-founder equity splits when you incorporate the business, and you should incorporate before opening your doors. 

During the planning phases of the business, many founders discuss equity splits but don’t put them down on paper. That is a big mistake because when tensions run high, any verbal agreements may not stand up in court. To ensure your interest in the company, you could hire an equity lawyer to draw up a pre-incorporation agreement spelling out the equity splits. However, that can be costly because it needs to be created from scratch with all the intricate details about your specific business. 

Usually, it’s best to incorporate the business and draw up the agreement at the same time. Your business lawyer can use a templated agreement covering everything, including co-founder equity. 

 

Why Incorporate So Early?

You never know when disagreements between you and other founders could arise. Typically, these things happen very quickly and without warning. If you start the business and things go well, one or more co-founders could decide they deserve more. You could easily end up in a battle over equity if you don’t have your incorporation agreement in place. 

 

Deciding on the Amount of an Equity Split

An additional consideration is the amount of equity split. An equity lawyer would advise you that a 50/50 split is not the best option, even though it may seem fair. It could result in a deadlock when making important decisions which could threaten the business.

You should decide on one founder to be a majority shareholder and the other(s) minority. If you are a minority shareholder, the other partners could push you out anytime. If the partnership is dissolved, as a minority shareholder, you will walk away with less.

As the company grows, things may change, and you may need to revisit the equity splits. Be sure to document any changes to accommodate tax implications. Documentation should be through stock purchase agreements, not offer letters, consultants, or employment agreements.

The bottom line is you should incorporate, as early as possible, formalize equity splits in writing through stock purchases and determine who should be the majority and minority stockholders. How you come to these decisions is entirely up to you. 

 

Help with Equity Splits

Contact Haber Law if you need help documenting your equity splits or incorporating your business. We are a firm of full-service business lawyers who can help you with your corporate needs from inception to dissolution.