5 Co-Founder Dilemma Regarding Roles & Equity

We have a company with 5 co-founders and are having some serious issues with work process. We started with 3 cofounders and just assumed we'd do an equal equity split without thinking it through. We eventually added 2 more cofounders and continued the equity split as we hadn't progressed a lot to that point.

So now we have 5 cofounders at 20% each. We each put in the same base capital (it was pretty minimal).

In my opinion our current set up wasn't well thought out, isn't fair or sustainable. I am looking for a solution in terms of how to restructure, and the best approach to take when bringing this up and making it happen.

We have not defined a leadership structure yet, there is no CEO. The roles look like this:

Founder 1: Brought the group together. Functions primarily as an adviser, has full time commitments. Good domain expertise.

Founder 2: In charge of building the user base including all marketing. Has had other companies before. Full time. Good domain expertise.

Founder 3: In charge of building the website. Full time, but has moved to another country making working and communication a bit more difficult. Has put in the most time so far of any cofounder.

Founder 4: In charge of all b2b sales. Full time. Some startup experience, but less than 1+2.

Founder 5: Good business experience. Full time. No particular domain within the business, kind of handling operations but not an area of specialty/expertise/passion.

What is a fair way to address this and come to a solution without totally offending everyone? We are only 4 months in. It is awkward to bring up now, but worse to let the mistake continue and ruin our future success.

Thank you for your expertise with this, it's been baffling my mind for a while.

You are unfortunately living one end of the "easy way out" on equity distribution that often leads to issues. The other is when a founder hoards 90% of equity "just because".

It's actually pretty simple to set common stock distribution once you give yourself a loose framework (and partners you trust) to use. Here's what I do:

1. Create a matrix.
2. Add one column for each founder currently in the early startup. Note: there's a difference between a founder and a key employee. The tests are lead/follow (are they setting the pace or following the pace?) and investment (will they leave if things go sour or stay with the sinking ship?). Employees should be treated differently, namely salaried.
3. Add one row for each of the following aspect: Vision (the concept/deliverable itself), Execution (process/plan/model design and execution), Knowledge (either domain, business, etc), Contributions (indicated via tangibles, such as money, time, assets, etc...) and Responsibilities (roles, accountabilities, reports, etc.)
4. For each cell, considering near-past, present and near-future contributions, add 1, 2, 3, 5 or 8 points based on their contribution to said factor. This is judged relative within the row. So, if the idea (Vision) is wholly coming from one individual, he/she gets 8 and most others get 1 or 2 points. If everyone is contributing the same general amount of time and money (Contributions), everyone gets 3 points.
5. A given individual's share of common stock should be the total of their points divided by the total of all points.

The company may want everyone to participate and then discuss, if the group is open-minded enough. In your case, you may have no choice but to do it this way, given no clear-cut final arbiter. This matrix can be re-run when there's a big shift in the company and/or on a periodic basis.

This segues into another major issue: you have no CEO. Without better personality sketches, IMO, Founder 2 seems like the CEO, unless Founder 1 is a driving "visionary". Founder 2 has domain and leadership expertise, and is full-time. But, the individual who started the team usually should have first-call on this role. This should be weighed against who will be the most effective startup leader. Essentially, the one with the most equity should be the CEO. Irrespective of method, you must establish someone who is going to be the pacesetter for all aspects of the company.

Good luck!

The main inequality I see in your list is that you have four full-timers, and one who has other full-time commitments. That one is also the person who brought the team together.

Organization So for me, Founder One sounds like your natural chair. The others more or less cover the key areas of the business - but you're having work process issues, so you need some more structure. I'd start by adding more structure to the processes, and then see if you need more structure in your roles.

It may be that you need to define a CEO role. You'll almost certainly need to at some point. The diagnostic question to ask is, are customers suffering poor service as a direct result of our slow decision-making? When the answer is 'yes,' you have a problem that's well-solved by establishing a chain of command (and Founder Two looks like CEO-in-waiting from your thumbnail sketch).

Equity Equity-wise, you have two potential issues.

Firstly, you don't have a viable model to grow the team. You don't expect that future joiners will get as much as the initial founder group. (Or, if you like the idea that people always come in on an equal basis, you have the wrong corporate vehicle, and should consider how you could operate as a partnership. But I'm going to assume this isn't your intention.)

Secondly, Founder 1 may be rewarded on an equal basis to the four full-time founders, and that may be a serious problem.

Happily, these two have a common question at heart. Going forward, how are people being rewarded for working in the business? Specifically, what's the balance going to be between salary, bonus / revenue share / commission etc, and equity / dividends?

Option 1: Freeze equity If equity isn't going to be part of your incentivization going forward, then I suspect you'll simply continue with your present division. Within the equity-holding group, you may need to normalize things - for instance, if you weren't paying yourselves at all but taking dividends, that needs fixing. And for others coming in, be aware that if you're not offering equity, you can't expect (for instance) people to take lower salaries to the same extent the founders will.

Option 2: Issue new shares If equity is something you intend to use, then it may be most natural to look at how you will issue new shares to both founders and others. That would tend to have the effect over time that all founders will be to some extent diluted (you presently share 100% of issued equity, and that will reduce), but Founder One will dilute faster (holding a constant number of shares, while the number of issued shares increases).

In that case, it may be something you all essentially welcome that your relative shareholdings will come to more closely reflect your commitment over time.

Or it may be that this could be *un*welcome. In which case, Founder One would need an alternative route to acquire additional shares at the same rate as the others - most naturally, by buying them.

If I'm right that Founder One is the natural chair, getting the issues out on the table, managing the discussions and helping negotiating a result ought to be their next priority.

You seem to have co-mingled 2 separate questions. Your first question seems to be "How do I calculate a fair equity split?" and the second seems to be "How do I raise this question?"

On the first question, here's the best article I've ever read on the topic, and it provides a good method for calculating some percentages: http://www.geekwire.com/2011/wrong-answer-5050-calculating-cofounder-equity-split On the second question, there's no easy answer for you. Sorry. You'll have to bite the bullet and bring it up. I can't speak for you and your team, but if I was going to try and bring this up, I'd a) do it soon and quick and have good solid reasons for why things need to change, and b) have a tool in mind that I'd propose, but let the team decide together what formula to use.

For the reasons on why things need to change, take your pick - here are some possible ones:

• a crappy equity stake right now will sour the deal for future investors
• you should be implementing vesting on options as part of the restructuring (or reverse vesting on stock) to keep everyone safe from people that loose interest
• you haven't planned for a pool for future employees
• things are getting serious, and the 1/5 split looks sloppy, which could dissuade investors
• most important: you're feeling uncomfortable with the current structure

Instead of re-arranging the equity shares, you could try increasing the responsibilities of the co-founders who are not worth the 20%, in your opinion. One thing is not clear to me though. How would you re-arrange it and why?