What happens to equity as the company grows?

What happens when you start a company using Joel's Totally Fair Method to Divide Up The Ownership of Any Startup with two technical founders whose roles change over time?

Imagine the case where the company grows and new Developers are hired. One of the founders is happy to remain a Developer (no interest in management or business) while the other goes on to work on Management or Business Development. Initially they had a 50/50 split but suddenly things feel a little uncomfortable because the founder who moved up a notch feels that they are contributing more to the company's bottom line than the founder who remained a Developer.

I've always felt that shares should represent one's ongoing contribution to the company. I just never defined what form of contribution (money, time, vision, etc). Has anyone else run into this problem?

1. What, if anything, should happen to the split of shares?
2. What would you do differently if you could go back in time to the moment the company was being formed? Would you formulate a different agreement?

I don't see anything in your question that indicates the original 50/50 split should be re-evaluated.

Yes, you can re-evaluate and possibly change equity splits in the future. However, depending on the original agreement, all owners would have to agree to the new allocations (something that may not necessarily be easy), and there must be a valid reason for doing so.

In the scenario you provide in your question, you indicate that you think the manager/business founder should get more equity than the developer founder. That doesn't make sense to me. Assuming they are both putting in equal (or just about equal) time in the startup, they should remain at 50/50. The actual roles don't matter, what's more important is the amount of time each founder puts towards the startup.

If you want the startup to succeed you need different roles. You can't have all developers, and you can't have all business folks. Does it make sense to give someone more equity just because of their skillset, when both skillsets are required to be successful? I don't think so.

Additionally, the risk is the same for both founders. Their roles in the startup don't make one founder hold more risk than the other. Presumably, both founders are spending the same amount of time in the startup, and have put in the same amount of startup capital into the business. If the risk is the same, it seems only fair that the equity be split 50/50.

I find it interesting that usually the business folks think their role is more important, while the developers think their role is more important. The reality is, both roles are important and necessary.

What, if anything, should happen to the split of shares?

In the scenario you outlined, nothing.

What would you do differently if you could go back in time to the moment the company was being formed? Would you formulate a different agreement?

If you are concerned about this you should look into vesting, but again the important factor is the time put towards the startup, not the roles. Vesting shouldn't change equity splits simply because of a change in roles.

Zuly and Tim both have great answers. Equity/shares is basically about rewarding the people who risked everything to make the idea happen. When a business becomes profitable, there's no more risk involved (or at least, a lot less risk) and so even though you've settled into different roles in the now expanding business, there's little risk, and so there should probably not be any changes to the split of shares.

I might add that the one time where things may need to change is if one of you is taking a bigger risk still. And I don't just mean one person is the CEO while the other is not. (Turns out, titles don't have a whole lot of meaning...)

For example, if one partner is just going about his/her business as usual, while the other person takes the millions that they've earned and gives it back to the business (so now they're an investor as well) then you'd probably want to allocate some more shares to them, as an investor, with the specific amount dependent on how valuable that investment is to the business.

As far as how things should be done, back at the beginning, if you were both planning on working equally as hard (usually the case) then the 50/50 split is exactly what you want, though as Zuly points out, vesting is very important. So, no, I don't think anything different should have been done differently at the beginning.

Remain the same, nothing, and no.

Assuming they are both actively participating and the expected levels then the original agreement stands. One can't just change the allocations because the situation changes.

The company needs each person and the company needs disparate roles and skills.

This illustrates perfectly why Mike Moyer's approach is superior to the classical "carved in stone" split.

Circumstances have changed and now one co-founder is spending much more time that the other. Maybe the other co-founder is even happy with it and want to gauge his bets by also working on another project?

So now what? Renegotiate the split?
Let us say I am the second co-founder who worked equally hard all year with 50% of the pie in vision and now you want me to give up part of it?
How emotionally easy is that?

The core problem here is that I feel giving away say 10% of X. But what is X?
Zero? A billion?

Now consider two possible scenarios:

• S1 - I don't give away my 10% because I feel I earned by all previous hard work I put into the venture. Instead I tell my partner, I am going to work harder, longer hours, then finding myself not exactly doing what I like and secretly resenting it. Even though I work even more hours, the outcome of my work declines and the project eventually fails. Now I have 50% of 0.
• S2 - I give away the 10% or whatever and use my free time for a new small project B. Then suddenly I realise that working on B, I learned something really useful for A! And this idea becomes a critical push for A to reach a great success. Now I have 40% of X with X = say a million.

I'd say, S2 sounds better :)
But to get there, I had to make a painful emotionally difficult decision to part with my 10%.

Now, if I am lucky, and my co-founder recognises the value of the new idea I brought to the table, she may offer some shares back. But maybe not? After all, this would take another emotionally hard decision with the illusion (I emphasize: illusion ) or giving some value of her equity. It is illusion because 40% of X is greater than 50% of X' whenever X/X' is greater 5/4 :)

Now what do we have following dynamic allocation model?

• S3 - Both my partner and I accumulated our roughly equal "pie points" that will be later converted into equity but not now. I can now decide to split my time between A and my new project B without any bad feeling. My partner continues full time, so we both agree that it is fair that he gets proportionally more contribution points than me. I work on B, discover my great idea and come back to implement it for A. Now I have made one-off contribution, which we add as my "contribution points" accordingly to what my partner and me feel fair. Now our venture is great success, we sell it to Google for 100M and only now we know what X is! Only now we convert our "imaginary points" into real ones, get filthy rich and live happy life ever after :)