How to split ownership in a startup with a scenario like the one below?

All,

This is a case with a friend of mine who is a first-gen entrepreneur and close to cutting a deal with Angels for a funding of $400K.

But before I ask you his question, here is the situation, step-by-step as it unfolded.

a. My friend (Say A), had this idea in Nov '10 while on a $100k per annum job

b. He decided to quit his job because he saw the 'bone' in the idea and wanted to give it a shot

c. At that time, he had already submitted a raw version of the idea to a couple of business-plan competitions and got reasonable reviews as well

d. So A consulted his mentor, who is quite an expert in the field and this mentor has helped him out a lot with ideas, validations, contacts etc since then. Now, convinced with the idea, A quit his job by Dec end and started working on multiple hypothesis of the idea to pilot the one with the highest success rate

e. So, between Jan and Mar'11, he travelled around, met a lot of people, did a lot of research and finetuned his hypothesis further to 'set sight' on an executionable pilot strategy for the next 9-12 months)

f. This being a very niche idea, he saw the importance of 'proving the concept' to investors with a model and hence set forth on the pilot starting Mar'11 with his $45k savings

g. By Apr '11, he had just started on the pilot and met this person B (who had just quit a $45k per annum job to try something of his own) through a random connection

h. Person B was super-enthusiastic about the idea and expressed interest in seeking an opportunity with the start-up

i. All along, while A was planning his pilot strategy, he never felt the need for a Full-time employee, since he felt finding someone who appreciates the idea was difficult and besides his $45k wouldn't permit A to hire a full-time employee for the pilot

j. But A and B vibed well and could sense a lot of positivity around. So A explained his situation and asserted that he can't pay B anything at least till Dec '11 and in fact, that the idea in itself might bomb and could come to nothing.

k. Besides, A said that B's contribution would never go unrewarded in terms of stake (no promises of any money)

l. Now, 7 months into the pilot, they both have done some outstanding work and are pretty close to roping in angels with a ticket of $400K for an exchange of 25% stake (please assume ordinary shares all along) which pegs the start-up's valuation at $1.6M. But throughout, they had 2 big fights leading to B offering to resign (and in both occasions, B admitted he over-reacted and was thinking too ahead of himself and A felt a soft corner for B and decided to forgive and forget in both instances)

m. Now realizing the biggest mistake commited, A and B both want to settle stakes and compensation issues once and for all

n. Consider the following:

Agreed pools for shareholders outside the founding team: Angels - 25% ;
VCs (at a later stage) - 10% ;
Employees (outside the founding team) - 15% ;
A's mentor and friends (who supported him throughout lending money and shoulders) - 5.5% ;

So, that is, there is a decided pool of 55.5% of the stock going to shareholders outside the founding team.

How should the remaining 44.5% be divided among A and B given the following,

Idea - Entirely A's till even strategizing pilot;
Money invested - 94% A's and 6% B's;
Time invested - A (effectively 13 months) and B (effectively 8 months and B did an awesome job and complemented A more than A could have imagined);
Contribution to pilot - A (45%) and B (55%)

Both A and B are real honest people and don't want to screw each other over (even unintentionally).. In such a case, how would you suggest, A and B split the 44.5% between the two of them (considering vesting to be the same for both)? And also the fact that A nevertheless would have completed the pilot (albeit 2-3 months later than the case now) even if B never joined the startup? And it is incorporated as a private limited company!

I'd do 75/25.

Why? Because as far as I can tell, B is not critical to this business, but A is. I didn't see much in your description about B's contributions. B sounds like a nice to have. If you want to dig further, check the co-founder equity calculator, it should give you similar results.

Also: stop planning how many shares the VCs or angels will get. You just don't know, since no transaction has happened yet. It's irrelevant for the discussion between A and B anyway. As you raise more money, all the existing shareholders get diluted the same.

Well you could bring in a mediator to try and settle things, but it sounds like A and B are at least talking to each other and happy to sort things out themselves.

You could also get A and B to write what they think is a fair percentage, then split the difference.... assuming they are both happy to accept the result whatever it comes to.

At the end of the day whatever percentage they get is worthless unless the business brings in a profit or is sold. Any shrewd businessperson would rather have 10% of a company with high earnings vs 40% of a company with zero earnings. Squabbling over a few percentages here or there isn't such a big deal. Life will be long enough to present opportunities both in this business and other future ventures.

so having said all that... I would suggest letting go of one's ego and pride, split what they have 50-50, and concentrate on building the business.

If it was me, I'd split A and B 50:50, as life is way too short to worry about this stuff.

In the short term, this allows all parties to move on. In the longer term, who knows who'll contribute what. Maybe B will bring in a big customer, or talk to a blogger and help get traction, or come up with some great way to improve profitability.