Does the founding team’s equity split affect the team’s stability as the venture grows?
As I described in my original “Splitting the Pie” post almost a year ago, my initial interest in equity splits was sparked by the contrast between how the founders split the equity in our “Zipcar” case versus my “Ockham” case. Specifically, those two cases suggested that the equality of the split could have important implications for the stability of the founding team. Last month’s post about the initial quantitative analyses of my equity-split data summarized the factors that increased or decreased the likelihood that a founding team would split equity equally versus unequally. This post will detail the quantitative results regarding the implications of the split for the stability of the founding team over the first two years of the venture’s life.
In particular, I analyzed how well the equality of the split predicted whether all founders would still be working for the venture 6 months, 12 months, 18 months, and 24 months after the founding of the venture. My data was collected in the Spring of 2006 (see here for details on the surveys I use to collect my data) and included 998 founders from 326 multi-founder technology ventures.
The table below shows the major factors that had statistically significant effects (at the p<.05 level or better) on team stability (defined as whether all founders were still working or not) at each 6-month milestone, with a “+” showing a significant positive effect on team stability and a “-” showing a significant negative effect on team stability.
In non-table form, the results are as follows:
- When the team invested the same amount of financial capital at founding, the team tended to be more stable throughout the 2 years.
- When the team had a heterogeneous (i.e., widely differing) amount of prior work experience, the team tended to be less stable for the first 12 months, after which the effect became insignificant.
- When the team split the equity equally, it tended to be more stable throughout the 2 years.
However, this last result (#3 above) is counter-balanced by two factors:
- Teams that split the equity equally and raised a round of outside financing during a period tended to be much less stable in that period, any time during the first 2 years. (In its magnitude, this effect completely washed out the positive effect from #3 above.)
- Teams that had been friends before founding and split the equity equally tended to be less stable for the first 6 months, after which the effect was insignificant.
Interestingly, regarding founding with friends, these results suggest that founding teams that included people who had been friends before starting the venture were no more — but also no less — stable than were other founding teams. However, as shown above, the combination of founding with friends and splitting equity equally did have a significant (negative) effect on stability.
Any thoughts or reactions to any of these results? (Most important, do your experiences conflict with these patterns or highlight other important factors not covered here?)
My own experience is that I’ve done two startups with equal equity splits and friends. Both have had some problems. The first has changed to such an extent that we’re discussing breaking up the company and going our seperate ways. The second is going to be rebalanced as I’m buying out my partner/friend. In order to maintain the friendship he’ll retain some miniscule equity.At times in a startup, everyone is on edge. If one partner perceives that another isn’t pulling his load or is hedging his bets AND they’re already friends, I can see that it’s easy to begin expressing dissatisfaction in strong enough terms that the friendship starts to suffer. Familiarity breeds contempt.However, both of the startups mentioned necessitated that the team consisted of these partners. There was no other way to launch with the available resouces. Sometimes you just gotta do what you gotta do.
Noam,You’re right on the money. I would offer one more thought… ensure that everyone is in alignment on executing the plan. This removes the “personal agenda” problems that usually surface in the first 12 months. I’m on my 4th startup up. I’ve had the same partner on three of them (over ten years now). We always start with the same amount of equity each. This time around we added a third partner… she brought some unique skills to the table and she has the same equity we do. So far everyone is executing as a team in total alignment, focused on the goal of “solving a customers problem and making money”. Cheers,Peter
When I was starting up my first venture in China, I was never encouraged to start any business with friends and family, neither sell to friends and family. It’s like a taboo, because business deals can be so tough sometimes and therefore harm relationship. A good business is something eveyone wants to buy.
Any reaction? Yes. Your sample size is too low, and you haven’t collected enough additional explanatory data to draw conclusions or base predictions upon.
I’d love to hear more, “Anonymous,” so we can get something productive out of your comment. What types of explanatory variables would you expect/want to see? What are the alternative explanations you have in mind that such data could help test?
Noam, Interesting study on equity splits.In terms of how this initial “founder choice” of splitting the equity (equally or unequally) affects team stability, I would point to another consideration: exits.My hypothesis is that, upon exit, an unequal equity split can change the power balance among founders in a subtle but crucial way, creating instability.(Note: First, I must say that I am considering “team stability” in a broader sense that simply the end/demise of a startup due to instability over a set period of time, but insisting more on the actual internal dynamics of stability of the team members.)Let’s take this with a simple example. Let’s look at fashion retailing company < HREF="http://harvardbusinessonline.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=800002" REL="nofollow"> Kate Spade<>, founded by a husband and wife team (Founder #1 and #2), who subsequently brought in two additional friends later as founding associates (Founder #3 and #4). The equity split was 30-30-20-20 respectively between the 4 founders. So, the founding couple controlled 60%.Now let’s examine what happens when the company thinks about several exit options, notably a VC buyout, IPO, cash infusions and various strategic partnerships. Let’s consider the example of a proposed VC buyout of 40% of the equity, which is one of the main scenarios the team was considering. The team liked this alternative because it left a “majority stake” of 60% and the benefit of control to the core founding team of 4, rather than ceding control of their company to an external player.However, after this transaction, the voting rights and the power structure has nevertheless changed in an important way, I think. After the deal, the husband and wife each control 18% (0.30 initial share *0.60 founder-owned equity post-deal), for a combined total of 36%. Founder 3 now owns 12% (0.2*0.6) and Founder 4 also owns 12% (0.2 *0.6), for a grand total of 60%. The remaining 40% is controlled by VC.Here, while the core 4 still control the company (60%), the founding couple seem in effect to have lost control over their company (36%). So, in most voting decisions, they will need both Founders 3 and 4 on-board to counter an unpopular VC decision. In other words, Founders 3 and 4’s bargaining power has substantially increased.This will surely lead to erosion in team stability or even coalition building problems.Actually, even if the founding couple ally their 36% share with another founder’s share (let’s say Founder #3’s 12% share), they still own 48% and are short of a direct majority. They thus seem to need the support of BOTH founders to gain 50% majority. However, 48% is still more than the VC’s 40%, but that remaining 12% becomes a key swing stake.To be fair, it would generally unlikely that the founder would vote with the VC against the other founders, because founder interests are typically aligned. For many foreseeable reasons, however, that founder (#3 or #4) could disagree with the other founders on a specific issue, or even yet simply seek to “sell out” his/her share to the VC their 12% for cash, giving the VC a majority stake (52% vs 48%).It seems like this early “founder choice” of giving 20% to Founder 3 and 20% to Founder 4 (because paying with equity was cheaper than paying large salaries) has created, several years later, a perhaps unintended consequence when the VC enters.For this reason, it seems like unequal splits could lead to some interesting power struggles, or at the least some shifting power dynamics, if push comes to shove when considering potential exits…
My partner and I founded on an equal split. It is over 8 years with VC funding and still working well. A key factor is to have complementing skill sets.If the skill sets are similar I feel the second guessing happens at times of crisis leading to negative effect. I truly feel that to increase the chance of success it is good to have complementing personalities - risk taker vs. non-risk taker, optimist vs. realist. I am not understanding the reason for why equally split and raised round had to have negative effect. A reason could be that the new players in the management team have tilted the power equation. Even though the equity is split equally the power equation may not be equal.Last comment is two founders with equal split have the highest chance of success and more than four founders has the least chance. I don’t have data to validate it though.