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How to split equity in a new business - an innovative approach

If you’ve been wondering how to split the equity in your new venture, here’s a great option worth considering - a flexible shareholding that changes over time to take changing circumstances and contributions into account.

I picked up on this from Paul Jacobson, who wrote about an innovative approach to equity in a new business touches on the challenges faced in implementing it.

I love the idea as it offers a solution to entrepreneurs for one of the frustrations and difficulties in starting up a new business.

Practically, here’s an example of how I would carry it out assuming it was myself and another partner:
  • Set up a new company ["Private company", or "closely held company" if you prefer that].
  • Set up the company with 1,000 authorised shares. [The authorised share capital reflects how many shares in total the company can issue to shareholders, although not all have to be released]
  • Initially issue 100 shares between the partners depending on our current commitment - if it’s my idea I might get 60 shares and the partner 40 shares. [The number of shares issued can be anything up to the authorised number available for issue, in this case, 1,000]
  • In the shareholder’s agreement, I would include clauses that allow for further shares to be issued based on meeting expected contributions to the business until its up and running. If my job is to get the operations up and running, and my partner’s job is to develop the system, then make the issue of the remaining 900 shares to each based on expected contribution and specific milestones, so then if I get the systems in place by 20 April ‘09 I get 200 shares, and then staffed up and operating by 15 May ‘09 I get another 250 shares. If my partner sells to the value of R1 million by 15 May ‘09, he gets 200 shares, or if he sells R2 million by that date, he gets the full remaining 450 shares.

In this example then there could be several possible outcomes, including:

  1. We both do what we were going to - I end up with 510 shares [60 + 200 + 250] and partner gets 490 [40 + 200 + 250]. Effective shareholding = 51%:49%
  2. I pull my weight but he doesn’t - I end up with the full 510 shares, and he gets only 240 [40 + 200]. Effective shareholding = 68%:32%
  3. He pulls his weight, and I don’t - I get perhaps 260 shares [60 + 200], and he gets the full 490 shares. Effective shareholding = 35%:65%
  4. Neither of us does anything - who cares what the shareholding is anyway as the business isn’t working!

As the “effective shareholdings” show, these make allowances for an ideal situation as well as changes in control based on the founders meeting their expected commitments.

I believe that whatever you choose - don’t over-complicate things - your primary objective is still to get the business up and running, and then profitable as soon as possible!

After all, 10% of something is worth far more than 100% of nothing.

This is just an idea which is relatively sound to my knowledge but would require legal input to understand the exact intricacies and legalities. Hopefully, it sparks some creative solutions for you though.

Please leave your thoughts and comments on this below, as well as any other ways you’ve come across to solve the age-old shareholding problem.

Photo “trivial pursuit - orange token with wedges.” 

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