Trying to get co-founders to agree to certain equity splits can be painful. Poor Curly.Yesterday evening we attended a really interesting seminar on entrepreneur and investor equity splits. What are investor splits, you ask?
Splits are the various percentages of equity that each owner or investor in a company owns. Say Moe, Larry and Curly decide to start a company making whoopee cushions. They would need to decide what percentage of ownership each person will have in terms of equity, which can be defined as the amount of ownership in terms of stock (common or preferred).
As we found out yesterday, establishing the right split between the co-founders of a company is very important because ideally, as a company starts to grow, it will require additional funding, which will most likely come from an outside source or sources. These outside sources (i.e. venture capital firms or strategic investors) will be looking to receive their own portion of equity in exchange for the funds. This means that as the company grows, Moe, Larry and Curly can expect their percentages of equity to get diluted, or decrease.
I always thought that dilution could only be a negative thing, until the panelists at the event explained that there are two kinds of dilution:
1) structural dilution- related to company ownership in terms of %
2) economic dilution- related to ownership in terms of $$
Even if you experience a decrease in structural dilution, the idea is that as the co-founder of your company, economic dilution could lead to an overall monetary gain for you. Why? If your percentage of equity is worth more later down the line than it was when you first started the business, then technically, your share of the company is worth more money.
As we continue to grow our company, we know that we will have to secure some source(s) of outside funding, eventually. The topics covered by this panel provided us some really insightful pieces of information about preparing for additional investment.
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