During software engineer Ryan McGeary’s nine years working at seven startups, he has weathered contentious dramas, legal battles, and broken friendships stemming from arguments about how equity should be shared among founders and early investors. At his latest venture, BusyConf, a two-year-old Web service for conference planners, based in Leesburg, Va., his experience was frustratingly familiar—“things got unnecessarily ugly”—and resulted in him buying out his partner earlier this year. “There’s got to be a better way” to handle equity stakes, McGeary says.
Recently he stumbled across just that: so-called dynamic equity splits, an idea making the rounds among Chicago startups. The concept is described in a book called , by Mike Moyer, an adjunct professor of entrepreneurship at Northwestern University and founder of venture capital firm Lake Shark Ventures. Basically, Moyer’s idea assigns monetary value to every tangible and intangible contribution individuals make to a startup, from intellectual property and relationships to time and cash. Each founder keeps track of his or her hours, accumulating equity in a “grunt fund,” based on a formula that assigns a weight to each contribution that person makes.
The goal is to ensure that founders, early employees, and investors are awarded for everything they bring to the table, not just their own money. If someone wants to leave—or is fired—before the company begins making sales, the book has guidelines for determining how much equity they should retain, if any. “I read it all in one night because it was so relevant to my situation,” McGeary says. “I thought, ‘This is so simple, why aren’t more people doing it?’”
Because equity accumulates based on hours worked, those who devote more time to the project build up ownership faster, even if they bring less cash or experience initially. That’s why Moyer calls it a “dynamic” split, as opposed to the traditional static model. “I tried to give everything a formula and calculate a value for it,” he says. “For instance, how do I account for my truck if I bring it into the business? What about someone who’s providing facilities for the company? Shouldn’t a senior executive with a fantastic Rolodex be worth more than a junior developer?”
Typically, startup entrepreneurs quickly divvy up equity in equal shares or based on monetary input. They don’t bother to discuss details that will become contentious later, such as who will spend the most time on the venture, says Melanie Rubocki, a vice chairwoman at law firm Perkins Coie who specializes in emerging companies. That haste often backfires: “Liken it to every school project you were ever on. One person does the work, one does nothing, and the rest bumble along with varying contributions. Yet everybody shares the A. People harbor resentment, and relationships fall apart,” she says.
“It puts a science into the art of creating a company,” says 28-year-old Zach Haller, a paralegal in Chicago who’s using Moyer’s model to build his startup, FoundinTown.com, an online lost-and-found service. “I’m not making enough money to hire paid employees, so I wanted to offer equity to early stakeholders,” he says. Haller saw Moyer’s book being passed around at a local business incubator, and then his attorney recommended it. “I like the high level of transparency, where everyone agrees how the equity will be divided fairly,” he says.
Simply starting a discussion about the division of equity is a plus, since the topic can be so fraught with emotion that many entrepreneurs specifically avoid it, says Clint Costa, a business attorney specializing in startups at Harrison & Held in Chicago. He came across the idea through a blog post Moyer wrote and has since recommended it to clients. “I think it’s terrific for very early-stage startups, before there is value,” he says.
The sticking point for Costa is Moyer’s idea that startup entrepreneurs should not bother with formal partnership agreements or corporate paperwork until their venture is bringing in steady revenue or attracting outside investment. Moyer says spending money on legal services before the founders prove their concept is a waste of time and startup funds: “I’ve talked to a lot of lawyers, and they hate charging startups for that kind of work because they know that only one in 25 will actually make it,” he says.
Costa worries that operating on a handshake alone is too risky, so he’s working on a template for a “grunt fund agreement” that early-stage partners could print out and sign without hiring an attorney. It would lay out the dynamic equity split formula the company is using and specify a time frame by which the company would formalize ownership legally, he says.
Having the dynamic model as an option probably would have saved a lot of turmoil earlier in his career, McGeary says. He’s loaned Moyer’s book to two people he’s contemplating bringing on to help get BusyConf off the ground. “They’re coming in late, but they understand [the dynamic model], and if they put in the time and effort, they will get a fair deal.”