How do you divide equity at the very beginning?
There’s really two schools of thought: one school of thought believes that hey, everyone should be 50/50, or 33, 33, 33. Or on the other hand, you could say, “What is each person bringing to the table?” You can try to assign a value to that and split it up that way.
No matter which way you choose, you must vest the equity. Do not give out the equity all at once to any founder. You need to make sure that this equity is vesting over a period of time, so that everyone is incentivized to continue to work for the company. There’s a time-release to the vesting which is critical to protect your interests.
This is important, because if someone gets cold feet, or things change, they can exit and they won’t have those million shares that now you have to figure out how to get back.
When you do decide to vest shares, you really need to fill out the 83(b) Election. This cannot be overemphasized, because so many startup founders have run into issues of paying enormous taxes when there’s a liquidity event or an exit, because they did not file 83(b) Election correctly.
The 83(b) Election is a simple form that most attorneys should give you that allows you to pay the taxes on your shares up front rather than as they vest. This means that when the value of the company is very low, you can pay those taxes now, and avoid having to pay the taxes as the shares vest. As your company valuation increases, the value of those shares will increase, and now all of a sudden you have to pay taxes on that.
No matter whether you decide to set up a company and issue equity equally or based on the value of what the person is bringing to the table, you’ve got to make sure you have vesting agreements in place, and also file that 83(b) Election.
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