Startups: how should cofounders split ownership?
12/04/2023
4 min
Share
Many entrepreneurs decide to start their new venture in teams to increase available resources. In doing so, they must choose how to divide the ownership (equity) among the founders. They can opt between an equal split of equity, for example a 50:50 split in a team of two, or an unequal split, for example, of 75:25.
Both equal and unequal splits are frequent in practice. For example, 67% of North American technology startups are opting for an unequal split. This early decision has important consequences for startups’ future performance : in our latest research article published by the European Management Journal, we show that new ventures with an unequal equity split grow faster and are, thus, economically more successful than companies whose founders have chosen an equal split.
Social relations
Our analysis of more than 24,000 German startups shows that companies with an unequal ownership split have a substantially higher growth rate. They achieve on average a 1.3 percentage point higher 3-year growth rate than teams with an equal split. In addition, teams that have unequally divided equity are more likely to welcome new investors, which explains part but not all of the performance advantage of these start-ups.
However, there are also advantages to teams with an equal equity split. The founders of a new venture are working closely together on a day-to-day basis. They mutually depend on each other when combining individual perspectives and discussing prior experiences. At the time of creating the venture, the team sets out its principles for working together – and potential growth might not always be the main decision-driver.
These principles form the basis for their social relations. A major decision therefore is whether a team wants to work together as a group of equals or whether it has a “leader”. This decision is reflected in the equity split. It is important to point out, however, that this decision is sometimes taken unconsciously without an explicit discussion of the topic.
For instance, in our study, a founder of a German start-up in the software industry stated that she had chosen to start out with an equal split because she was new to the sector. This person was more secure in developing an equal relationship with her co-founder. This balance was helpful for dealing with uncertainty. However, in her next start-up, this entrepreneur wants to take the majority ownership position because she can then bring in her prior experience as an entrepreneur. She therefore wants to benefit from the greater freedom in decision making that a majority share brings.
Concretely, teams who chose an equal split are characterized by a preference for equality and fairness, and team members’ contributions are based on reciprocity. They place high importance on collective decision making and harmony and are willing to forego economic success to some degree to realize this goal.
For instance, we observed a German team of two entrepreneurs that was developing a new model of childcare facility to reduce current shortages in the country. In the team, each founder was responsible for a clearly defined domain with equal importance for the startup. They decided to split equity equally because trust was very important for them. In addition, their main motivation was to solve a social problem, not to grow fast.
In teams with an unequal split, in contrast, everyone is expected to contribute in proportion to their ownership share. More influential founders (with a larger stake) are therefore expected to contribute more. These start-ups are motivated by financial success and adapt more aggressive growth strategies to reach their goals.
For example, the founding team behind a platform guiding users to the best offers for a leisure product, was aware of the need to ‘scale’ fast. They started out with an initial team of three and an unequal split. After a successful entry into the market, they were actively seeking an investor to join their team and ultimately succeeding in attracting investment that helped to further improve their service.
Similar survival rates
When starting a new venture, entrepreneurs should note that the initial decision about the equity split can have long-lasting consequences – as our results in Germany remain relevant elsewhere in a Western context at least. Our results do not imply that all new venture teams (NVT) should choose an unequal split. In fact, organizing with equal or unequal splits are both viable models for an NVT as we find similar survival rates for these startups.
As for potential investors, they should not consider NVTs with unequal splits to be the only appropriate recipient for their financial investment. While startups with an unequal split may promise higher financial returns, it is possible that startups with an equal split work better when the founding team is pursuing social or environmental goals. As such, investors should ensure, before investing, that the internal organization of the team has a good fit with the goals that the NVT pursues.
This is a translated version of the article originally published on the Conversation France.
The original article in French can be viewed here.
