Ask the attorney: What’s the best way to split equity?

(Editor’s note: “Ask the Attorney” is a weekly VentureBeat feature allowing start-up owners to get answers to their legal questions. Submit yours in the comments below and look for answers in the coming weeks. Author Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a boutique corporate law firm specializing in the representation of entrepreneurs.)

Question:  My two friends and I have been working on a new venture for almost a year.  Our site is in beta and we actually have a few customers (it’s a subscription-based model).  We’ve spoken to a lawyer about incorporating, but we don’t know how to split-up the stock.  Should everyone just get one-third?

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Answer: Not necessarily… The splitting of equity is a significant business decision, which must be negotiated among the founders based upon their respective contributions to date and their expectations going forward.  Simply dividing the shares equally among the three of you may sound fair on its face, but it’s usually not the correct decision.

Factors you need to consider include:

• Whether any of the founders contributed cash and/or intellectual property to the venture – which would warrant a higher percentage for that founder.
• Whether any of the founders will be working part-time or less than the other founders going forward – which would warrant a lower percentage for that founder.
• Whether any of the founders put in more time prior to the incorporation (or actually started the venture) – which would warrant a higher percentage for that founder.
• Whether any of the founders will have greater responsibility or will be adding more value going forward than the other founders – which would warrant a higher percentage for that founder.

The bottom line is that every venture is different, with varied contributions (past and future) by the founders.  It might help to sit down with your co-founders and your lawyer and hash this issue out.  As I have previously discussed, you will also need to hash out the vesting schedules, including whether any founders will vest a portion of their stock “up front” and/or whether a  one-year “cliff” will be imposed on any founders.

Something else to keep in mind: When launching a venture, the first rule of thumb is to incorporate as soon as possible (when the venture has as little value as possible).  Among other things, this allows you to be able to issue stock to the founders for a nominal purchase price, meaning they can share in the increased value of the company (and quickly begin the capital gains holding period).

To the extent the venture’s incorporation is delayed and its value increases (due to the meeting of certain milestones, etc.), there may be tricky tax issues with respect to the purchase price or value of the shares issued to the founders.  If the company were ever audited, the IRS may take the position that the shares sold for a nominal purchase price actually had value. That would make those shares a form of compensation to the founders (particularly if the shares were issued on a date close to a financing date) and there would be taxes due on them.

As I have previously discussed, another good reason to do this is to protect against personal liability. Good luck!

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.