Cutting Up the Founders’ Pie

By Frank Demmler

Two friends decide to start a business. “We’ll go 50-50,” one says to the other.

Three graduate students have worked on a research project that they want to commercialize. “Just like the three musketeers; all for one; and one for all. We’ll split the company three ways equally.”

Four neighbors share passions for baking. “Let’s start a catering business,” says one. “That’s a great idea! One hundred divided by four means 25% each,” responds another.

That’s a story that repeats itself multiple times every day. IT’S ALSO ONE OF THE MOST COMMON MISTAKES FIRST-TIME ENTREPRENEURS MAKE. In fact, my friend, Fred Beste of Mid-Atlantic Venture Fund, attributes two of his famous, “Twenty-Five Entrepreneurial Deathtraps” to this issue.

You did see the word, “deathtraps,” didn’t you? As in, the company crashes and burns. As in, best friends become vicious enemies. As in, a family’s net worth goes down the drain.

Within thirty seconds of deciding to start a business, the seeds of its destruction are sown.

In the beginning, There were the founders

When a company is first launched, the founders own 100%. As already indicated, the often-used method for dividing that 100% is to divide it by the number of founders. “It’s fair,” is the common explanation.

Have you ever heard, “The road to hell is paved with good intentions”? This is a prime example.

What if…

Before I discuss what should be done, let’s look at a few “hypothetical” situations. What if:

• You put in 10 hour days, six days a week and your “partner” shows up at 10:00 a.m. and leaves at 3:00 p.m., except on days when he’s got an earlier tee time.
• You quit your job, forego salary, while your “partners” stay in their jobs “to help fund the business” until it can afford “to pay them.”
• Every time you try to do something that you consider important, but costs some money, your two “partners” veto it.
• You want to raise investment to help the company realize its potential, but your “partners” don’t want to take the risk. “We’re doing just fine the way we are.”
• The company is running through cash flow raindrops and can’t cover payroll, so you draw down your savings to make the checks good. Your “partners” can’t come up with their “fair share,” but they assure they will when they can, but never do.

I could go on and on, but I think you get the picture.

Things to consider

You need to consider the past, current, and future contributions that each of the founders will be bringing to the company.

Idea

The company wouldn’t exist if it weren’t for the original idea, and that is certainly worth something, BUT there’s a lot of truth in the saying, “A successful business is 1% inspiration, and 99% perspiration.”

Business Plan Preparation

The development of an initial business plan is a surprisingly difficult and time-consuming effort. To pull together and organize all the thoughts of the founding team, filling in the blanks, identifying and reconciling the differences, and producing a document that captures the essence of the business and helps persuade banks, investors, board members, and others to support the company is a mammoth undertaking, as anyone who has done it will attest.

Again, the plan is a necessary element of starting the business, BUT execution against the plan is where the real value lies.

Domain Expertise

To what degree do you and your partners have meaningful experience in the business of your business? Knowing the industry, having relevant experience, and having a Rolodex full of accessible contacts can greatly improve the company’s probability of success and speed its growth rate. Otherwise, it will take longer to get commercial traction and you’ll have to pay for these assets, usually by hiring someone and including equity in their compensation package.

Commitment and Risk

You’ve probably heard the old saying that “a chicken is involved with breakfast, but a pig is committed.” Similarly, the founders who join the company full time and are committed to making it a success are much more valuable than founders who are going to sit on the sideline and cheer you on. In addition, the opportunity cost of joining the company rather than pursuing an existing career is not trivial.

Responsibilities

Who is going to do what? Who is going to go stay up at night when you can’t make tomorrow’s payroll?

As an aside, it is my very strong recommendation that someone has to be the “boss.” Your primary strength against your competition is the speed with which you can act. Don’t neutralize that by debating every decision among the founders. Usually, any quick decision is better than the “right” long and drawn out decision. Even if you ignore all of this unsolicited advise and decide to be “equal” founders, I encourage you to make one of your team a “little more equal” than the others.

Advice to entrepreneurs

1. Splitting up the founders’ pie is not a trivial undertaking.
2. Rarely should it be split evenly, even though that’s what many start-ups do.
3. Consider the past, current, and future relative contributions of the founding team members to the ultimate success of the company.
4. Build a network of mentors, advisors, professionals, and entrepreneurs who have “been there and done that.”

Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University. (Website)