The primary purpose of allocating equity among the founding team is to incentivize future contributions and a long-term commitment to the company. When allocating shares among co-founders, consider what each person in your co-founding team will be contributing to the future growth of the business. Then, allocate shares in the company to match an appropriate reward for that expected future work. If the expected contributions are fairly equal, then the initial shares should be allocated equally. From this starting point, the founding team can adjust the numbers around the margins for disproportionate past contributions to the business (like seed money, code, the idea, etc.), but do not let the past skew the results too much. Assess how these factors will bear on a team member’s expected future contributions.
Then, and this cannot be emphasized enough: Impose time-based vesting on the shares of each co-founder. Share vesting protects the company and the other co-founders in the event that the founding team’s initial estimates of someone’s future contributions are off target. Co-founders can part ways for any number of reasons. With vesting, if a co-founder leaves the company, then the co-founder is entitled to keep only the shares the co-founder has vested over time through involvement with the company. The usual Silicon Valley vesting schedule provides for monthly vesting of shares in equal increments over four years, with a one-year “cliff” before any shares vest. Without vesting, a co-founder could walk away at any time with a large chunk of the company’s shares without needing to contribute anything to the future value of the company. Do not let this happen to your company. The time to impose vesting is at the time of incorporation when everyone is still friendly with each other and excited to build the company together.
In practice, when incorporating a new Delaware corporation, a good starting point for founding teams is to authorize 15,000,000 shares of common stock. Of the 15,000,000 authorized shares, the co-founders should allocate only 10,000,000 shares among themselves and an option pool. The size of the option pool is customarily set to a number of shares between 10% to 20% of the initially allocated shares of the company. The actual number of shares within this range should be determined based on how much hiring the company plans to do in the time between incorporation and the company’s first round of equity financing (usually the Series A). If the co-founders think they will have greater hiring needs, then they can increase the size of the pool and reduce the allocations to themselves. Once the co-founders have decided on their share allocations, an attorney can help them document and make their share purchases and any recommended tax filings like their 83(b) elections. When the purchases are complete, the co-founders then hold issued and outstanding shares. The shares in the option pool do not become issued and outstanding until the company transfers them to someone through an award or a sale of equity. Nothing is done with the 5,000,000 authorized (but unallocated) shares until the company needs them.
Here is a sample capitalization table illustrating the above recommendations: