The Importance of Unequal Share Allocation

Allocation of shares to co-founders, at the stage of incorporation has been a common query among amateur promoters. It is extremely important to understand that the strategy used during initial allocation is bound to affect the company in the long term.

Let us understand the basic principle first. Usually, 80% of the authorized capital is allocated to the founders while the rest 20% is reserved for an equity incentive plan. Dividing a large number of shares among co-founders affirm their loyalty to the idea of the start-up and is bound to attract more investors. On the other hand, creating incentive for potential employees and service providers to the company is also important. Reserving shares for an equity incentive plan allows issuance of shares to employees, managers and consultants, making them personally involved in the company, which in turn leads to better performance.

Now moving on to allocation of shares among founders of the company, it may seem tempting to opt for an equal allocation. Both founders would want to contribute equally to the company and also bear equal risk. However, one must understand the problems that come with it. There are primarily 2 reasons due to which an unequal allocation of shares might be a more viable option for a start-up.

A. Quick Decision Making

Imagine a situation where an important decision has to be taken with the consensus of both the founders, but they disagree. The business as usual at the company comes to a halt until this difference is resolved. If it is not resolved amicably, it can lead to lingering differences among the founders themselves, which may have an effect on the future of the company as well. This is one of the reasons that a start-up may fail. By the time the management realizes that time is of essence or that a decision may have affected the relations between founders, they are nearing failure.

Thus, it is always better to pre-decide that who will take the final call in a situation like this. It not only saves time but may also salvage the relationship between the co-founders in the time of a tussle.

B. Appearing more Attractive to Venture Capitalists

Another reason to divide shares unequally can also be to make the company more attractive to Venture Capitalists. A mutual agreement between the founders to allocate shares unequally, sends out a message of trust and cooperation among them. This puts the company in a better spot than the one with equal equity allocation, in which VCs might hesitate to invest due to lack of trust between the founders and the possibility of a stalemate.

According to Noam Wasserman, author of the book ‘A Founder’s Dilemma’, a quick, even split suggests that the founders don’t have the business maturity to have a tough dialogue. During his research, he also found that unhappiness triples when founders split equity equally by default.