Divide the initial capital between founders

To uncover the subject, we conducted a quantitative study with a sample of seventy Galion entrepreneurs. A small majority opted for an unequal distribution (some founders having more capital than others), the rest having chosen a strictly egalitarian distribution (50/50 or 33/33/33 type).

These two approaches are based on a semi-philosophical difference:

• those who have chosen an unequal distribution highlight the fact that the composition of capital is supposed to reflect the relative contribution of each one, and that it is very rare that it is perfectly equal.
• those who have chosen an egalitarian distribution explain that this reinforces solidarity, cohesion and trust within the founding team.

Uneven distribution has a significantly higher statistical probability of success. In the sample studied, teams that opted for an unequal distribution of capital raised on average 2 times more money than those who opted for an equal distribution of capital. There is a similar ratio on exit valuations. If we include Criteo and Blablacar in the calculation (which because of their figures bias the averages a bit), the trend is even sharper in favor of an unequal distribution.

If we isolate the sub-group of entrepreneurs who have chosen an egalitarian distribution and who have more than 6 years of perspective on it, it is interesting to note that half express regret about this choice afterwards (“It was a big mistake...”). However, it should be noted that the subgroup in question concerns only 8 cases, so this result should be taken with caution.

To complete the analysis, French and American VCs were asked about the composition of initial capital on their 5 best exits. In more than 85% of cases, the distribution of capital was unequal.

In short, statistically speaking, the unequal distribution seems more optimal. However, this is just a statistical result and it is certainly not a question of affirming that an equal distribution necessarily leads to failure (there are plenty of good counterexamples).

That being said, the aim of this document is to propose a methodology for distributing capital between founders in a rational and equitable manner — it is hoped —. By forcing yourself to approach this topic frankly from the start, it tests the team's ability to tackle difficult topics and to resolve them constructively. In short, it seems a very beneficial exercise.

What we want above all is to give a tool that allows you to have a candid discussion with your associates. Each case is unique and all of the following figures should of course be taken as illustrative.

We started from the hypothesis that this is a nominal capital distribution without an issue premium. This means that we are in the case of an ex-Nilo creation and not in the case where a new partner joins a project that has already been running for several years or in which financial investors have already injected funds.

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I) Clarify who the real founders are

The first thing is to clarify who the founders are. It seems obvious but sometimes there are a lot of people who have contributed in one way or another to the genesis of a project. When it comes to compounding capital, lots of people want their piece of the pie.

The distribution of capital depends primarily on Level of commitment to the adventure.

Three categories can be defined:

1) The “founders”:

They are dedicated body and soul to the project. Not only do they dedicate theall of their professional time, but They are committed to staying there several years to ensure its future development. They are also committed to working without pay until the first real fundraiser and to assume the risk of a possible failure of the raising.

2) The “contributors”:

All those who have contributed their time or expertise to the project, but who at the same time have other professional activities.

3) The “first employees”:

Anyone who wants to join the project full-time, but on the condition that they Guarantee a salary right from the start. They may or may not be former contributors.

This distinction is fundamental, as venture capitalists only value founders who strictly meet the definition above. Sometimes they value certain employees with a truly exceptional profile and insist that they receive stock options quickly. On the other hand, regardless of the merits of casual contributors, this weighs almost nothing in their decision to invest. These contributors also include more or less prestigious names for which strategic committees are invented and who are supposed to give credibility to the project. Nobody is fooled, starting with the VCs, that in practice they only make a very marginal contribution to the success of the project.

This has a very important practical impact on how capital is distributed. It is therefore necessary to proceed in three steps:

1) first distribute the capital between full-time founders

2) then, in a second step, define a global envelope that will be allocated to the contributors to the project. This envelope will be debited in proportion to the founders.

3) distribute this envelope between the contributors and, if applicable, the first employees (typically in the form of a BCE for the latter)

Except in very exceptional cases, a contributor — regardless of his merits — should never have more than 5% of the nominal capital. Overall, if the total nominal capital envelope distributed to contributors is greater than 15% of the capital, it's a wake-up call for investors. This means that the real entrepreneurs of the project were too diluted at the start, which is perceived as amateurism. Many VCs refuse a deal simply because the pre-round capitalization table does not suit them.

How to deal with the case of one who promises to switch later full-time on the project?

• If it is at a certain and relatively close date (a few months) that depends on a personal constraint (notice period, project in progress to be completed...), we may or may not introduce a time penalty that depends on the progress of the project in the meantime (see below the concept of concept validation).
• If it is at an uncertain date (typically linked to a fundraiser), there is no real commitment or risk taking. We come back to the case of the first employees.
  
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II) Forget (at the beginning) the money invested

In the Galion spirit, we assume that the startup is intended to raise funds in the fairly near future from professional investors.

This point is very important and makes it possible to state a first fundamental principle: the financial contribution of the founders should not have an impact on the distribution of capital.

In other words, if a founder has much greater financial resources than the other partners, this should not affect the initial distribution of capital. This is a major difference with traditional SMEs where it is often the richest who has the biggest chunk.

One could argue that the money invested is part of the contribution to the adventure. But in a fundraising logic, nominal capital is supposed to be marginal compared to the value of the startup and therefore to the money that will be raised subsequently from financial investors.

The amount of initial share capital is thus calculated in such a way that the partner with the lowest financial resources can put his share at nominal value.

What happens if the startup needs additional funding from one of the partners? In this case, this should be considered as an internal fund raising with the application of an issue premium to be negotiated between founders.

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III) Evaluate everyone's contribution to the project

In order to determine the most equitable distribution possible, the approach is to draw up a list of criteria that is as objective as possible. Once these criteria are established, the idea is to make a small table in which we will evaluate each founder according to these criteria. Once the table is filled in, we deduce by a small and very simple calculation the percentage of capital that belongs to each person.

It may seem odd to embark on such a detailed quantitative exercise, but experience shows that this approach makes it possible to objectify the subject and prevents the discussion from turning into cookie-cutter emotional statements such as “I am better than you/I am worth that... etc.”

Finally, it is important to specify that this tool is just there to give orders of magnitude and at the end, we can simplify the results to have a intuitive distribution.

Above all, it is a question of evaluating the past and especially future contribution of everyone in the project. The 6 criteria selected are as follows:

1) Initial concept

2) Validation of the concept

3) Technical and non-technical roles

4) CEO position

5) Relevant previous experience

6) Relevant sector expertise

Each criterion has a weight that can vary from zero to a certain maximum depending on the particular context of the project and the team. The list of criteria and the weighting proposed below is of course a simple suggestion drawn from experience, and each team should feel free to adapt it as they want (making sure that everyone agrees beforehand).

1) Initial concept (between 0 and 30 points)

It is often said with good reason that ideas have no value, only execution counts. That is not entirely true. Some ideas are still more fruitful than others and especially some ideas are better able to attract the right talent and capital, which is key for starting a startup.

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2) Validation of the concept (between 0 and 120 points)

Sometimes when a company is formed, the initial concept is just a draft with nothing more. Sometimes some partners have already worked several weeks or months to gather elements that give consistency to the initial idea. It can be a detailed business plan, a market study with potential customers, a technical model, or even a real operational prototype. These elements can provide important metrics to give credibility to the project and make it in fact (even if it is largely illusory) less risky. This can attract even more talent and capital and therefore has significant value for the project.

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3) Technical roles (between 70 and 130 points) & general roles (between 90 and 110 points)

We expect a founder who has a general profile that, depending on the needs of the startup, he can potentially do sales, finance, operations or marketing, depending on the needs of the startup. Indeed, it is often difficult to predict in advance what the exact contribution of generalist founders will be, since this ability to deal with very different problems is the trademark of good entrepreneurs. For technology, on the other hand, you cannot improvise on it and only founders who have the appropriate skills will be able to claim to contribute usefully in this field. Hence the idea of separating on the one hand the founders who will mainly have a technical contribution and on the other hand the generalists who will take care of the rest. The general needs are essentially the same in all startups, so the specific variability linked to the project is quite limited (between 90 and 110 points). On the other hand, depending on the nature of the project, the impact of the technique on the success of the project can vary enormously, resulting in a much greater variability (between 70 and 130 points).

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4) CEO position (between 40 and 100 points)

A team that has not clarified from the start who is supposed to decide as a last resort scares off investors. The choice of who will be the CEO of the startup is a very structuring element of the project. The CEO is the natural interlocutor for financial investors. They will be very sensitive to his profile and this will weigh very heavily in their decision to invest. In addition to instill vision and corporate culture, VCs also expect the CEO to be able to make the tough decisions especially those where there is disagreement between co-founders.

Note that in the Galion study, among the teams that chose an unequal distribution, in 80% of cases, the CEO had more capital than the others.

For all these reasons, the particular impact of the CEO in the smooth running of the project justifies a capital bonus linked to this role. The amount of this bonus should be adjusted according to the founder's previous experience as CEO, with the idea that this experience is supposed to be a predictor of future contributions. From 40 points if it is the first time he is in this role, the bonus can go up to 100 points for someone who can demonstrate a long and successful CEO experience in very complex contexts.

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5) Relevant previous experience (between 0 and 100 points)

Succeeding in growing a startup requires very specific skills. In other words, having successful experiences in other professional contexts is not a good predictor of success in a startup. On the other hand, statistics show that startup serial founders become more and more effective over the course of their projects (hence the interest in starting your entrepreneurial career young!). VCs are very sensitive at this point in their decision to invest.

As a result, only the experience like founder of a startup has been retained here. The amount of the bonus obviously depends on the trajectory of previous startups. You can count 20 points for someone who managed to raise a few million euros, up to 100 points or more for someone who led a beautiful unicorn to a successful exit.

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6) Sectoral expertise (between 0 and 20 points)

For some projects, sectoral expertise makes it possible to avoid some trial and error and to save time on the first iterations of the project. However, over the long term, this type of sector expertise is often overrated, as founders can quite easily recruit these experts as employees or consultants. Hence a fairly limited bonus for this contribution.

In the end, we end up with a table that has this form:

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IV) Some illustrative cases

We will illustrate the method on 2 practical cases: Kiwee and Criteo. In reality, the distribution of capital among these startups was not done with this quantitative method, but this retrospective exercise made it possible to better calibrate the model.

1) The Kiwee case:

Initially, JB developed a game concept around the mobile Internet, a trendy sector in 1999 (even if the terminals of the time were unable to provide a satisfactory experience), which convinced Francis to join the project.

The concept is correct without being great, so 15 points on this criterion.

Neither Francis nor JB have a technical background. They share the 100 generalist points and the 80 technical points (the project is technically not very complex) are not awarded.

It was decided that JB would be the CEO. He has no experience in this role, hence the 40 points.

Both JB and Francis can claim sector expertise on mobile internet, which gives them 5 additional points each.

We end up with the following distribution:

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A few months later, JB and Francis were joined by Jean who arrived as a third partner.

The concept has not changed. On the other hand, in the meantime, JB and Francis have hired a small junior team and have made good progress on a technical and marketing prototype, which gives the project much more consistency, so they share an additional 100 points.

Jean does not have a technical background either, and so they now share the 100 generalist points by 3. JB has gained some experience as CEO and his score has increased to 42 points. Jean also has a slightly more senior sector expertise than that of Francis and JB.

In the end, we end up like this:

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2) The Criteo case:

Criteo was born from the merger in 2005 on the one hand of JB's project and on the other that of Franck and Romain. The original concept (a recommendation engine) is quite vague. JB and Franck independently had the same idea at the start. They share the 10 points of the concept.

At the time of the merger, the two teams had already worked for 6 months for JB and more than a year for Franck and Romain. Each project put into production an operational site with real users, hence the 70 validation points. However, the technology developed by Franck and Romain is much more robust and they share 60 of the 70 validation points.

The project is by nature very technological, and therefore is credited with 130 points on technology. On the distribution of roles, Franck and Romain share the technique, while JB takes on the rest.

JB becomes CEO. He can already claim 5 years of experience in this role as CEO on a team of 50 people, hence the 60 points. In addition, JB has a successful experience as a startup founder by having raised 6 million euros until a sale where all shareholders have come out positively, which gives him 30 additional points.

None of the 3 co-founders has any particular sector expertise.

In the end, we end up with the following distribution:

To come back to the fact that the money invested should not be a criterion for distributing capital between founders, the Criteo case is quite instructive. The original structure created by JB had an initial share capital of 250,000 euros. However, once the three partners agreed on the distribution above, Franck and Romain did not have the personal resources to put 62,500 euros each (25% of 250K €). The solution was to reduce their capital so that they could still get the desired percentage.

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V) Managing founders' capital over time

In principle, the only events that change the initial distribution are fundraising.

However, in the Term Sheet Galion, we introduced an additional concept related to time.

The idea is for the initial distribution of shares to be confirmed by the effective duration of active presence of each founder in the company. The typical case is when one of the founders finally brings disappointing value to the project and is pushed out by the rest of the team. In this case, the other co-founders diluted themselves unnecessarily at the beginning. To overcome this problem, the Galion Term Sheet thus offers a quarterly “vesting” that allows value to be accumulated over time, the “unvested” balance can be redeemed at nominal value in the event of an early departure.

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For more details, please refer to the explanatory document of the Term Sheet Galion.

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