Equity Negotiation

The Equity Negotiation Between Kiran and Madhu

Here we present a role-play scenario between two co-founders, Kiran and Madhu, negotiating equity splits for their new venture.

Initial Positions (Before Negotiation):

• Madhu's Rationale (played by Aswathi): Madhu initially proposed a 53% stake for herself and 47% for Kiran. Her rationale was rooted in:
  • Technology-based Product: The venture is a tech product, requiring significant ongoing development effort, a role Madhu would primarily undertake.
  • Lessons from Rent the Runway: The importance of a strong CTO (Chief Technology Officer) as seen in the Rent the Runway case, where technological shortcomings caused issues.
  • Idea Origination (moderately important): Madhu was the originator of the core idea.
• Kiran's Rationale (played by Ashana): Kiran initially proposed a 51% stake for herself and 49% for Madhu. Her reasoning focused on:
  • Operations, Revenue, Marketing, Networking: Kiran would handle critical aspects like operational management, revenue generation, networking, and marketing.
  • Sales and Marketing Background: Her expertise in sales and marketing is fundamental to bringing the product to market.
  • Industry Connections: Her uncle's connections in the investment industry would be crucial for securing funding for an investment-focused social media platform.

Challenges in Negotiation: The negotiation was notably uncomfortable for both parties. This discomfort stemmed from:

• Friendship Dynamics: Negotiating with a friend made it difficult to maintain objectivity and directly push for individual claims.
• Subjectivity of Contributions: While they objectively recognized each other's skill sets, it was hard to disassociate this from their personal relationship and the perceived equal effort at the start.

Convergence to a 50-50 Split: Despite initial positions advocating for an unequal split (which is often advised for clearer decision-making), Kiran and Madhu converged to a 50-50 split. The reasons for this convergence included:

• Mutual Understanding and Trust: Through the conversation, they gained a deeper appreciation for each other's roles and contributions, acknowledging their equal importance.
• Desire for Closure: Both preferred a deal, even if not perfectly optimal, over no agreement at all.
• Flexibility for the Future: Kiran's willingness to be flexible about future equity adjustments played a role in reaching a consensus.
• Preserving the Relationship: A key factor was the desire to preserve their friendship and rapport, believing they could make a 50-50 split work through trust and communication.

This particular negotiation is healthy, characterized by back-and-forth discussion, mutual understanding, and a knowing decision to proceed with a 50-50 split, with a commitment to revisit it later.

Alternative Negotiation Outcomes: Equity negotiations can take various turns:

• Quick Handshake: One party might quickly concede due to discomfort in discussing money, leading to a potentially suboptimal or unhappy agreement.
• No Agreement: Parties might fail to reach a consensus, causing the venture to fall through.
• Unhappy Consensus: An agreement might be reached, but one or both parties remain unconvinced or unhappy, which can breed resentment later.

Key Considerations in Equity Split Decisions

The negotiation highlighted several factors that founders consider when splitting equity:

• Inputs/Contributions:
  • Skills and Expertise: Madhu's tech expertise and Kiran's sales/marketing background and networks were critical inputs.
  • Financial Investment: Both investing 50,000 rupees was also an input.
  • Idea Origination: Madhu's initial idea.

It's important to reflect whether equity is the only way to compensate for these inputs. Alternatives include salaries (though often difficult for startups), or deferred payments detailed in contracts for specific contributions.

• Control/Decision Rights:

  • An unequal split (e.g., 51-49) is often suggested to streamline decision-making, allowing one person to "call the shots" and avoid "analysis paralysis" or endless debates. Equity can serve as a proxy for decision rights.
  • Nuance: However, decision rights can also be defined via contracts, independent of equity split. For instance, a 50-50 equity split can be accompanied by a contract granting one founder final say on tech decisions and the other on sales/marketing decisions.

• Profit Sharing:

  • Often, people assume profit sharing must mirror equity split. However, this is not necessarily the case. Profits can be shared disproportionately to equity, as stipulated in a contract (e.g., 50-50 equity, but 60-40 profit share).

The True Nature of Equity

Equity is often misunderstood or conflated with compensation, control, or profit sharing. Its true essence is:

• Ownership: Equity fundamentally represents ownership.
• Residual Risk and Rewards: It is the claim on the residual value of the company after all contractual obligations (like debts and salaries) have been met. This means owners bear the ultimate risk and reap the ultimate rewards.
• Tool for Uncertainty: Equity is a powerful and flexible instrument for navigating the inherent uncertainties of venture development. It allows for:
  • Expansion of Founding Team: Bringing in new co-founders or key personnel as the venture evolves.
  • Adaptation to Pivots: Adjusting ownership as the idea or business model pivots.
  • Capital Infusion: Attracting external investment.

Equity is akin to a "joker in the pack" – a highly valuable and flexible tool. Therefore, it must be distributed and managed with extreme care over time, as it holds significant implications for the venture's future and the relationships among its owners.