Working Paper: NBER ID: w16922
Authors: Thomas F. Hellmann; Noam Wasserman
Abstract: This paper examines the division of founder shares in entrepreneurial ventures, focusing on the decision of whether or not to divide the shares equally among all founders. To motivate the empirical analysis we develop a simple theory of costly bargaining, where founders trade off the simplicity of accepting an equal split, with the costs of negotiating a differentiated allocation of founder equity. We test the predictions of the theory on a proprietary dataset comprised of 1,476 founders in 511 entrepreneurial ventures. The empirical analysis consists of three main steps. First we consider determinants of equal splitting. We identify three founder characteristics -idea generation, prior entrepreneurial experience and founder capital contributions - regarding which greater team heterogeneity reduces the likelihood of equal splitting. Second, we show that these same founder characteristics also significantly affect the share premium in teams that split the equity unequally. Third, we show that equal splitting is associated with lower pre-money valuations in first financing rounds. Further econometric tests suggest that, as predicted by the theory, this effect is driven by unobservable heterogeneity, and it is more pronounced in teams that make quick decisions about founder share allocations. In addition we perform some counterfactual calculations that estimate the amount of money 'left on the table' by stronger founders who agree to an equal split. We estimate that the value at stake is approximately 10% of the firm equity, 25% of the average founder stake, or $450K in net present value.
Keywords: founder equity; entrepreneurial ventures; equity division; negotiation costs; valuation
JEL Codes: G30; L26; M13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Larger teams (C92) | Less likely to split equity equally (D33) |
| Greater heterogeneity among founders (L26) | Reduces likelihood of equal splitting (D30) |
| Equal splitting (D30) | Lower pre-money valuations (G19) |
| Decision to agree to an equal split (C78) | Substantial economic cost (J17) |