Australian entrepreneurs are increasingly exploring dynamic equity splits – an emerging flexible approach to equity management for the founders of pre-investment start-ups.
Dynamic equity splits are agreements that set out a series of rules for increasing and decreasing equity shares based on time, effort and cash committed to the business.
As the system is new, entrepreneurs exploring it will need to seek legal support.
Daniel Mumby is a serial entrepreneur and has worked with a lawyer to create dynamic equity splits (DES) for the four start-ups he’s currently working on.
He told StartupSmart the emerging approach was better suited to start-ups than the standard fixed equity split, as it was able to scale and fluctuate as the business does.
“The fundamental point about DES is that it’s a fairer system. It says ‘here are the rules by which we’ll use to determine equity later’,” Mumby says.
“You can’t predict what will happen, you can only allow for what might happen. A DES allows you to change the structure of your business and de-risks sharing equity.”
The equity remains flexible until a ‘trigger event’ such as an exit or external investment when the evolving breakdown of equity ownership needs to be fixed and formalised.
Mumby says the process does require some trust, as one founder technically holds all the equity until the trigger event, but working out the rules of engagement and equity has been a really positive step for his teams.
“This process fosters and creates trust. You’ve got to make a judgement call right at the beginning about if you trust each other, and what the rules are,” Mumby says. “Relying on one founder to play fair is both an inherent flaw and benefit because you need to seriously think about who you’re partnering with.”
The approach is still evolving. While the system works for a ‘units of trust’ scenario, it may not work as a share allocation system.
“It’s a fairly new solution, and legal advice is absolutely critical,” Mumby says.
Yvonne Lee, co-founder of three-month old online collaborative consumption marketplace Oddswop, has also set up a dynamic equity split arrangement.
She and co-founder David Spalding opted for a dynamic equity split because they thought it was a flexible and more appropriate option for a start-up than a fixed contract.
“A formal contract seemed very cut and dry, and we weren’t really ready for that. We wanted something that was simple and fair, that reflected that the effort you put in was the effort you got out,” Lee says.
Lee adds the future of start-ups is never certain, so a flexible arrangement based on a clear set of rules meant the equity could alter as their involvement did.
Lee currently retains all the equity, but says they track the evolving equity split on a spreadsheet everyone can access, according to a formula everyone agreed to.
“If it does take off, it’ll be far more difficult if you haven’t worked out who is getting how much equity and for what reasons,” Lee says.
Lee is also using the approach for another start-up with five co-founders. She shares it’s even more useful in that situation, as there is more work going on, and it is more disbursed.