We, students at Wharton Business School, will be publishing an equity split guide a little later this summer.

Here is a short excerpt related to the topic at hand -

• Explicitly agree on the problem your startup is solving, the long-term goal, and the short-term plan. This will both drive an understanding of likely contributions and appropriate equity, and best position the venture for creating value.

• The goals of equity splitting are procedural fairness and the perception that the split is just.

• To create procedural fairness, follow an understandable process. Be open and honest both about the process and
the factors considered. Allow individuals to first consider their contributions alone, then come together to
discuss splits

If you must start a company with family or friends, consider two things: what needs are they filling, and whether you can talk to them about an anything-but-equal equity split.

Are they filling a financial, social network, or human skills vacancy in your business, and can you reward them appropriately for that? If they are filling only a psychological need for you: “I need someone on my side, and who better than my best bud?”, consider making them an advisor or an early employee instead, not a cofounder. Remember, avoidance of damage to your social relationships will be at least part of either your or their problems; you will want to avoid tough discussions to avoid the appearance of distrusting your friend. Consider whether you could fire this friend or family member due to underperformance. Build safeguards and explicit house rules surrounding communications, disagreements and arbitration to be able to move forward successfully.

Starting up with family or friends, or anyone you’ve had a prior social relationship with, but not a professional one, is fraught with peril. And yet, Wasserman notes: “Unlike actual strangers, friends and relatives have to undo a prior relationship (at least while on the job) to build something very different and potentially contrary—a professional relationship…Teams of friends may start off strong and enthusiastic, but as the realities of life in the workplace begin to settle in, professional issues can creep into cherished personal relationships”

Because friendships and family relationships are based on social structures that value substantive fairness, it seems that founders often bring in those thoughts when splitting equity with these cofounders, namely, splitting equity equally (and quickly!) to maximize objective splitting and to avoid painful negotiations with people they cherish. Martin Ruef’s research, however proves that this is fairly disastrous for a startup venture: “…Family relationships can skew equity stakes: When a core founder included a family member on the founding team, that family member received an equity stake that was 1.11 times the stake of a comparable non-family cofounder. This can make for a serious misalignment if the family and non-family cofounders are not actually making roughly equal contributions to the startup.”

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Keep an eye out for our equity split guide, that provides a broad sweeping survey of literature and interviews with over 20 start-up CEOs and founders about exactly what you should be thinking about and talking about equity splits, with co-founders, VCs, advisers to name a few parties.