Like the founders of Facebook who took each other to court over equity issues (and later settled this lawsuit for an unknown sum to one of the initial founders), many entrepreneurial teams struggle with the equity distribution in their start-up. The decision on how to divide the pie has to be made very early in the entrepreneurial process, but the consequences are far-reaching and completely unpredictable. In an article published in the Journal of Business Venturing, Professor Breugst, Professor Patzelt, and Dr. Rathgeber of the TUM School of Management address this problem and focus on the long-term consequences of the equity split for entrepreneurial teams and ventures.
The study shows that the essential factor in equity distribution is the perception of justice. Even very unequal splits can be considered fair so long as the team members’ contributions match the distribution. Importantly, these perceptions of justice have a major and long-lasting impact on the team and the venture. In the study, fair models of equity distribution represented an important basis of trust for entrepreneurial teams and the teams grew together over time. In contrast, if the distribution were perceived as unjust, conflicts developed within the team about the equity distribution which extended to other matters. Trust did not develop between team members, and thus the team started to fall apart, escalating in members leaving the venture.
Moreover, some teams started off in positively, but over time drifted into negative interactions. Those teams experienced massive pressure from their investors, who sided with a part of the team and isolated other team members. Across these fault lines, team members started to fight, resulting in a decrease in trust, and later withdrawal from the team. They also fell apart like the teams with the unjust equity distribution and faced team member exits.
These different team developments were important for venture outcomes: The negative team interactions prevented some firms from getting off the ground or even resulted in firm failure. In contrast, the teams with positive interactions developed their firms constructively: They won important awards, acquired new customers, and experienced employment growth.
Entrepreneurial teams can benefit from this study in several ways: Questions about the equity distribution need to be discussed carefully, including all contributions made to the venture. Further, when investors come on board, teams need to be cautious and emphasize an open exchange between the members. Finally, finding a fair solution can represent a major uplift to the whole team spirit. Reinforcing it will help a young firm to grow successfully as a team!
Prof. Dr. Nicola Breugst
Breugst, N., Patzelt, H., & Rathgeber, P. (2015). How should we divide the pie? Equity distribution and its impact on entrepreneurial teams. Journal of Business Venturing, 30(1), 66-94. Contact: Prof. Dr. Nicola Breugst, firstname.lastname@example.org