What is the best way to split equity for three founders?

You are thinking about it wrong.

Don't think of your organization as a pie. Think of it as a house.

When you add an extension (say a new kitchen) to your house, the value of your new kitchen now accounts for a larger *percentage* of your house, more than it did before.

But something else also happens. Your house is now worth a lot more.

I highly recommend you watch the series on raising money for a startup by the Khan Academy - http://robt.co/1u1wCsx

I agree with Jordan. I think the perspective that you are taking on this issue is not the best.

I do a lot of work with startups and i have run across the attitude many times where the founder is willing to dilute his or her ownership.

I guess the simplest analogy is this: is it better to have a small piece of something large, or 100% of nothing?

If the people that you have are integral to the success of the business and they are the "right" people for the job, give them a generous portion of the ownership, otherwise they will not be motivated to make the business successful.

This is one of those areas where you need to be very careful, because if they feel shortchanged you have given away ownership and not received equal value in exchange, this is a bad situation.

It is possible for a company to issue different classes of shares with different voting and economic rights. You could structure the equity for the new management to have restricted voting rights and for their returns to cut in only once your shares have delivered a certain level of returns.

You asked this question a while ago, I just noticed it. I hope it's not too late to convince you that the best way to split equity for three founders is to use a dynamic equity split that will allocate equity based on the actual contributions of the three founders while allowing for the possibility that their individual contributions will be different and may vary over time and you might lose some and add others. If you do a fixed split (like the one you are contemplating) it will not be fair and every time something changes you will have to renegotiate and amend your shareholder agreement.

Your main concern shouldn't be your personal holdings. Your main concern should be to get what you deserve and to make sure that everyone else does too. Contrary to popular belief, there is a way to get this perfectly right.

Most companies make the mistake of doing fixed equity splits at the outset of the venture. This is because most founders and advisers are unfamiliar with the benefits of a dynamic equity program and the ease of implementation.

A dynamic program takes into account the actual contributions of the various participants and allocates equity on the relative risk each participant takes.

In my book on this topic, Slicing Pie, I convert all contributions of time, money, ideas, relationships, supplies, equipment and anything else into a fictional unit called "slices". Every contribution can be converted using a conversion calculation that uses fair market value and a risk factor.

Once converted, it is easy to use slices to determine shares. You simply divide the slices contributed by one person by all the slices and you have an exact %. It is perfectly fair. It changes over time to make sure that everyone gets what they deserve all the time.

There is a recovery framework too, which dictates how equity is recovered from individuals in the event of separation from the company. In some cases they lose equity, in some cases there is a buyout. The model will tell you exactly what the buyout should be too.

Every other model is less fair. However, people at startups are taken advantage of so often they might not even notice (at first). When they do notice, relationships begin to deteriorate fast.

Like I mentioned earlier, I wrote a book on this topic and you can have a copy if you contact me through SlicingPie.com

Hi,
You raise a good and common question.
In addition to agreeing with Jordan's analogy (that your co-founders add value, and therefore you are gaining more value rather than losing it), I'll discuss 2 aspects: (1) how the equity should be divided and (2) the implementation of this division.
1. How to negotiate the division of equity: a good tactic in negotiations (and this is a negotiation) is to try and first find out what the other side wants. You mention that you don't want to be left with 30-40% of ownership, but perhaps each of the other founder's was only expecting to get 20% (each) in any case, which leaves you with 60% (problem solved). So first try and understand how they value themselves (equity wise).
Second, and assuming that they do want a larger percentage of shares, consider creating 2 types of shares (either actual share types if this is permitted legally in your country, or based on the co-founders contract). Although it is sometimes simpler to have one type of share, this option may solve your problem - you will maintain control of the decision making, whilst they will have an equal split in the equity/profits. Just take into account that this needs to be very clear from the start, otherwise the other founders might eventually get frustrated with you making all the decisions.
2. Implementation of the division of shares: regardless of the amount of shares each founder gets, be sure to use a re-verse vesting system based on quarterly periods - meaning, each founder gets all the shares from day 1 (signing of founder's agreement), but the shares are subject to the reverse-vesting mechanism (meaning that they only officially become owned by that founder based after the full period - usually 3 years) has gone by. This mechanism prevents founders from leaving with all their shares after just a few months.
I've successfully helped over 300 entrepreneurs. I'd be happy to help you. Good luck