Splitting Equity Among Founders
themacro.com
themacro.com
It is hard to imagine a scenario with a normal (<=4) number of cofounders where it is reasonable to let someone who spends less than a year on the project to walk away with as much as 6% of the company. Having just wrapped up a 10 year company, it is honestly hard to imagine it being fair for that person to walk away with 1%.
As a fan of the saying "trust but verify" and its derivations, while I feel trust is important, I hate leaving such critical things up to trust at the end of the day.
No Cliff - Risk is that one founder sucks for a year and then takes some equity (2, 3%? How much vested in the first year anyway). If company goes for billions, you make a few million less - basically a rounding error.
Cliff - Risk is the controlling founder fires the non-controlling founder on day 364, but company still goes on to succeed. Loss is the non-controlling founder loses a year of his life where he worked for equity that was stripped from him.
Second, if you're doing equal split and you have three cofounders, without a cliff you're talking about someone who might walk away with 8% of the company without even having spent a year there. CEOs of companies routinely get significantly less than 8% of the company.
Finally, the "no cliff" risk happens all the time. People leaving after less than a year is practically the default setting. I'm sorry, but as often as malfeasance among founders happens (the fact that it's newsworthy when it does is suggestive), it's not the default.
The answer is: the former scenario is far more likely than the latter.
The less obvious circumstances would be a case where the person leaving is for the good of the company and acknowledged all around, e.g. it turns out that two good people can't get along and so one or the other leaving increases the odds of success, and leaving quickly and cleanly is in the interest of the company.
In both cases, the person leaving with some ownership expresses the underlying trust and without their ownership, their never really was any trust.
I've witnessed anger/frustration in 2-3 year old companies where one founder 'checked out' early. E.g. a college professor was offered a large share, for expert consulting privileges. Their expertise was perceived to have a large value to the new company.
After a year or two it became obvious who was getting the better deal. But too late for regrets - the prof still owns a small fraction of the company.
If you can't trust someone to not abuse not having a cliff, you can't trust them enough to be cofounders.
Especially if a cofounder is putting sweat or cash equity in, he absolutely should not have a cliff of any kind.
If you're part of a founding team and you put cash in, get IOUs, and take cash back out later.
I started working n months before my co-founder
I started working full time n months before my co-founder
I brought on my co-founder after raising n thousands of dollars
I brought on my co-founder after launching my MVP
My take is that there's no such thing as a part-time founder, but if you really want to allow someone to be a founder while they have a full-time job elsewhere, just do the opposite thing: don't start their vesting until they're full time.
If you raise more than a full-time salary's worth of money, and that money is used to make a payroll that pays a prospective "co-founder", they aren't a co-founder. Treat them like an early employee.
Launching your MVP shouldn't have much to do with whether someone is or isn't a co-founder. If your MVP is fabulously successful and de-risks the project, don't bring on a co-founder; bring on an early employee. If it isn't successful, ignore it in equity calculations.
I disagree; not everyone who's qualified to be a founder is able to forego salary. It's a big problem right now; otherwise awesome prospective founders have to be lured away from $150-200k/yr jobs - and that's really hard if your salary offer is $0. It's a lot easier if you're offering $100k - it's not their market value, but it also allows them to more or less maintain their lifestyle.
Joel Spolsky covered all of this in his guide to equity, which is like a more detailed version of Siebel's post. If you have to give one co-founder living expenses, give the other co-founders IOUs for the same money when you get funded or start taking in revenue.
Would you allow co-founders to invest in their own company on the same terms as angel investors? If no, why not? If yes, how is this not equivalent to giving the salary-taking co-founder less equity?
But having said that: it's probably situational. If all the cofounders have roughly equivalent finances, maybe that's OK. But if some of them have, for instance, just sold a company, and the others are doing their first no-salary startup, it doesn't seem fair to allow the better-off ones to buy additional influence.
I'm using "fair" here as a shorthand for "things that will damage the incredibly valuable cofounder relationship more than it's worth".
This sounds like an argument for multiple share classes. Founders not taking a salary get extra shares, but they're non-voting shares, perhaps?
Right now, founding a startup is overwhelmingly for people from privileged backgrounds who can afford to be bold and work for no money because they have a safety net (parents, trust fund, etc) they can rely on if they fail. It sucks. There's a reason there are hundreds of food delivery startups every year: the only people with the ability to start companies don't have enough experience with the world to know what would even make a good company. Sometimes they stumble onto something wonderful, but most of the time they just fail, go live with their parents for a few months, then go start up something else. Repeat until they get tired and just get a 9-5 job at Google or Facebook.
Every individual has a market value. If I make $200k/yr right now, and I get an offer to work for a startup where I would make $100k/yr, how is it fair that someone who previously made $75k/yr gets the same amount of equity as me? After all, I'm giving up $100k/yr just to work here! It's better to ask someone "what would it take to get you to work here?" and pay them that. Then give them equity as an incentive to be successful.
I know the Silicon Valley hegemony is against talking about money like this, but people definitely think it.
You should know pretty early on what roles your core leadership team needs to have. You should set aside equity for those roles as if they were founders -- especially for senior people, who are often giving up a lot in salary to work for a startup. You're obviously not going to give founder equity to a CS grad fresh out of college, but maybe you should for say, your head of customer relations (if customer service is a strategic driver for you, of course). You should especially give founder equity to anyone whose job is to establish a department from nothing.
And does it really matter in the end anyway? If your company fails, your equity is worth $0 no matter how much you have. If your company is the next Google, then you're all going to be so rich it won't matter. But I would much rather have leadership who is heavily invested in the success of the company than someone who is just going to bolt to start his own company after 2 years because its obvious he's not going to get a million-dollar payday.
That said, you still have to protect your equity (liquidation preferences, vesting schedules, etc). But the focus on one founder or another's role is usually meaningless: your leadership team works as a team. If you have weak links, it should be easy to get consensus around a buyout or contract renegotiation.
You sound like a VC. While some investors might not care about any exit smaller than Google, let me assure you that there are plenty of companies which are worth more than $0 but less than $23B; if a company is acquired for $5M, there's a big difference between owning 5% and owning 50%.
Equity in an early company is 100% based on potential. Why should the guy who filed the paperwork and found an investor claim all the equity for a company he has not yet built? What about the efforts of the other employees (who will probably end up doing just as much for the company)? Unless you're paying them an above-market salary, don't they have some right to the company they helped build?
As patio11 commented recently: "There appears to be a liquid market for businesses which are profitable. That is a Tokyo word. Means 'makes money'"
Pithy sayings aside, the point of the article is to be forward-looking with equity splits. All of the reasons you list are rearward-looking: they're about things that have happened in the past. The article assumes that you want your company to be much bigger in the future and that most of the work is ahead of you, which is generally YC's investment thesis. If you're happy where you are, you could easily substitute employees for founders, but they will never be as motivated as someone with a big equity stake.
To put it another way, all those items may matter for a small business organized in another way. But a C-corp is legally a "person" separate from it's owners, officers, and employees.
If so, they're not an early employee.
/snark
A really good way to handle this is with vesting, which is something every company should have. Normally stock vests as you spend more time at the company, in my opinion it's totally fair for cofounders to have equal stock allocations but if one founder was working for 6 months before the other joined they should be 6 months ahead on their vesting.
In any other circumstance, the "earlier" founder and the "later" founder have aligned interests in regard to equity independent of vesting schedule. An "earlier" founder insistent on more aggressive vesting may be symptomatic of an underlying poor relationship.
That's not to say that there couldn't be circumstances in which two founders naturally have different vesting schedules, e.g. the "earlier" founder incorporated the final entity prior to the "later" founder's involvement. But from a formal standpoint, if both founders are there the day of incorporation, then that's where the clock starts.
Two red dots, and some blue and green squares, followed by a blue and green pie chart. This is followed by the same two red dots with more blue squares.
It sort of reminds me of the occasional articles you see about particularly egregious elementary school support materials. If Suzie muttonates half her mickmackles, how many glomploots will Bobby need for the spimbliz? Wakalixes make it go!
The point was that you shouldn't divvy up equity based on work already completed, because that split does not represent the division of labor in the work that is still necessary to get to a viable product. Here's how I would illustrate that:
Image 1: A person in a red shirt holds a red apple. A person in a green shirt holds a green apple.
Image 2: A bushel basket holds 18 red apples and 2 green apples.
Image 3: An apple-pie chart made from the very first bushel represents an equity split of 90% to redguy and 10% to greenguy.
Image 4: A wider shot of their orchard shows two trees with red apples on it, and 8 trees with green apples, still to be harvested.
For Google - backend skills were way more important than UI.
For Instagram - UI/UX.
If you were all there together at the inception of the company and all agree to work fulltime on the project and can contribute equally than it makes sense to split up the equity equally. But just saying "everyone should get the same share" seems to simplify things a bit much.
A very common set of cases that is only slightly more complicated than this is the one where everyone in reality has started working in earnest on the company at approximately the same time, but for whatever reason, one of the team members feels that some work they did prior to starting the company with their partners also counts as "earnest work". Most of the point of this article is that you shouldn't complicate your company by accepting that argument; you will regret it down the road.
The next most common set of cases is that "cofounder" status is used as a recruiting tool. The company really wants to work with a particular person, but that person doesn't want an employee role. This can happen months or even years after the company has been founded. The simple answer here is that a cofounder is whoever the existing cofounders say is one. I personally think you're better off keeping things simple: if you call someone a cofounder, give them an equal share of the equity. If the road ahead doesn't have enough opportunity for a new cofounder to contribute so much that they'll earn the share, don't call them a cofounder.
After that, you're on your own.
This shouldn't be ignored however. If one founder has more immediate liquidity needs than the other, the non-salary-taking founder should receive some compensatory benefit for leaving cash in the company. The way that I like to resolve this is for the non-taking founder to essentially be paid in convertible notes or some other form of equity for the salary that they are giving up. In other words, founders split the initial equity pie equally, but then have the option of receiving cash, notes, or some mixture.
If I can figure out how to make interpolated equity work from a tax perspective, that would be the optimal solution. https://medium.com/this-time-is-different/interpolated-equit...
The intent was to determine an objective calculation of each founder's equity position. The process exposed some serious flaws, insecurities and heated discussions around the general efficacy of such an experiment. It felt petty and rather naive.
I left the team out of principle, but helped close the round and became an advisor.
My general rule is start at equal positions and apply reasonable adjustments based on hard contributions (ie, financial, etc). Building a company is a process that will be redefined as you go. However, the team dynamic shouldn't. If the team cannot grasp this concept, then leave.
This allows the founding team to acknowledge the extra work without creating an uneven equity split.
If you're finding it important to draw these kinds of lines between founding team members, that's a sign that you might not have the right founding team members. A founding team that "clicks" and works together is incredibly valuable, probably far more valuable than any year's worth of billing you've ever done. Don't mess it up with stuff like this; it's just not worth it.
Man, I am even more procrastinatey than normal today.
https://capyx.com/cap-table-guide#vesting
https://capyx.com/vesting-calculator
Full Disclosure - I am a co-founder of Capyx.
[+] Startups are basically all about people who are theoretically "unqualified" to do things repeatedly doing things they are unqualified to do.
Shouldn't 1/36th be 1/48th? Because 25% has already been vested at the 1 year mark, i.e. 36*(1/48) + 25% = 1 = total stock.
https://hn.algolia.com/?query=solo%20founder&sort=byPopulari...
https://news.ycombinator.com/item?id=10665306
https://news.ycombinator.com/item?id=10665034
Should probably be merged, and themacro.com might benefit from redirecting to the canonical URL :-)