We are 3 co founders and we have 33/33/33.
I want to quit it in 2 months and we are currently in the process to raise 500K for 25% before the end of the year.
Is it reasonable for me to keep 10% of it. - They think it's way too much.
Sell to them 10% right now - How much??
Sell 13% of it after the 500k raised - How much??
Thanks!
However: having 10% of the company owned by a non-particiapting founder is a big red flag for many investors, and would be a significant obstacle to the company's success. So you might want to consider settling for significantly less than 10% simply because you may end up making more money in the long run. 10% of zero is still zero. If I were setting up a company today I would have a back-loaded vesting schedule: 10% the first year, 20% the second, 30% the third year and 40% the fourth year. On this schedule, your share at 18 months would have been 4.95%. If I were you, I would offer to take that.
If you're raising $500k for 25% of the company, that means you think that the company is worth $1.5M now (because the company now plus the $500k would be worth $2M). So your share on a flat vesting schedule is about $180k, on the back-loaded schedule it would be about $74k. If you want to cash out you should offer to sell for significantly less than those numbers because you want everyone to think they've gotten a good deal. You never know when you'll want to do business with someone again in the future. A reputation for being reasonable is worth a lot more than $180k.
You need to decide what you're doing before you approach investors because you need to achieve clarity on what you're selling them: is this a company with three founders, or a company with two founders and one ex-founder (and is the ex-founder willing to sell and if so for how much)?
The most fair option is already mentioned - to maintain your 33% that makes all three of the founders equal as of today, and then allocate a new share allotment to dilute you out over a new specified vesting period.
If you want to show future investors good will, ask to maintain a seat on the board.
There's just not enough equity left to incentivize, create an options pool, hire, raise future rounds, etc. It is a Huge red flag, and the likelihood of success decreases dramatically.
I tried to raise once with 28% of the company being gone from our seed round, and it was a major, major concern. If this company ever needed to raise again, they'd be dead in the water. Therefore, the founder ends up with 33% of nothing instead of, say, 5-10% of something, and it's in his or her own best interest to take a smaller piece.
Now 5%? Maybe 10%? That stings, but at least it leaves the company something to work with.
It's more likely what annovikov said, the one leaving has serious doubts about the strategy but got out-voted.
Think of it as two separate companies: Startup A, which you co-founded, and which ended up dissolving, you seeing nothing for your efforts (other than whatever salary you managed to scrape out); and then, Startup B, which you bought a huge number of shares of for the amazing price of $0/share, and now get to smile as those shares appreciate, like any investor. It just so happens that Startup A and Startup B are the same company at different points in their life, but that shouldn't change your views toward the two situations.
This would be a red flag whether he accepted 33%, 10% or 5%.
The question is, is the flag "more red" if he has a higher percentage.
That is absolutely a red flag. If someone owns 25% of the business, they better be working to grow, improve, or otherwise assist the business on a daily basis. If nothing else, out of self-preservation to protect and grow their investment.
If they're a 1% investor, that's a different story.
If it's 25% and the angel doesn't appear to have angel experience, you can bet that future investors are going to want to interview the angel!
- understand the industry;
- understand the go to market/sales approach; or
- understand the current stage of the company and what it takes to move to the next.
And within each of those, they should have relationships, information, and strategies that accelerate the company in some way. It's not just a "look at my linked in and tell me who you'd like to meet" but a focused "I know A, B, and C who beat the problems that you're dealing with. let me get them right now and see if they can offer advice" and then a while later "Oh, you need X. I know a guy who does that. I'll get back to you."
Investors will likely push for a recapitalization to reset the cap table and remove the outstanding equity all together.
Is it still generally the case that the entirety of the options pool for employees is well under 10% (more like 5%)? If that's the case, I get that it may be limiting for the investors, but hiring & building a team is pretty "cheap" from an options standpoint I believe.
I would say he should stick to 12%. It's derived from an industry standard. VCs who have a problem with this are, pardon my french, greedy assholes.
There are plenty of places for handwaving and hope in startups already. The ownership status of a departed founder should not be one of them. That should be crystal clear.
This really puts a giant question mark on why anyone would bother with a non-CEO founding role. Startups are hard enough as it is, adding to it the potential of losing all your equity because you had a falling out with the CEO makes it almost not worth the trouble.
Engineers getting into partnerships with domineering business types should definitely watch out for this and evaluate their options. At least when you work for Microsoft and leave after 2 years, they cannot claw back what you earned over that period of time.
That's why you set up terms up front. If, when they decided on a 33/33/33 split, they also decided on a vesting schedule, they wouldn't have this problem. The OP would get some percentage value based on math, from contract terms they all agreed to when they started.
If you're losing all your equity after over a year of work just because you had a falling-out with co-founders (or investors), you didn't do your homework.
So which side are you arguing on?
What exactly is this standard? Haven't heard it before. (serious question)
edit: from the parent:
A typical vesting agreement would have vested your stock over a 48-month period, so after 18 months you would have vested 33% x 18/48 = 12.375%
Assuming that they're taking the high road and that the potential investor is well aware that a founder is leaving over a disagreement regarding strategy, which I sure hope they are, the investor is walking in with eyes open and is making a bet that the person leaving is incorrect. That seems to me to be perfectly reasonable.
If you want to be generous (as the person leaving) you can certainly offer to let the investor or co-founders buy you out at the same valuation the investor is getting.
If you want to be extremely generous and a little creative, you can ask for an amount of money that would make you feel you hadn't been cheated in exchange for all of your equity stake. After all, you disagree with their strategy, so perhaps you are skeptical that the equity is worth anything and would rather just get decent back-wages for the work you've done and wash your hands of it.
In that case, perhaps you can just ask for something like $200k for all of it and call it a day. If I disagreed enough with the company direction to leave, I might call that a huge win relative to putting in years more effort and eventually getting nothing at all out of it!
You have to settle on some kind of amount. And then you can be flexible about the payment of the amount - it could be over 36 month or someting.
My experience was it took 3 years with layers, lost friendships - and in the end we enden exactly the same place - same amount and everything. I sold 50% of my stake right away, and should have keep the rest. Big mistake.
My recommendation would be to find an amount - yep - it's hard. But it will only get worse from now.
The investors buy up 99.99% of the company for $500k at a $1 premoney, and then give out 75% of the company to current management in order to incentivize them to stay.
I am using extreme numbers here to make the point, but current management almost always gets a carve out.
There's nothing to stop the other founders from doing the exact same thing you are doing - leave and retain the company. Give them a compelling reason to stay.
I am asking about who gets to decide what is considered fair dilution. Assuming good will on all sides, I like the idea of your suggestion. Assuming non-cooperation, I am wondering what the worst case could be for OP.
In the same vein, they can't raise the $500k and then immediately dilute the investors. That's also theft, called fraud.
He seems to have shown a lot of good faith in this matter so far.
The two founders own 66%, presumably 2/3 of the board seats (but if they can't even be bothered to write a vesting schedule they probably don't have a board at all). For the sake of argument if each of them own 10k shares (30k total), there is nothing criminal about the board voting to issue 100k new shares to the two remaining founders. So now they each own ~48% and OP owns ~4%. Shitty move? Yes. Morally and ethically terrible? Absolutely. Will OP sue them? I would hope so. Illegal? Not even a little bit.
The way you prevent this is by having a contract. But again, OP was just doing this with his buds so no need for a contract, right? This is why you sign a contract for anything you're doing that involves more than $100 in assets or a few weekends of time.
Is this startup a moonshot? Do you have recurring revenue? Are you cashflow positive and using the raise to expand operations? Do you expect it to grow exponentially in the next few years? Was your contribution tangible? Are your continuing contributions required for the project to be successful or can you hand off your responsibilities without a hiccup? Do you know the tendancies and desires of your incoming investors? Do you expect the company to raise capital through equity in the next few years. etc. Did you draw a salary from the company? Are there any shareholder loans? What's the board structure of the organization?
Many of these comments assume that they know the answers to the above statements. They don't. Go speak with a reputable lawyer who deals with these types of transactions and ask him what the tax implications of your decisions are as well as a framework for negotiating a positive exit.
What that agreement should say is something along the lines of "each founder gets 1/48th of their shares for each month of having been at the company." There's usually a "cliff" of 1 year, but it looks like you're past that.
That being said, you need to realize that you bailing may put everything in jeopardy, as investors are likely to be spooked, and will likely be unhappy with the significant dead weight of .33 * 18/48 of the company. If I were you I would strongly consider taking a smaller piece in order to give the company more room to grow.
The fact that you're currently selling 25% of the company for 500k indicates to me that the company has a long way to go before spitting off serious profits, so I'd opt for whatever makes the company most likely to be successful, or you'll end up with $0 anyway.
Also realize your "percentage" will change as more shares are issued, an options pool is created, more dilution comes in, etc.
If no vesting currently in place, you have to do exactly nothing. The stake is yours. Your co-founders might not be able to raise investment, but you can't be forced to sell your stake. If you're reasonable, you pick a price for your shares and ask them to buy you out. If they are not willing to do that, just keep it.
If OP wants to, OP can not agree to any vesting agreement, keep his whole stake, and likely do significant harm to the company in doing so (of course I'm making some basic assumptions here, but I think they're fair, and about as good as we can do considering the lack of information). If OP does that he or she is actually shooting him or herself in the foot, and destroying the value of his or her own shares.
I can certainly see many scenarios where it's actually in OP's best interest to give up more of a stake, though it's impossible to know without knowing what type of company it is, revenue and growth rates, etc. If we assume it's a software startup raising at a $2m valuation I would strongly encourage OP to play the long-term game, as the likelihood the stake will be worth nothing if he or she takes 33% off the table right now is remarkably high.
https://ozar.me/2015/12/what-does-it-mean-to-buy-out-your-pa...
The first thing to do is read the startup's legal agreements. In our case, when we started the company, we agreed that partners (owners) could not participate in a business that competed with our own. You could leave at any time and do something competitive - but if you did, you thereby let go of your ownership. (You may also have a vesting schedule.)
If it's not obvious to you what your legal agreements mean, get a lawyer. Most lawyers will talk to you for 30 minutes for free to decide if it makes sense to hire them. Hiring a lawyer won't be cheap. You need the lawyer to tell you if you can simply walk away from the company and retain all of your ownership. If you can, then just ask the remaining partners, "What would you like to pay me to buy out my ownership?" It's simply a matter of what you're willing to accept.
Don't get hung up on valuing what the company will be worth in the future. If you can't agree on strategy, you won't agree on a valuation, either. Just ask them what they're willing to pay, and see if it lines up with what you'd accept. If it doesn't, and you can retain your ownership, and you believe the company will be worth a lot in the future, then walk away and keep your ownership.
But if you don't have that legal ability to keep your shares, then be prepared to accept a cup of coffee and a smile, and that's about it. (In our case, I bought out my cofounders because it was the right thing to do, but don't expect your partners to do the same. It's just a matter of character and your negotiation skills.)
As in, offer a price to buy me out - but you have to be willing to accept the same price for your share (which is the incentive to make a fair offer). Ofc i've only seen it in 2 person partnerships but imagine can be generalised.
Then if one person has $27,000 in their private bank account and the other person has $14,000 then the person with $27,000 can offer $14,001 and the person with $14,000 is forced to accept.
If one of the parties happens to be overdrawn on that account and have net -$3.70 then the other party can ofer $5 and the overdrawn party would be forced to accept.
Now granted in the real world people can raise buyout capital from their private network on short notice -- but doesn't this show great unfairness, if the parties aren't both independently much richer than the value of the business they're discussing?
For most startup founders who own, say, 50% of a startup whose last valuation was $7 million, that is nearly all of their net worth. The vast majority probably could not so much as raise $50,000 on short notice. So, if one of the parties already has a hundred thousand, they can offer $55,000 and the more cash-strapped party would be forced to accept it.
So what gives. I just don't get it at all. Like, I don't even get the theory of why this is supposed to be fair... it just seems "obviously" broken to me -- so I must be missing something.
Not necessarily - for example, in my own company's case, the company itself paid out the other partners. The company can take on debt to buy out a partner's shares (or a portion thereof) if the existing partners are willing.
I couldn't have afforded to buy out my partners personally, but with the business's assets, I could.
If the shares are worth $3.5 million, how much do you think the guy leaving can raise on short notice? If you say anything over $100,000 you are delusional.
Investors don't even see the value in companies that are provably worth $1 billion. Even in retrospect you say, "well yeah history showed it is worth $1 billion, and the founder made a good case for that, but actually that is like a founder making a good case that he will role 10 "6's" in a row on a die, and then proceed to do that. The chances that he was going to do that are actually just 1 in 60,466,176 so the correct value of that "$1 billion" share is actually $1 billion / 60,466,176 = $16. That seems a little low - I'll give you a $100 for it. That's my annual budget for lottery tickets."
Investors don't value startups correctly and the idea that a guy can quickly raise money for a buyout of a stake in a company he's leaving borders on delusional. Plus, who would invest in a company with a negative signal that strong: that a guy who owns 1/3 of it wants to leave it.
There is obviously absolutely no way for a cash-poor founder without prior exits to raise anywhere near $3.5 million for a 50% buyout of a company raising a round at $7 million.
honestly - have you tried raising money around the seed stage? It's brutal, if everyone is on board and there are no negative signals of any kind.
I wouldn't be surprised if no poorly networked, cash-poor founder has raised significant (>$1 million) for a shotgun buyout of a company he's leaving, on short notice, ever. I might be wrong though, and I'd love to know if so. In my model it's really, really hard to raise money.
If you cannot raise (with e.g. 20% discount for the trouble), the valuation is wrong.
As a result the poor founder will not be given a fair offer. Which is why I don't get how shotgun clauses are supposed to be fair. This is pretty "obvious" to me. So I might still be missing something.
I say that the situation you described is so far fetched as to be irrelevant to a discussion of "shutgun buyouts" in general.
How did the company reach a $7M valuation? They might have sold 1 share out of 7M shares for $1. That, technically, would make it worth $7M. But practically, it isn't.
Let's say company raised $3M at $4M pre-money => $7M post money. That's not unreasonable. At this point in time, the company has $3M in the bank, so it is indeed worth at least $3M.
Let's say "cash poor founder" only has $100K in the bank. If "cash rich founder" offers to buy 50% for $500K (five times what "cash poor founder" can afford), then it is extremely easy to raise $500K, for a promise to pay $550K from company coffers the next day, because in fact those $500K will buy control of $3M.
And that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc - because the investor who put $3M into that company is likely to lose it in a variety of real world cases without those clauses.
I say your cases are not impossible, just extremely improbable. In practice, it is easy to borrow against a grounded valuation with some.
The poor founder will likely get an "unfair" offer, but "unfair" here is within 10-20% of a fair offer, not a 50% or 90% as in your examples.
I assume poor founder is a smart founder, of course - he might not have access to lenders/investors, which could get him treated unfairly; But of course, that's also the case for having illness, immigration problems, disability, etc. Money is an advantage, lack of money is a disadvantage -- but it is not fatal in these cases in general.
1. Why do you say cash-rich founder's offer of $500K is within 10%-20% of the market price of the shares, when in fact the market has just priced the company at $7M, half of which the market has therefore just priced at $3.5M? It seems to me that $500k is 1/7th of $3.5M, so the offer is only 14% of a fair offer...
For example, what if one partner is greedy and wants to buy out the less greedy, but also poorer, technical founder, after they have some huge windfall that gives huge value to the company. (Some of which is reflected in the $7M valuation they've received - which is not at all low.)
2. You write "that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc". Would you say under the typical clauses offered by VC's, they would allow the remaining founder to spend an unexpected and large amount of money from the company coffers in order to buy out the other partner? (Or repay a debt investment they had raised to do so)? Why would the investors allow that? Especially if it was not envisioned explicitly under "use of funds" and, of course, they'd rather have two partners work on it than one. (But the greedy, cash-rich funder would prefer to own and have the company by himself.)
3. You write - "he might not have access to lenders/investors, which could get him treated unfairly". Would the company be able to raise debt to finance a buyout of one partner by the other or is that not something a company can raise debt for?
Thanks for your answers. I'm pretty shocked at everything you've said. (As you noted at the top of your comment, I misinterpreted you also.) By the way, this does not apply to a situation I am in - and I hope won't apply in the future. I simply do not really understand the clause and its implications in the real world, that well. Thanks for your help.
- founders "Rich" and "Poor" have 50%/50% split, with zero investment so far.
- they raise $3M at a $4M pre-money valuation. This is highly unusual for a "seed"/"pre-seed" stage, but not unusual if they already managed to bootstrap, have paying customers, etc.
- cap table is now: 3/7=~42% investor, 2/7=~28% Rich. 2/7=~28% Poor. (This is your first mistake: poor's stake in the company is worth $3.5M but rather $2M, on paper), and his 28% actually controls ~$850K of cash (assuming perfect democratic voting rights).
1. I am not saying that. I am saying that if the rich founder makes a $500K offer (5 times what the poor founder can afford), the poor founder will easily raise those $500K, because they control about three times as much in voting power. Any offer significantly below $3M * (4/7 * 50%) =~ $850K, e.g. $500K, means that one can raise $500K, and "buy 850K" with it. So the offer, even by rich dude, is guaranteed to not be below $850K. If the company has tangible measurable business, and the real worth is indeed $2M, then the same would be true for any offer significantly less than $2M.
2. Not, they would not. They might buy the founder out themselves, perhaps through the company, but they would not give a carte blanche for that.
3. It is possible to raise money for that, but it would usually be in the form of bonds or loans (essentially different mechanics for the same principle), not in the form of equity.
Discussion of pre-money valuation
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I don't understand why you continually use the pre-money valuation for how much a stake is worth! Usually post-money is used, isn't it?
This is how I think about it - tell me if I'm wrong: let us see if pre-money or post-money is the more appropriate metric, by looking at the extremes. You create a machine that poops bars of gold and show me. I want to buy 99.9% of your company for a billion dollars. You say okay, because you want to go invent something else using a billion dollars, and anyway you're pretty sure I can grow it to a seven hundred billion commodities company, which will make your remaining stake - which might come with anti-dilusion or ratchet clauses, so you always have 0.1% of the company - worth a further $700M. And the rich guy takes all the risk regarding whether he can actually grow it to $700M or fucks it up. You have your $1 billion today, either way, and obviously anyone who can invent a machine that poops bars of gold has good R&D ideas for how to use $1 billion. So you agree.
Ground condition: you had owned 100% of the company. A $1b investment for 99.9% of the company implies a post-money valuation of (1/99.9%) * 1 billion = $1,001,001,001. It implies a pre-money valuation of $1,001,001,001 - $1B = $1,001,001.
So how is the $1M relevant in anyway?
If the pre-money valuation is $1M then would the founder who just accepted $1B for 99.9% of the company, also accept a 50% buyout of the company for $2 million? After all, it's TWICE the pre-money valuation offer he just received!
Of course faced with two options - a 99.9% buyout of the company for $1 billion or a 50% buyout of the company for $2 million, he would accept the first one and not the second one, which to any reasonable person values the company at a much lower value.
As an even more extreme example, if the $2 million were for 100% of the company, then any reasonable person would understand that that offer values the company at $2 million. But the pre-money valuation is $0.
Which also OBVIOUSLY doesn't make any sense whatsoever. How does a 100% buyout offer of $2 million value a company at zero? Obviously it doesn't.
Would a guy looking at a 99.9% buyout for $1 billion and a 50% buyout for $2 million consider the second one to have a higher valuation? Of course not. But the pre-money valuation of the first one is just $1 million and the second one is $2 million - twice as high.
So we have three examples of absurd results from using pre-money valuation.
1. A hundred billion dollar investment for 99.9999999% of the company values the company at $100 pre-money ((1/99.9999999%) * (100,000,000,000) - 100,000,000,000 = $100). This is absurd.
2. A 100% buy of any company at any price values the company at $0. This is absurd.
3. A $4 million valuation (50% for $2m) can value the company higher than a $1 billion valuation - as long as the pre-money of the latter is lower. Again, absurd.
All of these absurd results make it totally unrealistic to use pre-money valuations so I really don't understand why you're doing it! Please explain in detail, as I've been used to using post-money valuations to talk about the value of a company. I thought this was standard.
Maybe I've grossly misunderstood something, so it would be very useful if you told me what!
Your other answers
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Your answer number 2 essentially means these kinds of clauses are only possible where there is not a VC on board, (because if there were, they wouldn't allow it and have protections against it in their standard docs), right?
You gave a partial answer to number 3 ("yes, but it would usually be in the form of bonds or loans") but as a practical matter would banks loan money to a company (say, against its assets as collateral) that was explaining to its loan officer at the bank that it was borrowing money to buy out one partner through another? At a practical level I didn't get whether this is something the company would probably be successful doing or probably fail doing. I have no experience with this. So I am asking whether banks would agree to that.
Thank you for all of your answers by the way! I am particularly interested in your list of reasons for using pre-money. It doesn't seem useful for me, or match people's intuitive definitions of valuation.
Don't take this as a personal attack: To me it seems you are very confused about the difference between share purchase and investment (these are NOT the same thing). In the world of company founding and funding, these go hand in hand with other things like dilution, vesting, rights of first refusal, "double dipping", and many more (and you practically need to be familiar with them to understand why things work the way they do; other wise, things that are very logical and pragmatic like shotgun buyouts don't make much sense).
I don't have the time to give you an answer all of these cases, but when you read on it, keep in mind that EVERY DEAL has both a pre-money valuation and post-money valuation, and the difference between them is exactly the money invested (in a "standard" investment deal). It is important to qualify a valuation (whether pre- or post- money) when you discuss it.
I did NOT use one or other valuation; I gave both, to make the numbers clear.
Again, until you properly understand the difference between share sales and share issuance (which is what is done in an investment), nothing will make sense. Make sure you have a good grasp of these -- a reasonable test if you got it right is to see if my "ground truth" example makes sense.
Thank you for the rest of your comment as well (not taken as a personal attack): I think you have identified one source of my confusion. I closely relate the idea of valuation to share price.
I will read up to get a fuller understanding, but could I just ask one question before you go: do the terms "pre-money valuation" and "post-money valuation" or does the term "valuation", mean anything when you buy 100% of the company from me (without issuing any extra shares shares, and the company doesn't get any of your money) for a certain amount? If that amount is $500,000 then what is the pre-money and post-money valuation (if these terms apply).
This should clear up my confusion as in this case no extra stock is issued. I will read up on the rest. I want to know if these terms (pre-money valuation; post-money valuation; valuation) even apply in such a case!
Thank you for taking the time to understand some of my sources of confusion. Other than this one, I'll try to get a handle on the rest of my questions from other sources.
For a buyout, you usually talk about price (although some people talk about "valuation" in this context too -- nomenclature is not completely standard here).
Before I had to fight for my legal rights a few times I always considered agreement more important than legal state. Don't do that. People will exploit that and give you much less than they owe you or ask much more than you owe them. Focus on your legal right first. You wouldn't give them your car or smartphone as a gift, right? Then don't just gift them your shares.
It sounds like there is no reason to sell your shares before the company gets more funding, which should also increase the value of your shares.
If you don't have a written agreement about the shares take whatever you can as fast as possible.
Maybe it's a confusion of how shares work? If you earn 1/3 of a company you earn 1/3 of what is considered the core value of the company (not sure how to call that in English). If a new investor comes he'll give you money to participate in your company. He gives you $1mio, then your core value grows by that amount and he gets a share of the company which equals $1mio/<old_value>. Nothing is lost.
The only way to lose in these deals if you sell a share of your company for much less than what it's worth. That can happen, e.g., if you give someone 1/3 of the company because you expect him to deliver something in the future (e.g., code the software you want to sell). But in that case you should put that in the contract. "You work here for 3 years, and for each you get 1/9th of the current size of the company." or "When the software with feature x,y,z is finished, you get 1/3rd of the company as compensation".
Make clear, legally enforcable contracts that state exactly what you want, and there's no problem.
"Hey you two, the fact of the matter is that I own 1/3 of the company outright. We didn't start off with a vesting schedule or anything else that would change that. Dwelling on that isn't helpful. I may be leaving, but I do want this company to succeed; my owning 1/3 of something that fails doesn't help me or anybody. I get that 1/3 of the company belonging to a non-participating founder will look bad to investors. However, I've put in just as much work as you two have up to this point, so I'm not just going to walk away empty-handed."
At this point it's just about good faith negotiation:
"I'm willing to let you guys buy me out of all or part of my stake. What do you think is a fair offer?"
All that being said, it is a shame that there was no vesting schedule set up in the beginning, so it might make sense for the OP and co-founders to essentially retroactively make one up, and, if they can all agree to it, all be subject to it. The OP will be giving up some of his shares, and the other two cofounders will feel an incentive to stay and work hard to ensure they vest as well.
The proper thing is to issue new options to remaining partners to dilute him heavily and keep them motivated to work at building business.
Whether or not it's best for the company that he keep it (I agree it's not) is an entirely different matter.
What they can do is either put him or themselves on a vesting schedule that represents share % with future work.
If you start a company with two other founders and agree to a 1/3 split each, or 33,000 shares. After a month you get bored and decide to let them make it a success, quit the company and tell them to wire you your third when they finally succeed.
In that case they can issue 1 million new shares immediately to themselves, and with very little tax consequence. It's a one month old startup, worth close to nothing so they can make them options costing a few pennies a share to make it fair and legal with no tax consequences .
In the case where you leave with a sale or investment pending, it gets much trickier. The shares have to be priced at fair value. If the company is about to sell shares at $15 per share, new options for the remaining founders can likely to be priced somewhere around $1-$5 per share since they will be common shares, not preferred shares like the ones being sold. They can be fairly valued much cheaper because won't have the special rights of preferred shares, and should be less liquid.
If it's fair, you're in the clear. The diluted partner might be unhappy, and could even sue (but would hopefully lose), but at least objective observers with good information about what went down would be ok with it.
If it's not fair, you open yourself up to lawsuits you may be unable to win, and your reputation as a fair dealer gets damaged, perhaps permanently, and people will think twice about working with you in the future.
I feel bad for your co-founders that you guys haven't had a vesting schedule in place or similar so that you would lose most of your equity now when you quit. Imagine having to work for free or for low pay in the future just to hand over 1/3 of the result to someone else. I don't know if 10 percent is too much or fair. I
I know you could say that you have worked for 16 months for free or very little but right about now is when it usually gets really tough. Your savings are probably up, maybe you haven't found a product market fit yet, maybe there are no customers yet. Doubts set in, both in you and your partner, family and friends. Now is when it hurts to continue.
So right now, I think the decent thing to do would be to increase the capital by a lot and let the co-founders subscribe for those new shares but have the shares vest gradually as they continue to work.
I also think if would be a decent thing to let the possible investor know that you are quitting before he commits.
Let's say that there are 30M shares now, and you each have 10M shares.
They can take that $500K and make it on a pre-money of $100K. That would mean the price per share was $100K / 30M = $0.0033 per share.
With $500K coming in, there are $500K / $0.0033 pps = 150,000,000 new shares.
Now there are 180M shares total, and each of you owns 1/18th.
Then the remaining founders can get a new grant to get around 75% of the company. The math to reach target percentage P with S shares is P * S / (1 - P). In this case, the remaining founders would each get 270M new shares.
The total number of shares would be 180M + 270M + 270M = 720M.
Let's look at ownership percentage now:
- Investor = 150M / 720M = 20%
- Founder 1 = 280M / 720M = 20% = 38.9%
- Founder 2 = 280M / 720M = 20% = 38.9%
- You = 10M / 720M = 1.4%
The founders get get all this done and in agreement with the investor BEFORE the round closes. They should also talk to a lawyer, because I'm just someone from the internet :)
- The more you try to hang onto, the less the other founders will have an incentive to keep going on this startup
- If you are a jerk, they may decide to start another company that does the same darn thing, and it'll be expensive to sue them
- If you quit before the money is raised, you might tank the raise
- If you quit before the money is raised, you might find yourself without an ability to defend your piece of the pie
I like the "is it reasonable for me to keep 10% of it"? I say yes, but you're not me, and I don't have all of the details. Again, there's no great solution here. However it goes down, if you want to win, you'll have to maintain the trust of your cofounders to avoid getting screwed.
Experienced founders also have vesting periods. It entices founders to stay, and is a fair way to value a founder's work when they leave. Typical 4 years with major events triggering a full vest.
$500k raise doesn't qualify here.
Each partner in your case is 1/3, presumably you are all considering yourselves at the same market rate, so your time spent is the same.
If you were to have done a 4 year vest, you would be getting 1/3rd of your shares at 16 months.
It's fair for you to receive 1/3rd of the current 33% of shares which is even more than 10% today. However, expect to be diluted down as the vesting for the other partners continues.
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Here's another way to look at it without retroactively creating a vesting schedule.
Each of you have contributed to 1/3 of the business, entitling you to 1/3rd now. Going forward, the remaining founders will be incentivized to stay by having new shares allocated to them.
Say, in 16 more months, the number of shares allocated will be double what it is today, and split between the two remaining founders. Your size goes down, but in proportion to the value that you are no longer creating on the business.
In this scenario, you need to work out that future allocation before you finish the 500k raise.
The theory, is that you have a certain percentage of the company (whether that is 10% of whatever), that is somehow "yours". But this is a private company, and you are a minority shareholder who presumably hasn't put much in the way of cash equity. What's to prevent the shareholders, after you leave, simply from dealing you out? There are all sorts of ways of doing this. The existing shareholders can get a liquidation preference in later rounds. The remaining co-founders (who presumably hold common), get paid out with a consulting bonus that acts as a drawdown on the equity, resulting in nothing for any of the minority shareholders after the preferred gets taken care of. If there are employees during a liquidation event, they can be taken care of with "Retention" or "Continuity" bonuses, and not rely on their holding of common.
Once you leave a company, I wonder how often (in the real world, versus they way we all want it to be) you simply end up with, completely legally, nada.
YC would likely know very well the answer to this - I bet it is north of 98% of the time.
I've seen it happen at least once at a company that I worked for that was sold to Oracle for about $100mm - everyone who stuck around for the liquidation event got retention bonus, plus one of the cofounders who had left (but still had a big chunk of equity) got a "Consulting" bonus - and, of course, the CEO (who had been around for about 18 months) got a monster payoff. Preferred shareholders (who actually had put down $$$) got paid off with a liquidation preference.
100% of the common shareholders, including some early employees who had a reasonable chunk of the company - were totally wiped out. Got nothing for their equity.
I believe this is fairly difficult to prove in court. It happens pretty commonly; it's not super hard to dilute someone out if the company wants to. In fact, it's probably seen as a good move by the board and all current employees.
Sometimes there are differences because different founders contributed different amounts. For example, this schedule wouldn't be fair if one of you had a side job.
Ultimately, it won't really matter. If they think you have too much ownership, they can issue themselves additional stock grants to get you down to what they want you at.
I see from your profile that you're a startup attorney, so you probably have seen a LOT more deals than I have, but to a certain extent you probably remember the messed up ones more than the ones that used boilerplate documents.
Multi-founder teams with no vesting does happen. I think that's a mistake and advise against it. Things go wrong way more often than people think.
I differ from many folks in that I don't necessarily advocate standard investor-friendly structures (though structures that are easily made investor friendly, yes). But founder vesting is one place where I agree with the standard line - it's really necessary.
Except for one situation: if the remaining partners don't believe the company is worth much, and you believe it'll be worth a lot, then that's the perfect time to buy THEM out. (Especially if you're having disagreements over strategy, and you believe you have a lot invested in the company.)
And the other situations.
If the rest of the founding team think you're holding too much; it may well demotivate them or cause them to leave entirely, damaging growth and ultimately your chances of success.
If incoming investors think an early investor or departed team member is holding too much equity they may be reluctant to come on board unless that situation is rectified.
Thinking about you as an early employee with 16/48 months of vesting, 10% is about right assuming you hit full "good leaver" provisions... but that's a huge proportion of the business to be walking out of the door.
I understand your co-founders' frustration. They now need to use the remaining 23% equity to replace you rapidly without losing critical early momentum. Even aside from no longer actively contributing that distraction will reduce the chance of the business succeeding.
Considering the gambles taken by all parties I don't think there's a right answer here. I guess I'm curious what you think the actual value of the equity is if you're willing to leave so early.
Unless you can read mental states from behind an internet comment, there was no need to resort to ad hominem to characterize the OP.
I've dealt with this in founding a company with my closest friends. I didn't agree with many aspects of how the company was being run and simply picked up and left. I also owned a significant portion of the company in my departure.
In my opinion, you keep the shares that have vested to you, not the shares you are entitled to. I left 2.5 years after signing my stock purchase agreement, so a large percentage of shares were already allocated to me. They tried to get me to give back some of my shares, but I worked extremely hard and sacrificed a lot over the 2.5 years (including working for free), so the shares were the only feasible form of compensation I could argue for.
Eventually what happened was the company issued more shares, effectively diluting my holdings to nothing.
They're still puttering along, doing the whole "I'm the CEO, bitch" thing, we're all still close friends, and I honestly don't regret a single thing about my decision because I was miserable working on it and fighting with my best friends every day.
Do what you feel is right and what will make you happy. In the end, that's what's important. Keep your shares. The chances of them being worth a significant amount are low, but in the event they're worth anything, you've earned that payout.
And you're still friends with these people? It's certainly their prerogative and legal right to do so, but it sounds like a shitty thing to do to a friend.
Dilution is inevitable, and faster if you leave and return unvested stock, but it sounds like this was a deliberate action by the remaining founders?
If you have any agreement (already, or a new one), if there's an agreed change in your vesting schedule, if you just give up your shares - you might have tax consequences, such as gift tax, other income, losses, etc - all depending on circumstances. Make sure you have a good tax person to consult with before signing anything.
I exited my business of ten years due to a combination of slow death by stress, strategic disagreement, and brexit.
At the time of my departure, I owned 30% of the business - 30% was held by my cofounder, 40% by an investor.
Long story short I sold 20%, with the company buying back the equity using cash reserves at what we collectively agreed was a fair market value, and I still hold 10% of the business in class B stock with equal voting and dilution rights to class A.
How you play this is critical, and I followed a few ground rules to get myself the best possible deal.
1) be amiable. Parting on good terms inevitably works out better.
2) determine your own terms and state them clearly and concisely.
3) make those terms realistic. Don't shoot for the moon, put yourself in the shoes of the guys who are remaining and think about what you would accept on their side of the table.
4) don't be shy. If what you've determined is genuinely fair, stick to your guns.
5) if you haven't, sit down with the other stakeholders and be frank.
6) consider your tax implications. In the U.K., it's critical to retain voting rights if you want entrepreneurs relief and still have a stake in the company. Ymmv.
7) avoid lawyers. They (particularly with a fairly small transaction) will gobble up an awful lot. The company should pay your minimal legal fees and transfer duty.
8) be prepared to walk away with nothing, or to leave things in a deadlock. They'll have to make a move as a major absentee voting shareholder is what we call an embuggerance.
Of course, all of this depends on the particulars of your contract and articles. I ensured, when the investor came on board 6 years in, that I held some power cards (tag/drag/pre-empt/tribunal/arbitration) which discouraged untoward behaviour on the other principals' parts.
That all said, consider your position - you want to leave as you've lost faith but you want to retain equity - you'll need a justification as to why you want to retain that. In my case I downplayed my disagreement over strategy and emphasised my personal needs, hence they agreed to me retaining some stock.
Good luck.
Forget what's contractually agreed upon and forget what's fair. The cap table affects the company's ability to raise money. That is a reason that founding shares should always include a vesting schedule or expiring "right of repurchase" so that premature departure of a founder does not result in a strange looking cap table.
It's reasonable for investors to say: "Who is this guy who owns X% and what value are they delivering?"
You'll have been there 18 months: 18/48 = 3/8 = .375. .375 * 33 ~= 12.
Your owning 12% is explicable. "He was early, he delivered stuff, that's his initial equity proportional to the time he was in the boat."
Best wishes with it.
Is anyone able to provide links to existing info on how to setup a startup that would have already setup a framework for a situation like this to be handled fairly? This is an opportunity for someone to say "next time, start with ____ because it covers this situation as follows: ..."
The founders who stay on board might try to dilute the departed co-founder's stake to nothing. Mark Zuckerberg did this to Eduardo Saverin. As a minority shareholder, you have to pay attention to the evolving cap table.
The only protection from dilution I saw mentioned in this thread isn't doing so well (gray at this point):
https://news.ycombinator.com/item?id=14357964
an agreement from the company that neither of the remaining founders can receive additional shares for 2 years [...] is a pretty effective way to protect against dilution
I don't want this specific point to detract from the original question asking for recommendations of competent template-y resources (legal agreements between cofounders) to build on when starting a startup.
Step Two: Decide what you're willing to live with based on what you learned in step one and have the lawyer draw up or validate an agreement based on those.
Step Three: Have a talk with the other principles with the "What you're willing to agree to" document and the "What you're entitled to" document ready on hand. Decide which way is the one you want to offer them and be ready to pull the other if things go badly. Negotiate it out and keep everything in writing.
Past that, pretty much everything is relationship/internal political issues that need to be resolved.
But, make sure you talk to an accountant and/or a lawyer before putting anything on paper or signing anything.
After much less time than 18 months, Cofounder Ron Wayne cashed out his 10% of Apple for $800. Are you at peace following Ron's path?
One other point is the notion that you're in the process of raising $500k. I, like many of us, have been in the process of raising hundreds of thousands of dollars for many years, decades even. Most years, there was definitely process but the only result was a donut between the $ and the k.
We don't know your finer details, but there's a good chance the entirety of the firm is valued at zero and so is your sunk cost of time. So it's not worth stressing over what percent of zero you manage to walk away with. Keep in the loop, slack off if you must, and pick a better moment (better than immediately before your hard work pays off) to walk away.
Either way; I would start somewhere around what your salary was (or a completive salary) and then add a bit for risk.
I would try and meet in the middle with equity or an earn out but people have different opinions. Maybe convert to debt; really depends what the company is worth, what you want and what the other 2 want...And what any legal forms / obligations are
One option we've used in these types of situations: You can enter into an agreement with the company whereby the company is given the option to repurchase your shares (or some portion thereof) in connection with a VC funding round. You can mutually agree on a valuation method (specified fraction of funding round price, 409A price, have a valuation done by an independent accountant). This allows the company to minimize the dead weight on the cap table, while allowing you to obtain some compensation for giving up your shares.
I would not recommend just offering to give up vested shares. What was the point of the vesting schedule you had agreed upon? I assume you've been working without a salary for 16 months, right? What compensation do they think you should get for that?
Happy to provide further advice off this thread, if you have further questions.
What I want to do is : I have 33% now and I want that 33% = A% + B% + C%
A% I keep it B% repurchased now C% repurchased later (after funding round for more valuation)
We all 3 agreed on this scenario and I wanted to have the good amount for A, B and C.
We are friends working together so we didn't agreed on a vesting schedule, and we worked without salary, and we each invest 10K to launch it.
I know that A% will be a dead weight, I got other advises saying 10% is too much, I should keep 1/4 of my 33% = 8.25%
It would be very generous of you to offer to treat things as if you were on a 4-year vesting/1-year cliff vesting schedule.
If you are comfortable with that, then B% would be 22% (let the company repurchase now). That would leave 11%.
If you are going to offer further generosity, then I'd say this: for every percent you give up to go into category C, then I would transfer an equivalent percentage from B to C.
What I mean is this: Let's say you were going to agree to make A% = 8.25%, as you suggest above. Then that would mean you are giving up 2.75% off the 11%. So, then the breakdown would seem to be: A=8.25%; B=22%, C=2.75%. But then I would move 2.75% from B to C, making the breakdown: A=8.25%, B=19.25%; C=5.5%.
Does that make sense?
There's no right or wrong answer here. But I'm trying to propose something that is defendable on principle, makes some logical sense, gives the company the room it needs to move forward, but also gives you something for your generosity.
Investors won't like this as debt has a higher priority in getting paid than they will.
A settlement agreement whereby the employee (you) gets a severance payment, which may (depending on your tax jurisdiction) be paid in installments over a period of time (years even).
Separate to the settlement agreement you sign over all(most?) your shares, and make it "clear" that the shares being handed over have nothing to do with the settlement agreement (of course they ARE related, but legally they must not be, talk to a lawyer about this).
A severance payment spread over years is much more attractive to investors as it means they take higher priority in the event of liquidation of the company.
It doesn't matter what they think. They're your shares.
If they think you shouldn't own 10%, then perhaps they should fork out whatever price it is that you deem to be sufficient for your 10%.
If they want to buy you out and they're raising 500k at a $2.5 million post-money valuation, I'd tell them to pay $625,000 for your post-raise 25% or $375,000 for the 15% you're prepared to sell. They should be grateful for your gift to them, if you were to sell your shares for less than a rate of $25,000/1%. Keeping 10% for your future, after having sunk 16 months into the company, is definitely not unreasonable.
The above is only my opinion and is not financial advice.
Odds are your share is worth somewhere between what you paid for it and how much you put in. In other words, somewhere between zero and close to nothing.
> Is it reasonable for me to keep 10% of it. - They think it's way too much.
33% over a 48 month vesting schedule is:
16/48*.33 is 11%.
Option A) Ask for 11% of the money raised, 11% of the company, or some combination thereof. (i.e. Keep 5% and sell them 6% for ~$30k)
Option B) Dilute you over time as the company grows.
A is about as low as its reasonable for them to offer you. If they aren't willing to meet that bar, just hold on to the full amount you are entitled until they agree.
With 3 founders, I think the max you can hope for is 3-4%. But get an agreement from the company that neither of the remaining founders can receive additional shares for 2 years.
I've been in this situation before, and that clause is a pretty effective way to protect against dilution.
But mainly, but not sticking out, you avoid a really punitive recap that could make your stake round to zero.
Take the emotion out of these discussions. First understand their perceptions, their standards.
Ask what do they think would be a fair? How would they prefer to structure the exit?
On this subject, Stuart Diamond is brilliant > https://www.youtube.com/watch?v=2QtZ-vObJrk
This puts the company at a valuation of 2M
After that you would have 1/3 of 75% of 2M, that is, 495k
You can base your "how much" answers on the above calculation (and previous money raised)
If you really don't want to be a part of it anymore, propose them to pay you in installments (depends on the company cash flow)
Divide your result by a factor of 5 or 10.
concretely how does this work? I understand dilution to be a function of premoney/postmoney valuation when raising, and nothing else. So all common stock holders get diluted equally
If they leave before the VC gets on board, you can just issue more shares to dilute them down to nothing.
You can declare a new class of shares with better voting rights, or better preferences, and issue yourself those. The actual numerical value of the shares may be within agreements, but they'll give you more control/entitlement.
You can form a new company, sell the assets of the existing company into the new one (or lease them if there are reasons why you can't sell). The old company will be left with some cash, the new one with the business.
You can just liquidate the old company, and pick up ownership of the assets post-liquidation.
Basically, private companies are worth whatever a clever accountant says they're worth. As soon as your co-founder stops being a director or an officer of the company, there are lots of ways to manipulate their claim on the company.
If they leave after the VC is on board, then the VC's advisors will have a suitable vesting schedule put in place. It's basically their problem after they get involved.
However, if you knew your co-founder intends to leave, and fail to disclose this during Due Diligence, you could be vulnerable to getting your arse sued to buggery.
Of course, some of this is ethically dubious. But (imho) so is claiming a stake in a company that you left while it was still worthless. YMMV.
Also, I'm not a lawyer or accountant, you definitely need to check with a qualified advisor not some random dude on the interwebs.
Your point about knowing the co-founder is intending to leave resulting in trouble is a very good one. Virtual guarantee that as part of a VC round, you will be making representations that you have no reason to believe any key employee intends to leave the company. you don't want to breach such a rep.
Obviously my advice is not only unqualified, but also criminal ;) It should definitely be ignored :)
Absent an agreement to the contrary, his other two partners can issue more shares to themselves, diluting him to near zero.
Or, a better solution, start a new company, agree to transfer the "assets" (if any) from the old to the new, removing him from the equation entirely.
Stuff like this happens all the time.