Equity is at the center of the entrepreneurial ecosystem. While passion may fuel the fire, equity is what keeps us going when all else has gone dark. It is a promise of a future glory day and an affirmation of our dream to “own” our company. As entrepreneurs, we covet our equity. It defines the control of our companies and can bring talent and money if used correctly. For these and other reasons, considering how you initially divide the equity among founders, and the terms under which you do so, can be critical. Many entrepreneurs have appropriately equated entering into a startup founder relationship as getting married – which is why such arrangement should not be taken lightly.
How To Divide Equity Among Co-Founders
Unfortunately, there are no hard line rules for dividing up founder equity. This is a discussion that must be had with your team. One common mistake among early entrepreneurs is to give away too much equity to people who have not taken as much risk as you have or sunk as much time and money into the company.
One interesting way to approach this is an equity calculator. Perhaps you should not use this as a hard line rule, but rather as a guideline when thinking about how to split up the company. This appears to be limited to straight web application companies.
One important consideration is Intellectual Property (“IP”) that will be assigned to the company. Again, this just goes into your calculations of what has and will be brought to the table at the moment stock is sold to a founder.
Important Considerations For Purchasing Founder’s Stock
Any IP related to the company should always be assigned to the company in one way or another when a founder purchases his shares. This includes the assignment of patents related to the company’s business (See a post by Ryan Roberts or a post by Jill Bowman for the reasoning and importance of this). Two popular ways of doing this are: 1) assign the IP value and make it a part (or the entire piece) of your purchase price for stock in the company or 2) assign the IP to the company in a separate IP Assignment agreement after each of the founders have purchased their stock.
There are some concerns that Yokum Tahu raises when considering assigning IP to the company in exchange for stock. Every founder should consider these things when dealing with IP assignment to the company.
Vesting (also called the Repurchase Option in many agreements)
Multiple Co-Founders: The biggest consideration when creating your agreements to purchase stock in your company arise when there are multiple co-founders. At the early stages, your founder agreements become more of a protection against a fellow co-founder than anything else – akin to a prenuptial agreement. This is why vesting is highly recommended by startup attorneys who deal with startups on a daily basis. Vesting gives the company the ability to repurchase a particular percentage of a founder’s stock if that founder leaves the company or under certain circumstances is fired. Yokum is also a big fan of vesting for founders. It is often regarded as the key issue for a founder agreements or stock purchase agreements.
Single Co-Founder: As suggested by Yokum in his brief answer above, vesting schedules might be a suggested practice for solo founders as well. Unless you are a serial entrepreneur – who can demand no vesting when negotiating with VCs – you will most likely be required to put vesting schedules into your stock purchase agreements upon raising money. As this point, these become assurances for the investors that you will not take off from the business they just invested in. That being said, getting the vesting clock ticking prior to raising money would put you in a better position. You should consult your attorney before choosing to put vesting into your founder agreement.
Vesting Commencement Date
The vesting commencement date can be the date of issuance of the shares, or an earlier date, in order to give the founder vesting credit for time spent working on the company prior to incorporation and/or issuance of the shares.
When considering founders: You should ask the question, if someone leaves early on or is fired from the founding team, should they receive some (or all) of their unvested stock? Some lawyers advise against putting acceleration in initial founder agreement because of the fact that a departing founder can walk away with a large chunk of equity.
When considering investors: Acceleration is a contentious topic when negotiating a term sheet and should be something that entrepreneurs push for. Some attorneys feel that initially having acceleration in stock purchase agreements strengthens the case for the entrepreneur and there should be acceleration in a stock purchase agreement prior to heading to the negotiating table. Stock Purchase Agreements can be amended to include acceleration after the initial purchase of stock has been made.