5 ms·

People who are doing this for the first time care a lot about the numerical split but people who do this professionally care a heck of a lot more about vesting.

by patio11 12y ago

People who are doing this for the first time care a lot about the numerical split but people who do this professionally care a heck of a lot more about vesting. Whatever you choose, your outcome will be a lot better with a defined vesting schedule. The standard one in the Valley is (for both of you!) "four year vesting with a one year cliff", which means that 25% of the eventual grant is durably yours on the 366th day and then 75% gets parceled out in equal increments every month for the next 36 months after that. I'd be inclined to have the company write you an IOU for your cash contributions so far, and split it 50/50, perhaps with one of you getting a tie-breaking share. The company can dispose of your IOU like any other short-term debt of the company at some point in the future when it has the financial wherewithal to do so. [See below about IOUs.] Your vesting clock starts 3 months ago, your partner's starts as of the day when he becomes full-time. I cannot emphasize enough that your equity split is not nearly as important as "Does bringing this guy on uniquely make this business successful and do I have confidence that we will both be happy with this arrangement 5 years from now?" Edit to add: As I get older and wiser, I am coming to appreciate the discipline of separating one's personal and business finances and explicitly receiving written acknowledgment for transfers of money into one's company. These feel like moving money from one pocket to another in the early days, but they are not, and explicit written confirmation of that fact will make your life easier in a lot of futures. For example, I know one entrepreneur who, like many, tightened his belt, ran up substantial personal debt, and put blood sweat and tears into building a company. Professional money came into the company. Without documentation that he had loaned the company money, the best resolution would have been asking the other stakeholders to approve increasing his salary so that he could cover his "personal" debts. Had that documentation existed, he would have had ample authority to extinguish that debt in the ordinary course of business, and it would have likely had favorable personal tax consequences.

gwillen 12y ago
Are you sure that 1-year cliff is a good idea for founders? A lot can happen in a year, and founder disputes are A Thing; and it sucks for the person with 49.9% to be in a position where any unresolvable disagreement in the first year means he walks away with nothing.
- patio11 12y ago
  I agree with you that a lot of founders have catastrophic breakups in the first six months. In most cases, this kills the company, and good riddance. In the cases where it doesn't kill the company, the cliff minimizes years of painful conversations of the general flavor "Hello, 10th engineer. We are happy to offer you 0.2% of the company, which you'll earn over four years with us. This grant represents 1/250th of what someone who worked with us for two months once earned." or "Hello, potential acquirer. That certainly sounds like a very fair offer. Unfortunately, I'll need to run it by someone who I haven't spoken with in 5 years who you'll be writing a check for several tens of millions to." Cliffs are, of course, negotiable. If someone suggested one to me with regards to my business, I'd accept it contingent on the clock starting at either launch or incorporation, either of which would result in the cliff being moot.
- jacquesm 12y ago
  It keeps your cap table clean, which you will really only appreciate later on.
- edanm 12y ago
  This also depends somewhat on what it means for someone to leave the company. This is actually not a simple issue - e.g. as the CEO of the company, you may be entitled to fire someone, even a founder, and that stops the vesting. But usually you'll have a board of directors, and the board is allowed to overrule the CEO, and guess who else sits on the board? The co-founder. This gets very complicated very quickly. That's why you should consult lawyers (or legal documents available online, but unless you're a lawyers you should consult one anyway). I'm actually not sure how this gets resolved in most startups. Oftentimes there are clauses like Shotgun clauses that try to solve this in a catch-all manner, providing a way of forcing people to sell their shares.
- paul_f 12y ago
  Usually for someone to lose their future vesting, they have to walk away, or be removed "for cause." A disagreement between founders is insufficient. Forming a company with partners is like a marriage. You can't dabble in it.
arsalanb 12y ago
>"I'd be inclined to have the company write you an IOU for your cash contributions so far, and split it 50/50, perhaps with one of you getting a tie-breaking share. The company can dispose of your IOU like any other short-term debt of the company at some point in the future when it has the financial wherewithal to do so. [See below about IOUs.] Your vesting clock starts 3 months ago, your partner's starts as of the day when he becomes full-time" This is something I tried to suggest to my former cofounder. His contribution was merely financial, and he wanted an exorbitant share of equity plus the title of CEO. I tried negotiating with him, but somewhere in the course of it I realized he was not the right person for any startup, and the venture was bound to fail with him onboard. I resigned and now have a startup that is quickly growing with loads of customers.
josephlord 12y ago
I'm probably missing something obvious but if all the founders have vesting schedules who actually owns the company initially? Surely there must be a legal entity that technically owns the shares even if they are contractually obliged to distribute them on the vesting schedule. With regards to documentation of loans to company and things like that is having it recorded as a company liability (to the named entrepreneur) in the accounts sufficient or was it more formal than that?
- danoprey 12y ago
  Technically, it actually works the other way around from vesting. Instead of you having 0% of your shares and working your way up to 100%, you start with 100% of your shares but the company has a Repurchase Right to buy back shares from you for (effectively) nothing. They incrementally lose this right until they have the right to repurchase 0% of your shares, which is when you are "fully vested".
- patio11 12y ago
  Ask your lawyer if you need clarification, but my understanding is that vesting is typically actually instantiated as a contractual term which describes the company as having a right to repurchase shares at par value or either repurchase or cancel options. For example, my LLCs have 10 million shares issued at par value 1/100th of a cent each. I own them outright. If for some reason I wanted to do a vesting agreement, I'd agree to the company having the option to purchase up to XYZ shares from me at par, with XYZ being any number up to and including the number defined by $VESTING_FORMULA_GOES_HERE. With regards to documentation of loans to company and things like that is having it recorded as a company liability (to the named entrepreneur) in the accounts sufficient or was it more formal than that? I figure as long as you're going to write it in the books of the company you might as well write a piece of paper saying "$COMPANY agrees to, at a date of its choosing within 10 years of the inception of this agreement, repay to $FOUNDER the sum of $SUM plus 5.0% annualized interest." Sign twice (once in personal capacity, once as authorized representative of company), date, file for later.
arghbleargh 12y ago
I am not experienced in these matters, but my intuition is that an IOU as you described isn't really fair in all situations. As an extreme example, if you invented and quickly prototyped a genuinely new technology that no one else knew about, then I would say your contribution is much more than whatever it cost you to make the prototype. It's commonly asserted that ideas are worth next to nothing, the difficulty is all in the execution, etc. I don't think that's entirely true. If your idea is just a vague one-liner like "facebook for pets", then sure, it's not worth much. But as you start building out a prototype, you're forced to be more specific and refine the idea, and it becomes more valuable. If you've got a handful of users and you've gotten some feedback, that's yet a bit more value. And if you've thought about the problem for a long time, you will probably have a good sense of what are the main challenges and what approaches won't work. That's valuable too. I don't think there is a well-defined line between refining your idea and "executing" on it. Obviously there is a limit to how much you can accomplish in the planning and prototyping stage. However, I suspect it is a lot higher than is commonly believed. Working for 3 months may sound like not very much on the scale of a startup's lifetime (let's say 2-5 years before it either fails or grows big), but consider this: maybe the OP did 4 or 5 failed 3-month projects before he or she got to this one, which seems somewhat promising. Suddenly that looks a lot more significant than 3 months. For this specific case, we don't have enough details to assess whether the OP has really hit on something big, or if there is still a lot of uncertainty about whether the idea will pan out. So unfortunately, after all that discussion, I don't really have an answer to the original question. I think what I would do in your situation is to make my best guess as to the "fair split" based on what I've contributed and the expected future value (let's say I decide it's 70/30), offer the friend that split, and if he/she accepts, I would immediately change it to 65/35. That way, they should be happy, but things are still close to fair from my perspective.
- Cthulhu_ 12y ago
  IANAL, but in that case I'd write an IOU for the monetary value (i.e. your hours), but arrange it so that the technology / patents / copyright / idea is legally your own, and that your company licenses the technology from you personally; that way, later on, you could make an arrangement that the company buys up the full rights to your technology instead of licensing it. Something like that.
espitia 12y ago
Thank you Patio for that reply, it really helped. As for writting IOUs for cash alone, why not my time spent working as well? I am guessing since my vesting schedule started 3 months ago, that would cover that correct? Also, being new to this, excuse my ignorance, what does vesting prevent? what does it encourage? First things that come to mind is if there were to be a fall out, the equity would remain under the one who stayed. On the opposite side, it encourages a long term commitment?
- pc86 12y ago
  The work is part of building the company. As a founder, the company does not owe you $125/hr for every hour you worked. However, if you "loan" the company $4,500 to pay a designer for something, it absolutely owes you that money back.

by patio11 12y ago

gwillen 12y ago

Are you sure that 1-year cliff is a good idea for founders? A lot can happen in a year, and founder disputes are A Thing; and it sucks for the person with 49.9% to be in a position where any unresolvable disagreement in the first year means he walks away with nothing.

patio11 12y ago
I agree with you that a lot of founders have catastrophic breakups in the first six months. In most cases, this kills the company, and good riddance. In the cases where it doesn't kill the company, the cliff minimizes years of painful conversations of the general flavor "Hello, 10th engineer. We are happy to offer you 0.2% of the company, which you'll earn over four years with us. This grant represents 1/250th of what someone who worked with us for two months once earned." or "Hello, potential acquirer. That certainly sounds like a very fair offer. Unfortunately, I'll need to run it by someone who I haven't spoken with in 5 years who you'll be writing a check for several tens of millions to." Cliffs are, of course, negotiable. If someone suggested one to me with regards to my business, I'd accept it contingent on the clock starting at either launch or incorporation, either of which would result in the cliff being moot.
jacquesm 12y ago
It keeps your cap table clean, which you will really only appreciate later on.
edanm 12y ago
This also depends somewhat on what it means for someone to leave the company. This is actually not a simple issue - e.g. as the CEO of the company, you may be entitled to fire someone, even a founder, and that stops the vesting. But usually you'll have a board of directors, and the board is allowed to overrule the CEO, and guess who else sits on the board? The co-founder. This gets very complicated very quickly. That's why you should consult lawyers (or legal documents available online, but unless you're a lawyers you should consult one anyway). I'm actually not sure how this gets resolved in most startups. Oftentimes there are clauses like Shotgun clauses that try to solve this in a catch-all manner, providing a way of forcing people to sell their shares.
paul_f 12y ago
Usually for someone to lose their future vesting, they have to walk away, or be removed "for cause." A disagreement between founders is insufficient. Forming a company with partners is like a marriage. You can't dabble in it.

arsalanb 12y ago

>"I'd be inclined to have the company write you an IOU for your cash contributions so far, and split it 50/50, perhaps with one of you getting a tie-breaking share. The company can dispose of your IOU like any other short-term debt of the company at some point in the future when it has the financial wherewithal to do so. [See below about IOUs.] Your vesting clock starts 3 months ago, your partner's starts as of the day when he becomes full-time" This is something I tried to suggest to my former cofounder. His contribution was merely financial, and he wanted an exorbitant share of equity plus the title of CEO. I tried negotiating with him, but somewhere in the course of it I realized he was not the right person for any startup, and the venture was bound to fail with him onboard. I resigned and now have a startup that is quickly growing with loads of customers.

josephlord 12y ago

I'm probably missing something obvious but if all the founders have vesting schedules who actually owns the company initially? Surely there must be a legal entity that technically owns the shares even if they are contractually obliged to distribute them on the vesting schedule. With regards to documentation of loans to company and things like that is having it recorded as a company liability (to the named entrepreneur) in the accounts sufficient or was it more formal than that?

danoprey 12y ago
Technically, it actually works the other way around from vesting. Instead of you having 0% of your shares and working your way up to 100%, you start with 100% of your shares but the company has a Repurchase Right to buy back shares from you for (effectively) nothing. They incrementally lose this right until they have the right to repurchase 0% of your shares, which is when you are "fully vested".
patio11 12y ago
Ask your lawyer if you need clarification, but my understanding is that vesting is typically actually instantiated as a contractual term which describes the company as having a right to repurchase shares at par value or either repurchase or cancel options. For example, my LLCs have 10 million shares issued at par value 1/100th of a cent each. I own them outright. If for some reason I wanted to do a vesting agreement, I'd agree to the company having the option to purchase up to XYZ shares from me at par, with XYZ being any number up to and including the number defined by $VESTING_FORMULA_GOES_HERE. With regards to documentation of loans to company and things like that is having it recorded as a company liability (to the named entrepreneur) in the accounts sufficient or was it more formal than that? I figure as long as you're going to write it in the books of the company you might as well write a piece of paper saying "$COMPANY agrees to, at a date of its choosing within 10 years of the inception of this agreement, repay to $FOUNDER the sum of $SUM plus 5.0% annualized interest." Sign twice (once in personal capacity, once as authorized representative of company), date, file for later.

arghbleargh 12y ago

I am not experienced in these matters, but my intuition is that an IOU as you described isn't really fair in all situations. As an extreme example, if you invented and quickly prototyped a genuinely new technology that no one else knew about, then I would say your contribution is much more than whatever it cost you to make the prototype. It's commonly asserted that ideas are worth next to nothing, the difficulty is all in the execution, etc. I don't think that's entirely true. If your idea is just a vague one-liner like "facebook for pets", then sure, it's not worth much. But as you start building out a prototype, you're forced to be more specific and refine the idea, and it becomes more valuable. If you've got a handful of users and you've gotten some feedback, that's yet a bit more value. And if you've thought about the problem for a long time, you will probably have a good sense of what are the main challenges and what approaches won't work. That's valuable too. I don't think there is a well-defined line between refining your idea and "executing" on it. Obviously there is a limit to how much you can accomplish in the planning and prototyping stage. However, I suspect it is a lot higher than is commonly believed. Working for 3 months may sound like not very much on the scale of a startup's lifetime (let's say 2-5 years before it either fails or grows big), but consider this: maybe the OP did 4 or 5 failed 3-month projects before he or she got to this one, which seems somewhat promising. Suddenly that looks a lot more significant than 3 months. For this specific case, we don't have enough details to assess whether the OP has really hit on something big, or if there is still a lot of uncertainty about whether the idea will pan out. So unfortunately, after all that discussion, I don't really have an answer to the original question. I think what I would do in your situation is to make my best guess as to the "fair split" based on what I've contributed and the expected future value (let's say I decide it's 70/30), offer the friend that split, and if he/she accepts, I would immediately change it to 65/35. That way, they should be happy, but things are still close to fair from my perspective.

Cthulhu_ 12y ago
IANAL, but in that case I'd write an IOU for the monetary value (i.e. your hours), but arrange it so that the technology / patents / copyright / idea is legally your own, and that your company licenses the technology from you personally; that way, later on, you could make an arrangement that the company buys up the full rights to your technology instead of licensing it. Something like that.

espitia 12y ago

Thank you Patio for that reply, it really helped. As for writting IOUs for cash alone, why not my time spent working as well? I am guessing since my vesting schedule started 3 months ago, that would cover that correct? Also, being new to this, excuse my ignorance, what does vesting prevent? what does it encourage? First things that come to mind is if there were to be a fall out, the equity would remain under the one who stayed. On the opposite side, it encourages a long term commitment?

pc86 12y ago
The work is part of building the company. As a founder, the company does not owe you $125/hr for every hour you worked. However, if you "loan" the company $4,500 to pay a designer for something, it absolutely owes you that money back.