What’s The Most Likely Mistake You’ll Make Founding Your Company & How Can You Fix It?
I’ve worked with a lot of startups over the past few years, and, by a wide margin, the most common mistake founders make is not having a vesting schedule for their equity.
It’s not a mistake to have everyone 100% vested if all the founders stick around. However, that’s just not realistic. Of the companies I’ve worked with, over 50% of them have had one or more founders leave.
Making matters worse, most founders end up leaving within one year of starting your company. Then you have the problem of an ex-founder with a large chunk of equity that the ex-founder doesn’t deserve. Ignoring the unfairness (which is a huge issue) it causes a big problem for you:
Your company is uninvestable.
Let’s say you and your cofounder each have 40% equity in the company. There’s no vesting schedule on the equity, and your cofounder quits two months after the company starts.
Your ex-cofounder now owns 40% of the company. Worse yet, you’re trying to raise money. What are you going to do because no investor is going to invest in a company with 40% of the equity owned by an ex-cofounder. It’s what’s called dead equity.
You’re going to have to fix the equity situation of your ex-cofounder one way or the other if you’re going to receive an investment.
The good news is there is almost always a way out of this situation. The path I’ve seen most of the founders I’ve worked with take is negotiating a fair settlement. In fact, every founder I’ve worked with in this situation has been able to negotiate a fair settlement.
You start by looking at what the ex-founder’s equity percentage would be if you had a vesting schedule in place. The typical vesting schedule is equity vesting over four years with a one year cliff. This means that during the first 12 months no equity vests, and then the equity vests (typically monthly) for the next 36 months.
Most founders leave within one year, so any equity you allow a cofounder to own if the cofounder leaves within one year is more than the cofounder really deserves. That’s important for you to remember because you’re being generous.
So start there. You can let your cofounder keep the equity, buy the equity from the cofounder, or you can do a combination of letting your cofounder keep some and equity and buy some equity.
The key from your perspective is you can’t enter into any agreement that kills your company. For example, let’s say you have $500K of cash, and you negotiate a deal that gives your cofounder $480K. That’s a kill the company deal.
What if you can’t reach an agreement?
I doubt it will come that because the choice your cofounder has is your fair deal versus nothing. Why nothing? Well you always have the nuclear option of winding the company down and then starting up a new company. Or you may be able to issue more shares and dilute your cofounder to an acceptable number.
Obviously you’ll need to consult with your attorney regarding your options.
Just remember that you have the leverage, not your cofounder. And remember that whatever deal you make can’t put the company’s future at risk.
For more, How Do You Deal With A Bad Cofounder?