

Who owns what? How to split equity in a new startup company - cwan
http://www.techflash.com/seattle/2010/01/who_owns_what_how_to_fairly_split_equity_in_a_new_startup_company.html

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gkoberger
The problem with this article is that the author is basing ownership of the
company on things arguably irrelevant to the actual company- qualifications
rather than contributions.

For example, his partner may have equal qualifications. But who is to say that
his partner will contribute an equal amount to the company?

A better way would be to come up with an agreement on how to evaluate equity X
years in the future, based on their performance. This also accounts for future
hires who deserve equity. Of course, part of the equity would have to be split
up at the beginning- but, no more than 20%.

Why should someone get equity merely because they "worked in film before web
development"? Instead, they should get equity because of the awesome demo
video they made.

This is certainly harder, but it makes more sense. There's no rush to split up
equity- after all, with the odds of flipping a company is relatively low and
IPOs being nonexistent, it's something that can potentially be dealt with
after a year or two.

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Flemlord
Strongly disagree about waiting 1-2 years to deal with equity issues -- equity
should be dealt with immediately up front. Everybody should be issued equity
via an ISOP based on their expected contribution over the next 4-6 years. If
somebody outperforms the expectation, they should be issued more ISOP. If they
underperform, they should be fired.

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aditya
Except when you say to someone, I'm going to keep x% and you're going to get
y% (where y is much less than x) because your future contribution isn't going
to be as much as mine, that person is either a) going to walk away or b) have
no motivation to perform at startup levels because you just screwed them over,
especially if you're not out there killing yourself every day.

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vessenes
This article will read really differently in four or five years once they've
either made some good money or gotten funded, or both, and one of the partners
wants to leave for a 'different opportunity.'

It misses: voting control vs ownership of financial benefits, the absolute
preference of capital over labor in how funders and the government think about
businesses, LLC vs corporation issues, dead-weight partner problems, title-
related compensation issues,governance and a few other things I can think of.

I tend to think of a simple best-practices setup in a situation like this to
be:

a) 50-50 voting control e.g. Class A Stock for the partners. b) if one was
deemed to get '60%' by the article's method, that owner would get the
remainder in Class B non-voting stock.

c) If a corporation: a valuation should be chosen upfront, and all non-labor
soft or hard contributions should be recorded as giving additional non-voting
stock, or (a bit easier with a partnership), as paid-in-capital.

1) if an LLC, paid-in-capital gets returned first, always, no exceptions
(until they're funded)

d) Lock salaries until the two owners are a non-majority on the board. All
additional money can come out via distributions.

e) If either partner leaves, company can buy out at fair valuation, with some
sort of note, or can convert up to 100% of leaving partner's stock to non-
voting.

That's a start at a workable situation in my opinion, I'd be interested to
hear people poke holes in it..

~~~
vessenes
p.s. post-hoc equity contribution conversations (e.g. a few years in) don't
work very well in my opinion: who got the equity benefits in the meantime? A
two-person review of equity later in the game is just going to cause problems.
It's better in my opinion to negotiate like a man up front, get all the advice
you can, get the best position you can, and live with the consequences. My
advice on this is wildly different if there's one founder and he's bringing in
a second partner later in the game, by the way.

p.p.s To elucidate the 50.50 vote option: typical valuations for minority
stock that does not come with good leverage, meaning one founder has majority
voting rights, discount the value by roughly 50%. Therefore, if you are not
protecting your right to vote, and shave off 1% to your founder, you have
ended up with about 24.5% of the economic interest if you ever need to get rid
of your stock. Also, good luck keeping your job if your partner decides he
hates you.

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Flemlord
The article misses the most important point -- who gets shares and who gets
ISOP? In the specific example behind the article, what happens if one of the
founders quits? The non-quitting founder is screwed because he gave up half
the company equity to a dud partner and has no way to get it back. The company
will probably die.

Actual issued shares should only go to investors with cash money, tangible
assets, or founder(s) with patentable intellectual property. Everybody else
(including founders who may have received actual shares for their intellectual
property) should get ISOP shares whose present value, when added to their
startup salary, would equal the salary they could make in the real world at an
established company. The ISOP should have a small cliff so founders who quit
after a few months don't get anything.

In my startup experience, most of them had issues like this with founders
payouts not reflecting their fair contribution. In one case, the founder quit
after 18 months but the company hadn't issued ISOP so he got his full cut when
the company was sold in 4 years.

In another case, founders got stock in direct proportion to what they
initially invested in the company. But they burned through the money in three
months, didn't get funded, and everybody worked for free for another 12 months
before they could start paying salaries. They didn't issue ISOP to make up for
the non-paying period, so a founder who invested $20k and worked for free for
a year got four times as much as a founder who invested $5k and worked for
free for a year.

~~~
gyardley
This sounds like a great way to end up paying short-term capital gains tax on
a liquidity event. Why give an additional 15% or so of your money to the
government? Get your stock up front, file an 83(b) election with the IRS, and
subject the founders to reverse vesting -- a buyback right in the event the
founder leaves that gradually expires over time. That way you own the
securities immediately and long-term capital gains rates kick in after a year.

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philwelch
"Our big challenge though, and one unique to a company started by two
extroverted developers, was the decision as to who should be CEO and CTO. The
titles aren't too important at the moment, but they certainly will be as we
begin to depend on each other for managing different responsibilities."

Is it just me, or is the idea of a company with two employees, both of whom
call themselves "chief ... officers" absurd on its face?

You _are_ allowed to change your job title later on, no? For instance, if
there are multiple officers two years from now, you can call some of them
"chief".

