

Ask HN: do cofounders get more equity by putting money after company setup - dear

If a company has been setup with an equity of $1000 for example, but later on it needs more money to run the business and the founders themselves put their own money into the business, do they create more shares?  How does it usually get handled if the founders put money not in proportion with their shares?  What would happen to thier shares?
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ScottWhigham
IANAL and IANACPA but I'd think the simplest solution would be the best: have
a C corp (or switch to a C corp) and then simply allocate more shares at the
current share price. The only problem with this would be getting everyone to
agree on the share price.

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dear
... and getting a lawyer which costs money. Is that right?

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ScottWhigham
I'm not sure how to answer that. Clearly we both recognize that attorneys cost
money so then your question must be about whether I think an attorney should
be involved? If that's the case, then yes an attorney should be involved. You
shouldn't be selling shares of stock in your company without involving an
attorney to some degree IMO.

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dear
So I guess contribution as loans would be the cheapest way.

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brudgers
All kinds of things can happen.

One alternative to creating a partial buyout - which is what an equity
redistribution would amount to - is to have the additional cash treated as a
loan.

The advantage is that this lessens the likelihood of hard negotiations between
the founders and the potential for hard feelings which is a risk in those
situations. I.e. it avoids the distraction of arguing over shares in what is
probably a dead man walking.

The interests of both parties are in keeping the company going. When one or
more cofounders give a priority to getting more equity, things are less likely
to end well and more likely to end sooner.

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dear
So if the company has a startup capital of $1000 (certain not enough to run
the company), the founder would have to continue to loan the company to keep
it alive. Someoneday in the future when the company makes enough revenue it
will start paying back the loan. Is that the idea?

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brudgers
There are all sorts of situations. As noted a loan is an alternative to a
partial buyout.

Supposing that in your scenario, one founder puts in $10,000 and gets 10% of
the other founder's stock. Assuming two founders and a fifty-fifty split, that
means the company is now valued at $100,000 and the selling founder (that's
the one without cash) has realized capital gains of $4950 upon which he will
owe taxes.

He may also be pissed off because the real equity, his sweat doesn't fall into
the equation. Maybe 45-55 isn't so bad. But each time this happens, the broke
founder has less potential upside. And he's been forced to sell. And to sell
cheap.

As his equity is reduced, his incentive to walk away is greater. In other
words, reducing his equity reduces the alignment between his interests and
that of the other founder.

Conversely, if the loan is unlikely to be repaid, then the additional equity
probably isn't worth anything anyway.

An advantage of a loan over partial buyout becomes more apparent if the
company is liquidated - let's suppose for $4000. In the partial buyout, the
55% stakeholder would receive $2200 and the other stakeholder $1800. In the
loan scenario, the lending party would recover $4000 and the other founder
nothing.

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meric
What about: Founder A has $10,000 to invest. Founder A lends $5,000 to Founder
B (at some agreed interest rate) and both founders invest $5,000 each, both
gaining equal number of shares. Founder B owes Founder A even when the company
goes broke.

Would this make it fairer in all situations?

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brudgers
The people involved determine what is fair not me. However, I can see some
factors to consider in regards to the personal loan.

First it prioritizes cash over effort. This expresses a lack of faith in the
startup. Second nothing poisons personal relationships like debt. Third it
means that B has an incentive to quit and get a regular job earlier in the
company's life cycle because he has an additional bill to pay.

Arm's length marriage is not a good idea.

I think the personal loan makes a hash of things. Suppose founder B writes the
critical piece of code? Should he require founder A to pay for it? Suppose he
makes the critical sale, should he get more equity?

Founders bring different resources to the enterprise. If one founder is unable
to contribute a critical resource, the sensible options are to find a working
source or forgo the enterprise.

If you must have your money back, don't invest in a startup.

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agilevic
Keep it simple until it has to get complex. Have all partners contribute cash
proportionally to their share in the business thus keeping the split constant.

