Not all businesses are started with just one person. Oftentimes, a group of friends or colleagues will start a business together, with each person bringing together something valuable. Having multiple founders can help to distribute risk while also leveraging the unique skills and talents of each founder.
When a company is started with multiple founders, it is important to make sure that proper ownership documentation is prepared to ensure that every founder is in agreement with how equity is allocated.
Particularly, each co-founder should have a good idea about what their partners are bringing to the table and how their contribution is assessed in terms of equity ownership in the company. This important issue needs to be dealt with and addressed as early as possible when a company is formed. Transparency early on can prevent future disputes from arising. Frequently entrepreneurs will think that disputes over ownership will one day resolve themselves. They rarely do.
Even if you start a business with family members and close friends, you all will be well served if you document the nature of your agreement and distribute equity in a manner that will ensure that there are options in case one individual does not hold their own weight.
You should ideally have no more than four co-founders in your business that will receive founder shares. It becomes difficult to control contribution fairly when determining equity ownership when there are more founders. Other key employees should receive stock options, not founder shares. The difference between the two is that founder shares are likely to be vested and earned at the beginning of a corporation while stock options are likely to be earned over a period of time. In many companies, 75% of outstanding shares are reserved for founders, 20% for employee stock options, and 5% for a board of directors or a strategic advisory board.
(1) Compare contribution based on economic value.
One co-founder may do the computer programming. Another may do the marketing. The third may have a full time job, but bring sorely needed initial financing. A fourth co-founder may bring know-how and technology into the company. How do you determine what is a fair allocation of stock in your business?
The answer is you should compare contribution to economic value in terms of dollars. What is the prevailing market rate for a person with a specific skill and how many hours are they spending? What would it have cost you if you had to hire someone as opposed to receiving a founder share? Once a common metric is established based on dollars, you can more easily justify why someone deserves more stock than another person.
(2) Reward full time co-founders.
Value the individuals who will or are working in your business full time. These individuals will be putting their heart and soul into your new business, and you should make sure their contribution is rewarded, and that they have enough upside to give 100% of their energy and focus. Offer them a salary that is commensurate with their contribution if you can. If there are no funds for a salary at the initial stages, recognize this in terms of equity and ensure that they are given leeway to take the business toward revenue as soon as possible.
(3) Appoint a CEO and create a board of directors.
One of the full time founders should serve as the CEO of the company. This person should be trusted with the economic future of the company, and should be tasked with the goals and metrics needed to achieve revenue and cash flow break even. Provide incentive shares in the form of stock options to keep such an individual motivated to do the best they can to ensure the business will succeed. Also, create a board of directors consisting of the CEO, the founders, and preferably at least one other external person.
(4) Create stock restrictions or rights to repurchase.
These terms will help ensure that if one co-founder leaves the company or otherwise does not hold their weight, there is a recourse to purchase back their stock should the board of directors agree.
(5) Recognize that investors putting in real money are likely to have the greatest control.
If one founder puts in a capital investment into the business, they will likely be a creditor to the business. It is not always necessary (and it is not often preferred) that a solely financial investor is provided with equity shares in a new company. What you want are founders that will bring something more – whether their personal skills, efforts, connections, or goodwill to help drive a new business toward success. This being said, those founders bringing in cash into business are likely to demand more voting and liquidation rights in case of default, and therefore are likely to be able to exert the greatest control. Therefore, pick your investors wisely.
This article presents the views of the author and do not necessarily reflect those of LegalForce RAPC or its clients. The information presented is general information and for educational purposes. No legal advice is intended to be conveyed; readers should consult with legal counsel with respect to any legal advice they require related to the subject matter of the article.