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.
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 not investable.
Let’s say you and your co-founder each have 40% equity in the company. There’s no vesting schedule on the equity, and your co-founder quits two months after the company starts.
Your ex co-founder 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 co-founder. It’s what’s called dead equity.
You’re going to have to fix the equity situation of your ex co-founder 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.
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.
Most founders leave within one year, so any equity you allow a co-founder to own if the co-founder leaves within one year is more than the co-founder really deserves. That’s important for you to remember because you’re being generous.
What if you can’t reach an agreement?
You do have other options.
For example, there’s always 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 co-founder 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 co-founder. And remember that whatever deal you make can’t put the company’s future at risk.
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