We are 2 co-founders - I own 40% and (let’s call him) Jim owns 60%. Jim invested $12.000 (funded the development), I’ve invested about $1.000. Most of the work except of programming (we hired freelancers to develop a sharing economy app) was done by me - I’ve done the initial sketches & app flow based on Jim’s idea, created us a website, got us a payment gateway, communicated with accountants, handled app submissions, marketing & social media, whole design & branding stuff, handled Android programmer, etc. Jim mainly handled the iOS programmer and a lawyer. The overall hours spent (and work done) are maybe in 85:15 ratio.
The app was released a few months ago, got some first users and great feedback from the startup community, but some huge bugs occurred so it’s currently in the stage of fixing them (it’d be done in like 2 weeks)
Now I’ve decided to leave after almost 2 years. I’ve proposed to Jim that my share from the potential sale of the startup will be reduced to 30% immediately and will be gradually reduced ever further over a period of 4 years to 5%.
Jim said that it’s absolutely unacceptable for me to retain ANY equity after I leave. He wants to pay me my share of the incorporation fee that I’ve paid and that’s it. He argues that once I leave the company I’m not entitled to any money he gets from the potential acquisition.
Do you think this is fair? I’ve tried to explain to Jim that what I want is a norm in the startup world and that the equity that I would retain is a compensation for the work that I’ve done to this point, but without any success.
If we don’t agree on my exit (taking my share of the incorporation fee) I think he will create a new company and operate the app like that - the thing is that he paid for the app development with his own money (not the corporate ones) so he argues that he owns the app.
I’d be really glad to hear your opinions & I will share them with Jim too
Thanks :)
My #1 rule for ventures, especially with friends, is to create an “ejection seat plan” at the beginning. The ejection seat is designed to save friendships and prevent teams from holding on to ideas too long.
Write down a list of milestones that must be achieved in 1, 2, 3, and then every 3 months up to 48 months. Agree that either partner can choose to eject without blame whenever the milestones aren’t met. Agree how much equity will be retained in the event of ejection. Follow the plan.
I credit five inspirations for the ejection seat plan. (1) Tim Ferris’ “dreamline” concept from 4HWW, (2) news stories about “golden parachutes”, (3) my friends who learned this with me the hard way because we didn’t do it, (4) the Stripe Atlas guide to founders equity, (5) my friend who helped me validate that it can work.
On the other hand, the emotional distress, distraction, and destruction of personal relationship(s) that can happen from arguing over this sort of thing is tremendous.
Your cofounder probably feels emotions surrounding you leaving. You probably do too.
That emotional context colors the conversation, and you both currently value everything you contributed so far in that context.
I would strongly urge you to consider prioritizing an amicable parting of ways over other considerations.
When you look back years later you probably will realize you were negotiating over such minor things, while risking the truly important stuff, like your personal energy.
Then understand that what both of you should have done is 4 years vesting with 12-month cliff.
With that come to an agreement that since you did two years, you should keep only half of your equity (20%), freeing up the remaining 20% so Jim can acquire better talent.
Long version (Excerpt from a post I wrote):
"These are the legal concepts you can use to protect founders from each other, the company from the founders and founders from a hostile board.
Let's run an Example assuming I'll be your co-founder and the company will grant me 48,000 shares for each of the legal concepts (The number 48,000 was chosen to simply math but does not reflect typical number of shares per founder):
1. Cliff
• If founder stays less than 12 months, no equity.
Example: In this case I receive 0 of my 48,000 shares.
• After 12 months 25% of stock is instantly vested.
Example: In this case I receive 12,000 shares of my 48,000 shares.
2.Vesting
• After the cliff, founder vests 1/36th of granted stock each month.
Example: In this case I receive 1,000 shares a month, on top of my previously earned 12,000 shares after the cliff for a total of 48,000 shares over a total of four years. If I leave in month 24 my total number of shares is 24,000.
3. Acceleration Triggers
• Single trigger: all stock is vested upon change of control or sale of the company.
Example: Let's say Google buys our company in my month 24 of vesting, in order to prevent google from firing me right after the acquisition in order to stop my remaining 24,000 shares from vesting, all my shares accelerate are granted immediately, thus accelerating the vesting
• Double trigger: some stock is vested upon termination without just cause.
Example: This provides a dis-incentive from investors, the board, or a co-founder from firing me if I am not done vesting, in order to free up equity to hire a lot more other people, if I am fired and it's not due to committing a crime like fraud then I will earn some stock, normally 12 months, without having to remain at the company for 12 months."
Even longer version: https://www.linkedin.com/pulse/startup-survival-guide-recrui...
You came together a couple years ago with a plan to make something and own it 60/40. Now you have something and you own 40% of that thing. I’m not sure how your continued employment matters at this point. It’s like saying someone needs to be employed at Apple to own Apple stock. They don’t.
Maybe I’m missing something.
You appear to own 40% of the company, which means you own 40% of the IP. Whether Jim paid for the development or not isn't super relevant, the relevant part is the contracts between Jim and freelancers. Who is assigned their IP? Who is listing as hiring them on the contract, the company or Jim?
Jim can try to play games by re-incorporating and moving the IP around, but you'd still be entitled to 40% of it. But you might have to sue to get it.
The good news is that you can just walk away now, and if it gets really big later, you can file your lawsuit if it might actually be worth something (see Facebook). In the meantime no need to stress about it.
Of course I'm not a lawyer etc etc, but from my experience this is how it would go down.
BTW if you wanted a fair deal, you'd get 20% of the stock now and forever. That's what you would have vested in with a standard four year vesting agreement.
This should be small enough that it won't effect him or the bottom line for the business, but provide value to you in the long term if the business does sell or raise significant money.
If you want to retain a working relationship with Jim, and keep some interest in this company moving forward, it sounds like the responsibility is on you, based on the way Jim countered.
Otherwise, it might just be that you walk away and take a hit, but you gain a valuable lesson for next time. Always have a written operating agreement to define how you will both act in situations like this. Codify the ins and outs from the beginning, get it on paper and take the emotion out of the process should you need to separate later.
If you own part of the company you don't just give that up without there being express wording in the charter (or whatever contract/paperwork you used to create the company). The problem you have is that right now, you own 40% of nothing so you're going to pay the lawyer you talk to (rather than have them work on contingency).
I should also note that this seems like a weird time to leave a startup ... did you really think you could cash out in just two years? Perhaps you haven't been "invested" in some time?
You could just walk away and keep the shares, but as you're a minority shareholder your stake will be diluted to approximately nothing fairly soon.
You're in a really bad position here. If Jim wants to be a %^&% about this then you're going to get screwed.
You may feel the value is yet to be realized, but then you should probably stick with the company. Jim's planning to do that, I assume because he thinks his future efforts in addition to what's already been done will make it valuable.
One other thing I'll throw out there. In general, maintaining a complex cap table for an early-stage company is very bad. Jim will have a devil of a time getting investment or funding when he has a 40% share holder who is no longer involved. The optics are bad and will spoil the deal. Given that, I'd consider being willing to part ways for future cash, perhaps cash payable upon closing the first $X in deals or something. Basically converting your equity to debt.
Leaving you 'empty handed', or only paying you the share of the incorporation fee also sounds unreasonable - you did invest time and effort and that largely remains unvalued in that case.
In the past I have dealt with similar situations by agreeing on the amount of hours and effort spend, and attach a market value to that. The leaving party then is paid that amount (either in whole, or stretched out over a period) and no equity is retained.
You have already offered a generous offer to the cofounder to reduce your equity stake over time and without knowing their side of the story, that seems like a great deal to take. You did put in two years of work, at a reduced, or $0 salary, and as a result there should be some equity that you retain.
You could simply just ignore everything and move on, and if the company sells get your 40%. You have already made an offer that he could have accepted, but chose not to for whatever reason.
So why stress more about it?
Agreements should be set in place beforehand as others have mentioned, specifically around vesting schedules and also control structures and so forth, but this is a good learning lesson for both of you.
So if you make a generous offer and instead of accepting it that person comes back and says you should have 0%, why are you continuing to put that person's needs first?
If your co-founder can’t understand this, then maybe it wasn’t meant to be in the first place.
Assuming no vesting / clawback agreement was in place:
Simple option: have Jim buy your shares at fair value, which may be very close to 0.00. If Jim is unwilling / unable to pay with cash, have the company write you a note for the shares. In both cases, Jim ends up with 100% equity, which is what you say he wants, while you are compensated for value created to date.
2) Your work has value, quite possibly more value than the capital put in by Jim.
3) If you own 40%, Jim has to buy your 40%. You position as a shareholder is not related to your position as an employee. Ownership doesn't disappear. I don't quite understand how/why you would reduce to 5% from 40% (without dilution events).
4) Don't sign anything until you talk to a lawyer.
I own 20% of the shares, it’s quite unfair but I really couldn’t care less. All i wanted is to make our startup work.
It might be irrelevant but I just thought I’d write it here
I'm not a lawyer, but if there's an invention assignment agreement in place the IP would be owned by the company, not Jim, despite his $ in, and thus it would be hard (not impossible) to dissolve and re-form.
Fail fast and move on to something new. Good luck.
If you walk away right now, you own 40% of the company. There are some business-world dirty tricks Jim can do to cut you out without paying, but they can take some time to pull off, and some are grounds for a civil lawsuit (in the US).
That 85:15 ratio in your favor should have accumulated some sweat equity. The initial cash infusion works out to 7.7% you, 92.3% Jim. In order for that to work out to 40% you, 60% Jim now, the company valuation with minimum-viable product should now be $22333.33, and the value of the work you added via labor should be $7933.33, and the value Jim added by labor should be $1400.
If that seems reasonable, so too should the 40/60 split.
The value produced by the programmer-contractors doesn't count toward equity. They converted cash into company assets as a consequence of the business structure you set up. The only reasonable ways for Jim to ethically increase ownership share after you leave is by putting in more sweat equity, or by infusing more cash directly. But legally, the ownership share was established with the expectation that Jim put in more cash, and you put in more work, and anything happening after would require renegotiating the agreement.
With respect to Jim contracting the developers directly, that would not matter in the US (with a decent lawyer). Clearly, he was doing that as an owner/officer of the company, so the work product belongs to the company. In business shorthand, he loaned the cash to the company he owns, and then immediately paid it out as majority owner to a contractor. The work product goes on the books as belonging to the company, along with a zero-interest debt to Jim. Or perhaps the initial capitalization was in the form of IOUs from Jim to the company, and in paying the contractors, he simultaneously redeems those IOUs. We can't say for certain without seeing the incorporation documents.
You are actually being too reasonable. Demand an independent valuation of the company. Take 40% of that as cash buyout. If the company valuation grows over time, take 40% of that, whenever Jim feels like buying you out. Jim is trying to lowball the current value of the company, in order to screw you out of the value you put in after the initial investment.
Remember that whatever deal Jim may propose to you, you could use the same valuation strategy to buy him out. If you could be bought out by paying your share of the incorporation fee, would it be fair if you paid him his share to buy him out?
Now, that is but a tiny legal detail -- I think the other comments on interpersonal relationships are much more important. He can screw you if he really wants to, and so can you.
I was a co-founder in a startup. It was split 50/50. I did all the development work and my partner did the business development work.
I had to drop out due to health reasons. I retained 1%, which I felt was fair. The main thing is they needed to bring in new people to replace me and needed equity to offer them. We did formalize it, and I have the legal documentation showing my shares in the company.
They have gotten investment so I'm sure my share is diluted quite a bit by now.
That was about 5 years ago that I left. At this point I'm ok if I don't get anything out of it.
Your offer is generous, but I can see why Jim would rather own the entire company. He would have to buy you out though, and I can see how just the cost of your incorporation fee is hardly enticing.
If he starts running the app by himself with a different company though, I think that’s a case for lawyers. A fairly clear cut one too.
I think you should absolutely be paid for your time and effort, preferably in equity. Given the structure of your corporation (and how the app was paid for), you may have few options.
Contact a lawyer.
Normally, (90%ile) investors get paid back and founders do not (founders own common stock). In this case, Jim owns 92.3% of the preferred stock. Additionally, he paid for a developer out of pocket, not with corporate funds.
Without insulting you, trust me, whatever your idea was it's not going to unicorn status. You are going to fall into the 90%ile. You must already know that -- you're leaving of your own accord.
I would suggest that you propose reducing your equity stake immediately to 3.85%, based on your preferred stock ownership minus 50% to reflect Jim's personal payment for iOS work. Hours spent != effort and effort != stake. If that were true, founders would make kagillions and investors would make pennies. Get over the idea that your efforts justify reward ... it's a lottery not a skills test.
Given Jim's so-far absolutist position, I would further explain how you can make his life hell by making him and the company look bad on social media, directly to investors, etc. (Pls ignore the fact whether you would or not -- you are negotiating here.)
3.85% is perfectly reasonable on both sides so this should be a good offer.
https://www.businessinsider.com/how-to-allocate-ownership-fa...
1. This is why 4 year vests are critical. For co-founders, IMO, 4 year really should be 6 year. So 40% should really be 10-20%.
2. Focus on good/bad cases. Frankly, the value of OP's contrib is high wrt current company, and low wrt the necessary work to be done and effort/risk compensation for the people to do it:
a. Failure -- who cares. This is the 95% case.
b. Small exit -- so let's say they get releaseable (tech), enough micro-pivots to solve early product/market fit (product), get early traction (marketing), some sales, some hiring & management, and given current state, more investment by co-founder. WOW that's a lot of time/$/work still to be done, say another 2 years and maybe now it's Jim and a few contractors or ever 5-20 people, to get to a small M&A. Those folks will be taking low pay, hard hours, & a ton of risk, and they can't all get 10%. If a $5-10M exit through that many other people and investors, how much is OP really responsible for, $1M? $500K? IMO most of the hard work is still to be done: initial app launch is pre-product-market fit and pre-traction. This is the 4% case.
c. Big exit -- First they need to do above product/market fit iterations, could be a couple years. Then they need to build the actual business. So they bring in investment and build an operational & growing business. Let's say 1-3 rounds @ 20% dilution each. Takes another 5-9 years over ^^^: figure out sales/marketing, turn that crank, hiring, a pivot mid-way through, etc.. And exit at 50-200 employees for say $100M. So much more work to be done. A lot of people's work to pay out on: if everyone got 1%, wouldn't be enough. Arguably your 2yrs is worth than a senior infrastructure engineer spending nights and weekends for 2yrs replacing your code so it could scale to 10M people, but is it worth 10X more? 100X more? Riding the labor of others to the tune of $1-2M is just 1-2%, so starting with 5% now is still great.
3. Future investors and acquirers may look at the cap table and see OP's dead weight on it. It's very solvable.
"5%? That'd be equity for 10-50 employees, who is this person? Let's agree to a smaller acquisition with small/zero payout, and invest in that new company."
Or "5%? As an acquirer, we want to pay the people we're trying to sign on to our team, not some dude on a beach who wrote some stupid app that isn't even what the company does today, let's shift proceeds to sign-on bonuses." So weirdly, in your favor not to be big dead weight. Even 10% is dead weight.
4. For remaining founder, so much heavy lift & investment & risk is still to go -- esp if a 5-9 year journey from here -- that 20-30% is demoralizing. Let's say they want to hire another CTO and give them say 20-40% (VESTING!!!). So your remaining cofounder has to do a huge years long lift for... 20%?