I've been reading and hearing from attorneys in Silicon Valley recently who remark about the often difficult legal disputes that arise between startup founders and partners, both in their initial formation stages, and later down the line as the business gets its first experience in that often brutal world we call the marketplace. It's not just the twisted, humorous kinds of stuff you see if you're a fan of the show Silicon Valley. This happens in real life too.
Those awkward moments: commitment issues don't just happen in romance
Oftentimes when startup founders sit across a table to hash out equity splits and trust and commitment issues, tempers flare. Or uncomfortable silences go on.
In this awkward and discomfiting process of forming new ventures, there’s no question that many founders would rather bypass all the messy stuff. Many will form their companies, assure one another they’re all in this together and, as a gesture of good will, divide their equity equally. While startup equity division that's based on an even split among all the partners might appear to be the fairest arrangement, it usually ends up with disastrous consequences and can set the startup on a course for failure.
Why startup equity division gets scrutinized by investors
Investors don’t like even divisions that can often lead to deadlock when tough decisions need to be made. In addition, even equity division may not reflect the contributions and commitments needed to ramp up the business before funding runs out.
Investors will scrutinize the equity split to determine the founders’ varying levels of contributions and commitment. They want to make sure the management team especially is appropriately incentivized to continue doing the heavy lifting, even if the business is based on great ideas, discoveries or technology developed by a non-managing equity partner. On the flip side of this equation, they want to see that people who aren’t engaged in the startup’s success can’t exert a disproportionate influence.
Think very hard - and get some good counsel - before deciding on your startup equity division.
Some of the best lawyers in Silicon Valley recommend that startup founders institute a one-year vesting cliff. For example, each founder would receive 25 percent of their stock after they’ve completed their first year of service with the company. The balance then would vest equally over the next three years they remain with the operation. This is a great way to both incentivize and reward those who hang in through the tough early years. A good attorney specializing in VC, PE and startups can advise you on best ways to divide your equity.
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