This is our first article in our ‘How To’ series.
Just about every emerging business/start-up lawyer could write a book (and many have!) on the topics of equity division, incorporation and the innumerable ‘other details’ founders need to keep in mind when starting a business! We think you can only properly address these issues with any specificity in a face-to-face or phone-to-phone conversation and, with that in mind, this writing focuses instead on some high level concepts and discussion points to cover with fellow founders in advance of your first sit-down with corporate legal counsel — a meeting we strongly recommend (and which, dare I say, many firms (big and small) will offer at no charge)!
1. Dividing Equity: There is no easy answer…and you won’t get one here
Sooner or later, it will come time to divide equity; and for many reasons it probably should be sooner. If not for tax reasons, then to put the topic behind the founders, to eliminate the proverbial elephant in the room and to allow the R&D, launch, coding, marketing, selling — the actual business work of the start-up — to continue in earnest without distraction from who owns the fruits of the tireless work that lies ahead for the team. So, how does one divide equity?
As we noted above, books have been written (as well as blog posted and tales told!) on the trials and tribulations of founders dividing the equity of a start-up. Take as much of those written words in to educate yourselves, but then take a breath — none of those companies are yours, and none of those founders are you. Take stock of your business, your motivations, your goals and then sit down with your co-founders. This is not a topic for emails, texting or anything other than sitting face-to-face and figuring out what will work for all the founders.
a) Ask your lawyers for input…but make the decision yourselves
Experienced lawyers, who regularly help with start-up formation, will have ideas and experiences to share. Seek their guidance. They have seen what has worked, and perhaps more importantly, what has not, for other clients. Your lawyers will have tools that will help you talk about key issues with your co-founders. Perhaps different vesting will help you bridge disconnects around those pitching in full-time vs. part-time? Could seed preferred stock or convertible notes address situations where one-founder is providing a disproportionate share of the initial cash that is allowing the company to bootstrap? Might different voting or contractual agreements bridge a divide where control is a concern? However, do not expect your lawyers to provide answers to questions like: “Should we split equity 40% — 40% — 20% instead of 1/3 each?” and “Should our shares be subject to 3-year or 4-year vesting terms?” because at the end of the day, it is you the founders that need to fully own the decision and accept these terms.
Take the ideas, put your cell phones away, and have a candid conversation with your co-founders. It is okay to not immediately agree — take the time you each need — but agree that once there is accord, nobody looks back and second guesses what should be a unanimous decision.
b) Keep it simple
One bit of advice in decisions regarding equity splits: keep it simple. In our experience, the more engineering done in dividing equity, the more opportunities there are for disputes and frustrated outcomes.
It is hard to predict the future — who will play what role in the enterprise as it grows, who will add value at what stage, etc. Start-ups succeed when everyone is aligned — especially the founders. An ongoing focus on complicated vesting or equity award mechanisms will only distract you from the important work of delighting customers, clients, and disrupting the industry in which you play.
2. Getting Incorporated (and some) Other Details When Beginning Your Business
Now that you founders have agreed on the equity split (no take backs!), it is time to get your company formed. Good news: this step primarily involves papering the decisions you’ve already made in discussions with your lawyers in the initial in-person or telephonic meetings…assuming such meetings actually took place!
a) Be Wary of Online Forms…
We are often asked why a team shouldn’t simply complete forms available for download and incorporate their companies online. The answer is simple — there is no strategic input from seasoned practitioners involved! It is true, you can form your company online after checking a few boxes to make elections that will guide which stock paragraphs are used to populate your formation documents, but again, this robs your company of the tailored guidance you can only get from someone that spends their working days thinking through issues you may not be considering, but should be, in connection with the formation of your own enterprise.
Legal forms serve as a starting point, but every company is different. If you were not somehow different, it is unlikely that you would be forming a company in the first place!
b) …and Everything Else?
Yes, this is self-serving, but it is also true so here comes underlined tip number two: Use a good lawyer you trust to form your company. Most importantly, this will result in up front discussions that will force you to give some thought to the direction your company is headed (from inception to exit and the funding rounds along the way) and raise other issues that may be applicable, such as IP ownership and patent portfolio strategy, inbound and outbound licenses, employee benefit matters — the list goes on and on. Many attorneys, like us, that practice in this space share a goal: to be among the first you contact when something of import happens to the company — good or bad. We take the time to learn about your company’s goals and to share experiences we have to help you achieve them. That being said, you need to find the right attorney for you. Ask questions about alternative fee arrangements, relevant areas of experience of the firm, as well as anything else that comes to your mind.
At the end of the day, it is all about trust at this stage: trusting your co-founders, trusting your legal counsel, and most importantly, trusting your intuition!