Dilution

Founders legal agreement � acceleration and anti-dilution

Shlomi Dinoor Entrepreneur

January 23rd, 2013

I�ve been reading about the set of legal documents during the formation of
a startup, specifically the founders agreement and wanted to get the team�s
opinion about a couple of topics.
I�m interested to hear your opinion (good/bad), how important it is, how
common it is and whether there are better alternatives.

The topics are:
1. Acceleration of shares in case of involuntary termination � in several
places founders have added a clause stating that in case of involuntary
termination their vesting will be accelerated by a certain period of time
(e.g. 6-12 months). This applied only for the founding team.
2. Anti-dilution clause � protect founders that leave (or let go) the
company from the board immediately issuing and allocating additional 10M
shares (by doing so they significantly dilute the former founder�s share).

Thanks!
Shlomi

Seth Kaplan Healthcare Technology Executive, Product Manager, Enterprise Architect, IT Strategist and Intrepreneur

January 28th, 2013

If you\'re joining a company you can ask for a "look-back" too. It\'s
protects you in the event your shares become diluted just before a big sale
or big investment, for example. Tell your lawyer you want a 12-18 month
look-back. That means that if the company sells for more than your stock is
worth at the time you acquired it, you get the difference. It prevents
asshole partners/investors from using their majority to dilute you just so
they can sell of your shares. The point of 12-18 months is because most
investors tend to lose interest after a couple of months if they can\'t get
what they want - rarely will an investor hang out for over a year for your
20%. Cold feet is more likely. So you\'re protected.

--
Seth Kaplan | shttp://www.linkedin.com/in/sethkaplan>[image:
Twitter]<http://twitter.com/superflytnt>[image:
Facebook] <http://www.facebook.com/kickme>

Ryan Jackson Founder at Paid

January 24th, 2013

My two cents:

This is actually a very important subject. I\'ll admit I don\'t have a ton
of experience here, but I have myself had to exercise these terms and help
those who had founder problems.

That said, as people often say, one of the largest reasons startups fail is
founder issues. In this sense, it is during founder formation that you
should focus on the *company first*, rather than the standard founder-first
mentality.

My recommendation, a standard 4 year vesting schedule with a 1 year cliff,
no anti-dilution clause. Here\'s my reasoning:

1. A founder leaving in the first year is usually more detrimental than
they have been help. Rewarding them for that seems foolish.

2. Depending on the amount of acceleration, you can be setting your company
back with investors because you have given away a significant part of your
company to someone who no longer contributes.

3. If you set your company up to buy back shares (at whatever point), this
price may seem silly up front, but choosing the wrong number (which is
easy) can leave you owing more money than your company has in the bank.

4. Standard dilution is a sign of growth. Growth is good.

5. If you are worried that your cofounders will dilute the shit out of you
when you leave, my thoughts for you are:

- Why are you planning to leave?

- You should probably not start a company with anyone you don\'t fully trust.

Contracts and terms are only as good as those who keep them. I\'m not a big
fan of working with people who are optimizing for their departure. I
understand that people make sacrifices to start a company, and sometimes it
doesn\'t work out. But tough luck. That\'s the startup risk, one that you
willingly sign up for.

Equity is not the same as cash and shouldn\'t be treated as such. Equity
represents a long-term investment that drives long-term value for a
company. Think about it. Every (standard) party who receives equity, even
when it\'s all up front as is the case of investors, is expected to
contribute over a LONG period of time (aka the entire life of the company
pre-IPO/M&A). Treat equity with founders the same. It is meant to be a
long-term incentive to adding/driving value to your startup. So why a
cliff? Mostly for the reasons above. But frankly, it\'s all about
expectations up front. You want to incentivize everyone (not just
founders, but employees, investors, partners, advisors, etc.) to contribute
at least a minimum to your company.

And if you are that person considering leaving a founding team, as all my
investors have told me and my peers: "Just leave." If structured correctly
up front, no single founder is entitled to money or IP, as it belongs fully
to the company.

Best,
->Ryan

How do you chat? http://optionize.com/nul1a

Tony Rajakumar Founder/CEO at SnugBoo

January 28th, 2013

Protective provisions are very important - something first-time founders
often don\'t fully grasp the importance of. I would get a lawyer who deals
with exec employment agreements and they can frame something suitable. If
the company fades away, these provisions don\'t matter. But if it takes off
and the company becomes valuable, you\'ll be surprised at who pulls out the
knives and how fast they do so. It\'s human nature at its worst, but having
these provisions will save you much angst and legal fees.

However, it\'s a balance as well. What if the other founder isn\'t working
out? That\'s why 1 is usually a fair compromise between the two poles. 2 on
the other hand seems to be overly protective, and can lead to negative
effects.

Also, keep in mind that professional investors will as part of an
investment push to unwind these provisions, because they would like maximum
flexibility to replace people. So if you\'re planning for VC investment,
make sure you have enough leverage (and multiple term sheets) so that you
can push back with vigor.

--Tony

On Wed, Jan 23, 2013 at 3:10 PM, shlomi.dinoor <shlomi.din...@gmail.com>wrote:

Max Avroutski

January 29th, 2013

Upfront vesting is only a good idea if there was significant "achievement" in bringing you to paying customers or MVP (minimal viable product) (I use "achievement" instead of "effort made", because if you wasted a lot of time and money on something that didn\'t bring you substantially closer to paying customers or MVP then it\'s a waste and in ventures only result counts, not participation)

In general vesting period should be the length of time it will take venture to be cash flow positive while paying everyone involved market rate plus 12-18 month for possible M&A with accelerated vesting clauses on achievement of milestones. Complicared -Yes, bat fair.

So if you spent 18 month and $20,000 and had 50% progress toward MVP by now i.e your entire business is not proven - I would not assign any vesting upfront. Because you all may end up being replaced or leave by the time company gets into cash positive area.

Max

--- On Tue, 1/29/13, Vinod Valloppillil <vihttp://www.quora.com/How-common-is-it-for-founders-to-vest-a-portion-...
)

Any of you guys have experience with this?

On 1/29/2013 5:55 AM, Barnabe Geis wrote:
Me too. For those interested, I\'ve attached a Grunt
Fund calculator, letter of job offer, and cheat cheat on one way
to calculate it. You definitely need a good timekeeping/project
management tool like Zoho. You need a grunt leader who essentially
holds all the equity until you divide the pie. It\'s probably the
fairest way to distribute equity, and prevent early mistakes and
spending sums of money on legal before company has any value, that
said it\'s not without risk.

BG

On Tue, Jan 29, 2013 at 5:44 AM, Richard
Shank <deve...@zestic.com>
wrote:

Max, I would love to see the quiz.

On Mon, Jan 28, 2013 at 6:41
PM, alphaone2k <alphaon...@yahoo.com>
wrote:

Dynamic
equity allocation that mentioned in Slicing Pie
book, is not optimal for some ventures and requires
a lot of management of timekeeping and specific
legal agreements that book doesn\'t provide, but at
least it is shining a light on this advanced way of
equity allocation. I also think that what described
in the book also have some economics errors.

Dilution is not bad, unproportional dilution is. So,
anti-dilution should be set as proportional dilution
between all equity holders - non alterable in future
agreement changes (without it once you are in
minority they can completely change agreement on
you) and persist in M&A. Fired for listed causes
(no more vesting), fired without a cause a full
vesting. Left - no more vesting.

You should start with maximum pro founder
agreement and if any VC would offer to change the
agreement then you have a decision to make whether
to alter the agreement or find another VC. VC that
not smart enouth to ask you to change founder\'s
agreement if they need it is probably not a best
VC to go with, so having strong pro founder
agreement shouldn\'t be an issue.

Should I put up a site that does a quiz, explains
every provision of a founder\'s agreement and creates
that proper founder\'s agreement? Would that be
useful?

Max

On Monday, January 28, 2013 8:41:32 PM UTC-5,
barnabeg wrote:

Hey, depending on at what phase you
are in and before spending money on legal
agreements, I would encourage you to download
and read the book Slicing Pie and consider
using a dynamic equity split, or "grunt fund".
Sent from phone

On Jan 28, 2013 6:01 PM, "Tony Rajakumar"
<to...@snugboo.com>
wrote:

Protective provisions are very
important - something first-time
founders often don\'t fully grasp the
importance of. I would get a lawyer who
deals with exec employment agreements
and they can frame something suitable.
If the company fades away, these
provisions don\'t matter. But if it takes
off and the company becomes valuable,
you\'ll be surprised at who pulls out the
knives and how fast they do so. It\'s
human nature at its worst, but having
these provisions will save you much
angst and legal fees.

However, it\'s a balance as well. What
if the other founder isn\'t working out?
That\'s why 1 is usually a fair
compromise between the two poles. 2 on
the other hand seems to be overly
protective, and can lead to negative
effects.

Also, keep in mind that professional
investors will as part of an investment
push to unwind these provisions, because
they would like maximum flexibility to
replace people. So if you\'re planning
for VC investment, make sure you have
enough leverage (and multiple term
sheets) so that you can push back with
vigor.

--Tony

On Wed, Jan 23, 2013 at 3:10 PM,
shlomi.dinoor <shlomi...@gmail.com>
wrote:

I�ve been reading about the set of
legal documents during the formation
of a startup, specifically the
founders agreement and wanted to get
the team�s opinion about a couple of
topics.�

I�m interested to hear your opinion
(good/bad), how important it is, how
common it is and whether there are
better alternatives.�

The topics are:�

1. Acceleration of shares in case of
involuntary termination � in several
places founders have added a clause
stating that in case of involuntary
termination their vesting will be
accelerated by a certain period of
time (e.g. 6-12 months). This applied
only for the founding team.�

2. Anti-dilution clause � protect
founders that leave (or let go) the
...

Anonymous

January 29th, 2013

Me too. For those interested, I\'ve attached a Grunt Fund calculator, letter
of job offer, and cheat cheat on one way to calculate it. You definitely
need a good timekeeping/project management tool like Zoho. You need a grunt
leader who essentially holds all the equity until you divide the pie. It\'s
probably the fairest way to distribute equity, and prevent early mistakes
and spending sums of money on legal before company has any value, that said
it\'s not without risk.

BG

Vinod Valloppillil Cofounder / CEO at Clementine

January 29th, 2013

Great discussion and I\'ve got a question on a similar note - we\'re
currently incorporating and our lawyer was asking us about "Upfront
vesting" for the founders.

The concept was new to me but, from googling around, its basically the
idea that the founding team gets some % of their shares (25% or less)
immediately on day1 with the rest vesting as usual starting on some
cliff. (for ex.,
http://www.quora.com/How-common-is-it-for-founders-to-vest-a-portion-...
)

Any of you guys have experience with this?

On 1/29/2013 5:55 AM, Barnabe Geis wrote:

Shlomi Dinoor Entrepreneur

January 25th, 2013

Thanks guys for your insights, certainly good points to take into
consideration during the formation.

On Thu, Jan 24, 2013 at 5:23 PM, Ryan Jackson <ryanwjack...@gmail.com>wrote:

Max Avroutski

January 25th, 2013

Ryan,
you are way off on many things here.

1)
"I\'m not a big fan of working with people who are optimizing for their departure." - as long as those people do more than just "optimizing for their departure" but actually contribute then it\'s a pity that you don\'t understand them. Unless it\'s a small or family owned or lifestyle or non-profit venture then every founder should be optimizing for exit because sooner or later he/she will exit or will be pushed off. Only few very talented founders can grow themselves with the company\'s needs for them and still be fulfilled working there after some years. So don\'t count on working there if it\'s not one of the few mentioned above; count on exit or you will be carried out when it becomes mature company or bankrupt.

2)
"...people make sacrifices to start a company, and sometimes it doesn\'t work out.� But tough luck.� That\'s the startup risk, one that you willingly sign up for." - In most cases "willingly sign up for" means you were stupid enough to signup for bad deal and if you were smarter you would have negotiated a better deal or found another deal.

�I was also stupid to signup for some things in the past and then I learned on my mistakes and now I don\'t make the same mistakes. [I make other stupid mistakes. :) Just not as often.] Just because there is a risk involved doesn\'t mean that you have to risk everything all the time, besides smart people work on minimizing their risk of starting a company like thinking about what can go wrong and how it could be mitigated.

3)
"Every (standard) party who receives equity, even when it\'s all up front as is the case of investors, is expected to contribute over a LONG period of time (aka the entire life of the company pre-IPO/M&A). " - investors that buy equity are NOT obligated by contract NOR expected by social norms to buy more equity or continue to contribute in other ways, unless it\'s some very weird or rare arrangement.

Anyway, don\'t want to continue picking on where else you are wrong here. I will just set a record straight.

1)
"Risk" in a new venture is in venture succeeding and should not be in loosing all or large part of your cash or "sweat equity" investment in the venture while others absorb the value you loose.
Therefor, leaving your prosperity to goodness of people is just stupid.
At a sale of the company, would you dilute out your bastest best friend so that you could get more equity that you absolutely need, if you legally could, in order to pay for ransomed or cancer treatment for your mom or dad that would save them? If you wouldn\'t do it, do you think that your friend wouldn\'t ?
That is why you should always get it in the contract.

Anyway,
2) A lot of founder agreements are bad because they copied over from completely different venture by lawyers that don\'t know much about the venture or economics. Founder\'s agreement will change depend on many specifics of a business and particular founder\'s negotiating ability.

It\'s 2:30am, I am too tired to explain why but here it is, if you ask, then I will explain.

The generic that should be a starting point is: 2-8 years (depending on venture) vesting on monthly or quarterly bases after one month cliff aka "free month". Anti-dilution set as proportional dilution between all equity holders - non alterable in future agreement changes and persist in M&A. Fired for listed causes (no more vesting), fired without a cause a full vesting. Left - no more vesting.

That way if some one have to quit 10 month after investing their work into a venture they don\'t loose everything, but don\'t own too much that any VC will complain.

So, in a team of 4 initial founders with equal equity and no monetary compensation if one quits after 10 month of 4 years vesting with one month cliff and 20% set aside for employes and advisory, he only got ~ 3.75% at that time, with 3 round of funding in the next 3+ years his share may be ~ 1.78% or less. Should a family of a guy that invested 10 month of his life into your venture and was killed by a drunk driver and left 5 kids get nothing? (forget for a moment whether or not he had insurance)

You should start with maximum pro founder agreement and if any VC would offer to change the agreement then you have a decision to make whether to alter the agreement or find another VC. VC that not smart enouth to ask you to change founder\'s agreement if they need it is probably not a best VC to go with, so having strong pro founder agreement shouldn\'t be an issue.

Now it\'s 3am. Maybe I put an app that does a quiz and creates proper founder agreement.

Max

--- On Thu, 1/24/13, Ryan Jackson <ryanwjackhttp://optionize.com/nul1a

On Thu, Jan 24, 2013 at 1:12 PM, Cedric Dussud <cdus...@hotmail.com> wrote:

Max Avroutski

January 29th, 2013

Few corrections,
There is no point compensating for sweat as it is not worth anything unless it yields a result.

As for IP, it shouldn\'t be compensated by equity ether, you get royalties if IP was pre company formation or you get nothing as it is a work product you working for the company and your already getting equity for your work.

--- On Tue, 1/29/13, Tony Rajakumar <to...@snugboo.com> wrote:

From: Tony Rajakumar <to...@snugboo.com>
Subject: Re: [FD Members] Founders legal agreement � acceleration and anti-dilution
To: "Vinod Valloppillil" <vi...@vinod.com>
Cc: "Barnabe Geis" <barna...@gmail.com>, "Richard Shank" <deve...@zestic.com>, "alphaone2k" <alphaon...@yahoo.com>, founderdating@googlegroups.com, "shlomi.dinoor" <shlomi.din...@gmail.com>
Date: Tuesday, January 29, 2013, 12:50 PM

The principle here is that it compensates for the sweat and/or IP that the founders have already put in before drawing up the legal docs. The cliff doesn\'t make sense in this context - the cliff is so that you get to see the person\'s performance before you commit equity. If you\'ve already spent significant time with each other, and you\'re making it more formal, then you\'ve already seen their performance and like it. So why have a cliff at that point?

As long as the majority of the stock is on a vesting clock, there won\'t be any issues raising money etc. If too much is already vested, professional investors very likely will make you restart the vesting clock on some portion of your already vested stock. Yes, really.

On Tue, Jan 29, 2013 at 8:31 AM, Vinod Valloppillil <vi...@vinod.com> wrote:

Max Avroutski

January 28th, 2013

Dynamic equity allocation that mentioned in Slicing Pie book, is not
optimal for some ventures and requires a lot of management of timekeeping
and specific legal agreements that book doesn\'t provide, but at least it is
shining a light on this advanced way of equity allocation. I also think
that what described in the book also have some economics errors.

Dilution is not bad, unproportional dilution is. So, anti-dilution should
be set as proportional dilution between all equity holders - non alterable
in future agreement changes (without it once you are in minority they can
completely change agreement on you) and persist in M&A. Fired for listed
causes (no more vesting), fired without a cause a full vesting. Left - no
more vesting.

You should start with maximum pro founder agreement and if any VC would
offer to change the agreement then you have a decision to make whether to
alter the agreement or find another VC. VC that not smart enouth to ask you
to change founder\'s agreement if they need it is probably not a best VC to
go with, so having strong pro founder agreement shouldn\'t be an issue.

Should I put up a site that does a quiz, explains every provision of a
founder\'s agreement and creates that proper founder\'s agreement? Would that
be useful?

Max