Partnership agreements · Founder equity

How do you deal with a Co-Founder who wants more equity Year 2?

Jeff Brink Aerial Drone Cinematographer at Freelance

June 26th, 2015

I own a C-corp (just converted from an LLC).  My business partner and I at the time decided to split 1/3 (me) - 2/3(me) based on the amount of money we put in.

A year and a half later, my partner found several key investors who also brought in a couple people to invest and now he wants more equity.

He wants to even us out claiming he brought in all of the investor money and he's worth more equity. How do I deal with this? What are my options? He's obviously not happy and wants more equity - what is the right move?  Is it common for founders to renegotiate their equity positions?

Manav Choksi Chief Operations Officer

June 26th, 2015

Jeff - as everyone has mentioned above, there are multiple facets to support a "fair" equity allocation. Bringing investors and funding to the table doesn't substantiate a basis for, what seems to be, a significant increase in equity share. If he leaves, will the investors leave? If so, then the investors are funding your co-founder and not the company/product. I imagine any sound investor would invest in a company due to many factors including, but not limited to, product, market size, confidence in executive team to execute, and traction.

If your co-founder is successfully growing the company from a business development role (assumed from your most recent response), then his equity should be aligned accordingly. A good approach do this would be to get a performance based share plan in place. Set vesting targets such as quarterly sales growth, marketing milestones, maintaining or growing margin, or a combination of the above. Remember, you can get creative with this by incorporating a time vesting requirement in conjunction with performance targets, which can also be based on a sliding scale (e.g. 50% growth in sales, then % of shares; 100% or greater growth in sales, then % of shares). It really boils down to understanding why your co-founder believes he deserves % ownership and then creating an equity plan which aligns with those expectations.

Steve Everhard All Things Startup

June 26th, 2015

Jeff, you are cofounders, but you are acting a little like this is your company and he is holding you to ransome for more equity. Trust between you is beginning to break down and you both need to fix that or your business will split between development and delivery and sales and marketing. You can redefine your business articles anytime you want but valuing each other for what you each bring is a little more important..

If you need future funding you are both going to be diluted. Right now there is no issue as you are really talking a share of future value and not an asset that you can bank today. If you never have a liquidity event (buyout, flotation) then your relative shareholding is moot, so we are really talking about a sense of equality and there might be earn out opportunities as someone else mentioned. Why would you worry about dilution in any case if your cofounder is adding value to the business? Having said that, do make sure that whatever you do doesnt't create a controlling interest faction between your cofounder and any equity (convertible or otherwise). This could be your bargaining chip for closing the gap between shareholding to less than 50:50. Whatever you decide you need to find value in each other and recover trust.

Michael Barnathan

June 26th, 2015

If he brought in the investment, you will probably want to reward that (and if you don't, it might break apart the team because now he feels like he's not getting adequately compensated for his work). Take a realistic assessment of the value each of you have contributed and can be expected to contribute in the near future, and choose whether to accept his offer or counter somewhere in the middle. If he's done more than expected, you probably shouldn't just reject his request outright.

Chris Carruth VP/Director. Strategy | Business Development | Operations | Product | Solutions

June 26th, 2015

I think this comes down to, as others pointed out, doing what's right. However, right is impacted by many things..are you both working full time? are you both on payroll yet or is one providing sweat equity and the other providing funds? is either of you contributing IP to the company under an assignment agreement or is it being licensed back to the company? are there bonuses structured that include equity rights? are there non-dilution clauses for either one of you?

I am sure there are others..ask yourself "what is the right thing to do"? Much of corporate America's CEOs who wound up in prison would not be there if they just took a moment and...

Anonymous

June 26th, 2015

just make sure you don't split 50-50: if you guys get into a fight and somebody has to leave with the other keeping the company afloat, make clear who is going to be in and who out.

Ming Tsui

June 27th, 2015

sharing is a good thing. be not too greedy. one cannot take money to their grave.

Reuven Granot Corporate Strategic and Scientific Officer at Perlis Ltd

June 27th, 2015

Jeff,  Steve's comment is very important and useful. If you are not working in harmony, you both loose this company. I understand that you both contribute and do vital activities to your start-up. I was and still am in a similar situation. 
When you signed your business agreement did you both invested cash? Was it the same amount or relative to your shares? Cash is considered more important than work and time spent.

Slicing Pie, Funding Your Business Without Funds by Michael D. Moyer is a good source to learn from. You can also get Mike's advice through his blog, or by his book at Amazon.
I am sure that there is no rule to follow. However if you do not convince your partner to happily continue spending his full time in your business, you will loose him.

I followed Mike's advice when my co-founder could no more be involved full time and left for an job with immediate income. he is still with us, but we agreed he forwarded me part of his shares. After his leave no more co-founders were willing to invest, and I accepted them with full co-founder rights, but they get equity based on success. So we are now 6 people working part time, while I am the only one investing cash and contribute full time (24/7). We have a new founders agreement and Company Regulations. We decide each in his formal position and we vote at Shareholders meetings according to our shares.

Decisions are done by founders related to their position (CEO, CFO, CTO,  and COO) and main decisions like dilution or investments are decided by Shareholders Meetings. Less critical decisions by our Board of Directors.

Yes, I must agree that except the technical part (I am a physicist and computer expert) most of my energy goes to organization, layers, advises and presenting the company to prospective investors. 

Convincing investors to spend serious amount of cash is crucial and your company probably cannot survive to GoToMarket stage without them.

Reuven Granot Corporate Strategic and Scientific Officer at Perlis Ltd

June 27th, 2015

If you did not signed a non dilution agreement with your co-founder than you should dilute.
It should not come only from your 2/3, since if yes, you loose this company and are just thrown out!

Raul Martin

June 27th, 2015

One aspect I feel few people have mentioned is the fact that each of you is supposed to have different roles within the organization.

Let's say you are the tech co-founder, you are in charge of handling product and the engineering team... and you have 1/3 of equity (as an example).  Suppose you have a co-founder that was in charge of marketing, sales and the business side (usually includes fundraising as well), and this person has the other 2/3 of equity.

In this event if you (the tech co-founder) managed to find an investor, I'd say its definitely something beyond where your core responsabilities lie. This could therefore, include some sort of compensation or change on the way the your agreements were made.

On your actual case, the business co-founder did something great, and probably deserves some sort of compensation too. Just bear in mind that doing that, is exactly what part of his responsabilities entail.
Fundraising is obviously a process where both of you would participate, but maybe keep this thought process I tried to explain in mind as you negociate.

Brian McConnell

June 26th, 2015

If he brought in substantial investment, he's probably justified in asking for more equity. Time worked is one factor, but so are results, and one the hardest things about startups is raising money in the early days. My $0.02