Issuing equity helps you protect it
This write-up was originally sent to subscribers as a part of our Mission Control weekly insights, a series where we share wisdom and quick breakdowns on topics from our entrepreneur support network.
Many founders fail to document or even discuss specific arrangements with potential co-founders and early team members. Typically, they’re waiting for things to become “more concrete” before they make anything official. Often founders think that by failing to make things official they’re protecting the venture if things don’t go to plan. But, paradoxically, failing to document the specifics in the early days puts you and your startup at a significant disadvantage if things go differently than originally expected. And, as you probably know, when you’re going from 0 to 1 things often go differently than you planned.
What’s the Big Deal? ->
When founders fail to discuss and document key aspects of early contributor relationships, answers to key questions about the company are left open to interpretation. Most importantly, when founders fail to document who owns the company, there is no clarity on who controls the destiny of the venture, who stands to benefit from it financially, and what happens when someone stops contributing. Detailing relationships, ownership, and vesting gives a startup a clear process for managing relationships as they evolve and protecting ownership when things don’t work out as expected.
The Details
Fictional co-founders Sarah and Sam decide to pursue something big together, they’re psyched to work together and they get cracking. Six months in, things aren’t going to plan: Sarah wants to keep pursuing the venture but Sam has seemed checked out over the past few weeks. What happens next?
The Best Case Scenario
Sarah and Sam talked in detail about roles, responsibilities, and contributions as soon as they realized they were going to get serious about building something together. Based on those conversations they decided who would be in the driver’s seat as CEO and what the equity breakdown would look like. They incorporated and issued equity with a standard 4-year vesting cycle and 1-year cliff. Both signed intellectual property assignment agreements in order to receive their shares to ensure their contributions belonged to the company.
Sarah initiates a conversation with Sam as soon as she notices a change, relying on the initial expectations they discussed and confident in the company’s ownership of intellectual property and the vesting provisions protecting the company’s equity. They mutually agree the company will move forward without Sam. Moving forward, things are clean: the company leverages vesting to automatically repurchase Sam’s unvested shares and maintains ownership of Sam’s valuable early contributions. Ownership is in the hands of the person actively contributing to the growth of the company and there’s relatively little risk of future disputes that could give investors pause. Tough? Yes. Company killing? Probably not.
Gust's Mission Control can guide early founders through all sorts of complex startup hurdles, like issuing equity.
The Common Scenario
Sarah and Sam immediately got to work, neglecting any detailed conversation about expectations. They discussed ownership verbally and via email, but never make anything official. Sarah immediately notices the change in Sam’s contribution but, without shared expectations and documentation, she’s not confident enough to start the conversation. She figures she can single-handedly accomplish the company’s goals even if Sam isn’t contributing.
Sarah avoids the conversation and spends the next 3 months closing the company’s first 2 customers and building a pipeline of 10 more. She’s resentful that Sam’s contribution has continued to slip but she’s excited about the possibility of raising a pre-seed round. Before she can do that she figures she has to have the conversation with Sam. Now, however, waiting this long comes makes that conversation thorny. The company doesn’t own Sam’s intellectual property but Sam’s early contribution is an important asset. Sam’s ownership isn’t clear but there’s a claim to something based on early conversations. Instead of working through the details when they were both aligned on prioritizing the company, they have to negotiate through contention and Sam has the leverage. The company can’t move forward until the situation is resolved. Company killing? More likely.
How Gust Can Help
During a recent Mission Control office hours we helped a founder navigate a difficult situation with an early contributor. We explored potential paths to resolving the issue and reduce the risk of a future claim against the company and also discussed ways to avoid the core issue when managing future relationships.
We followed that with a workshop to help founders examine arrangements for bringing on a new team member that might eventually evolve into a cofounder. We discussed different ways to document the relationship and to allow for it to escalate if things went well and resolve safely (for the company) if it didn’t.
Don’t put your mission at risk by skipping critical steps in early team building and equity management. Mission Control can help you navigate with expert guidance and discounts on tools to help you document your early relationships and equity grants. $99 / month, cancel any time
Gust's Mission Control can guide early founders through all sorts of complex startup hurdles, like issuing equity.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.