How to divide up my new company?

May 26, 2011 12:11 PM

I'm founding a startup! Yaaay! I have some friends who like my idea and want to help me. However, I have no money to pay them, so I'm guessing that I'll need to give them a piece of the action. I don't want to get screwed, but at the same time, I don't want to be perceived as a jerk. What is the most fair way to divide up the pie? What's the best way to approach this discussion without coming off as a jerk?

So, the idea is mine, I came up with it myself. I'm a developer, so I'll be writing a lot of the code. I have at least one friend who's really excited and willing to commit a fair amount of time to the project. I have a couple other friends -- a developer and a designer -- who are interested as well. I'm imagining I'll have to give everyone some kind of stake in the company, otherwise they really have no reason to work on it. I've never done this before, and don't even have any idea how to approach the situation.

The pitfalls are obvious. On the one hand, I could give someone a cut, and then they don't contribute, but they still own a piece of the company. I could give them too big of a cut, and wind up screwing myself. If I don't get anything on paper, someone could steal my idea or my code. Or they could come out of the woodwork somewhere down the line and claim that they're owed something, and I could find myself in a protracted legal battle, a la Facebook. And if I completely fumble this conversation, I could wind up alienating my friends.

How much of a cut do I give to my friends? At what point is it necessary to get things on paper? How do I even approach this (kinda awkward) conversation?

I'm meeting with the other (committed) developer tonight, and we're supposed to start planning the project. It will be our first real planning session, and I'm imagining we should talk about this stuff.

I appreciate any ideas, resources, and reading material you have to offer. As I mentioned, I have never done anything remotely like this before and have no idea how to even approach the situation.

posted by Sloop John B to Work & Money (23 answers total)

The founder's pie could help you quite a bit. Link

This guy has a similar/same thing, but with a Google Doc.
posted by SantosLHalper at 12:21 PM on May 26, 2011

I really, really suggest you get a lawyer. This is definitely something you want to structure and paper right from the start. Look for a lawyer with a background in startups in your business sector, and an understanding of how to protect intellectual property.
posted by bearwife at 12:22 PM on May 26, 2011

You don't need to lawyer up right away. Just get something down on paper. A friend and I are working on a startup right now. We decided that even though he's been working on it for a year longer in his spare time, we'd still split it 50-50.

The short answer is that you split equity between founders only (those who would quit their jobs and work full-time). Decide who will be your co-founders carefully.

Here are the resources I've been using, the first link the most useful:
http://answers.onstartups.com/questions/6949/forming-a-new-software-startup-how-do-i-allocate-ownership-fairly/23326#23326
http://www.paulgraham.com/equity.html
posted by just.good.enough at 12:34 PM on May 26, 2011

RE : Lawyer Up!

Good advice, and I'll probably take it. However, it doesn't really answer my questions, specifically "How much of a cut do I give to my friends?" and "How do I even approach this (kinda awkward) conversation?"
posted by Sloop John B at 12:34 PM on May 26, 2011

Hopefully as co-founders, you'll be comfortable with many more awkward conversations. Just a simple, "hey listen, let's talk about equity, should do it." Bring in these articles and work through them to figure out something fair. The bigger worry is over-valuing how much each of you brings to the table.

Are each of you ready to quit their jobs and work on this full-time without funding? With funding?
posted by just.good.enough at 12:39 PM on May 26, 2011

Oh my.

Okay, so what people above said.

But also? It's common that equity should vest over time. If they leave after a year, they should walk with x%; if they stay, that escalates over time. And there should be a cap. So they can earn up to y% of the company.

Obviously, since no one's getting paid, they should start with something.

And you should reserve a portion of equity in case the day should ever come that you need new partners or you want to sell part without diluting.

Have these conversations in email so it's documented.
posted by RJ Reynolds at 12:39 PM on May 26, 2011

It sounds like your friends aren't going to be working for you full time or anything.

Keep a 50% percent stake for yourself. Have everyone involved keep track of hours and divide the other 50% proportionately by how much time people spend on the project. I chose these numbers pretty randomly.
posted by pseudonick at 12:40 PM on May 26, 2011

Joel Spolsky's answer.
posted by rodgerd at 12:41 PM on May 26, 2011

I really, really suggest you ask this question at Hacker News. I have gone through this myself and the way I presented it to the parties I was working with on the agreement as follows: this is a prenup for the business. Nobody who gets divorced ever starts out assuming they will get divorced. But, despite that, it happens - a lot. So we start from a position of trust and assume things will continue that way, and use our good will and high regard for each other now to negotiate shares and exit scenarios that are fair to everyone and to the business in a worst case scenario. Doing it now means nobody will ever have to negotiate from a position of adversarial breakdown later, which is infinitely worse and means someone always gets screwed.

Also, if you cannot get through this phase, that's OK: it means you cannot run a startup or a growing company together and JESUS GOD are you better off knowing that now.

Two random thoughts: 1) Understand the shotgun clause. Admire the beauty of the shotgun clause. Evaluate a shotgun clause for your structure.

2) Not everyone works this way but I do, so: take your pie and divide it into equal parts. Look at how many pieces that is. Look at what that gives everyone in the event of a) no traction b) "lifestyle business" success to the tune of say 100K in sales a year c) Google buyout. Now make the arguments for reducing any single stakeholder's share to the benefit of any single other stakeholder's share. It's just an interesting thought exercise when looking at this problem.

Ultimately, there is no right answer, just so you know. It is about what each person at the table can feel good about and confident in.
posted by DarlingBri at 12:41 PM on May 26, 2011

"Guys and gals, I would love it if you contributed, whether in sweat or in cash. But before we even start talking about this, we need to get a lawyer. Not just so you don't sue me, but so I don't screw you."

As for how much, well, that's up to you. I'd recommend never giving up more than 40 percent -- that leaves 51 percent so you maintain control, and 9 percent to dole out to people who come in later.
posted by Etrigan at 12:41 PM on May 26, 2011

I was approached by a startup once. Their deal was having each person record the time invested, and when the product finally matured to the point of making money, their capital investment would be the the (hours * rate) / (everyone else's total).

This seemed like a horribly bad idea to me. It encouraged people to charge as much time to it as possible, and it made bringing on people late to the project impossible. It was also heavy with people who just wanted their piece of the pie. For example, the UI was redone twice and done in a way that if there was a project manager, would have never happened. Thus, a few of the graphics people had an incredibly large "capital investment." Also you could see people who were brought on to do some work, then they just gave up, but still were entitled to their share.

Needless to say, the project is still languishing in development hell.

I would really recommend dividing things up right now. Are you the only developer? Will you need another developer to finish the project or get it to the point where people will inject money? I really would recommend not being the only developer on the project unless it is a relatively simple task and you have ample time (I would argue that Facebook in its first incarnation was a fairly simple piece of engineering).
posted by geoff. at 12:45 PM on May 26, 2011

I think you start out with a base stake for everyone and then based on the hours worked you pay them in percentage rather than dollars.
posted by JohnnyGunn at 12:46 PM on May 26, 2011

Until you start the conversation you don't have a way to know either what other participants are hoping to get out of this or their real level of commitment. For you this sounds like your full on career direction right now. Would it be for everyone else? Is there anyone besides you who will quickly become essential for the ultimate success of the venture? Are there people who think it is cool and want to contribute and a fair piece of the action, but neither you nor they really know how they'll actually be helpful?

Other than the advice above I'd say to just open up that you want to work through all of this both so you can all stay friends, and because it is good practice for you in learning how to run the business. Then for each person (probably in a private conversation, it doesn't need to be terribly long) get a sense of what their goals are and what they think is fair. Now is the time to find out if you have incompatible viewpoints! From all that feedback, devise a scheme that works for you and then see who else is willing to buy into it. The above advice about keeping more than 50% control and having plenty left over to attract new interest both seem very appropriate. Vesting also is a good strategy.

Good luck!
posted by meinvt at 12:57 PM on May 26, 2011

My advice would be to find a way to pay them in cash, either now or a deferred payment. If they're not doing something significant enough that you're willing to cut them in as partners you don't want to be fooling around with ownership stakes. Your estimation of how much the company eventually will be worth is almost certain to be way, way off. So you're going to either underpay or overpay them wildly and somebody's going to be not happy. (History tells us that more than likely their ownership stake is going to be worth $0.00 in the long term, but let's stay positive!)

Or you could set up some kind of labor-barter arrangement. As a developer, I'm sure you have skills to offer.

Both of these approaches have the advantage of getting you focused back on your actual business, the building of which is going to be hellishly difficult. You shouldn't be spending your time worrying about how to slice the pie.
posted by Nahum Tate at 1:06 PM on May 26, 2011

Just popping in to mention that a good startup lawyer should be able to tell you what kinds of common arrangements are made in these situations.
posted by lvanshima at 1:42 PM on May 26, 2011

I have a startup. Are you sure you need all these other people? Don't bring others on board just because they are excited and your friends... you can use Elance to outsource a lot of tasks. You might consider running as lean as possible (coders only) until you actually have programmed the thing. Because once the product is done and functional and awesome, you have a lot more leverage when negotiating with the non-coders.
posted by blargerz at 1:43 PM on May 26, 2011

Assuming they are working on this more as freelancers or contractors than as cofounders, here's another approach:

- Work how much you would pay them in cash if the business was up and running and paying normal market rates for their services
- Keep track of this number
- Pay them in equity of equivalent value to the cash _when someone comes in and prices the equity_, meaning you have an investor or someone that values startups all day and puts a price on it. Then they are effectively buying stock with their comp.
- Naturally, they should get some additional warrant coverage or sweetening discount or something because if you could pay them cash, there is no way in hell they'd spend it all on your hell of risky stock.

I could give someone a cut, and then they don't contribute, but they still own a piece of the company. I could give them too big of a cut, and wind up screwing myself. If I don't get anything on paper, someone could steal my idea or my code.

Set this up so that they get paid in options (on the equivalent underlying dollar value of stock), and the company has a right to repurchase the options, the options vest over X years, and if they leave the company, they have to exercise the options within 90 days or the options expire.

Of course, this won't work if you don't ever expect the company to raise money, and, to be fair, the pricing of startups' is driven by a lot of things that don't reflect what the startup is "worth", but its at least a reasonable way to do things.

I think this is a bad strategy though if you are thinking of them more as cofounders or Employee #1 types and expect them to work on it "full time" (where, in a startup, the definition of full time = 2x full time in the normal world). That's a really tricky issue. Good luck. Key early hires generally start out w/ somewhere between 2 and 10%, (very generally speaking), and depending on how key a person is and how much dilution occurs, later financings often include a carveout to top up people you want to keep topped up.
posted by jeb at 1:46 PM on May 26, 2011

In addition, just because it was your original idea, does not mean you should get a larger share than anyone else who might be building it from the ground floor with you. An unequal arrangement from the beginning sets everyone up for resentments/theft/litigation down the road.
posted by blargerz at 1:48 PM on May 26, 2011

Sorry, have been thinking about it because you've reminded me how interesting going through this process was for me. Some other points I rarely see discussed:

1) There are voting shares and financial shares (or can be). Don't assume when dividing up the pie that everyone values the financial shares the most. When we did our deal, I traded financial shares for voting shares because having control over the product I'm bleeding my life into is much more important to me than whether I walk away with $X or $X*1.3. No, really.

2) Along those same lines, you need to consider death. It happens. In our agreement, if partner X dies, X's financial shares go to the family but X's voting shares are split evenly between the other partners.

3) You can create a partnership agreement that is legally binding without doing an LLC or other company formation. YCombinator strongly suggests you take this route.
posted by DarlingBri at 2:08 PM on May 26, 2011

First, view equity as payment for ongoing participation. Having the idea is worth essentially nothing in equity terms. The sweat to take it somewhere is what's actually worth equity. To the extent that you have any uncertainty about people's ongoing participation, that should be reflected in the equity distribution. If you can keep them off the cap table entirely until you're sure about their commitment, you should try to. Vesting is critical for managing this in a formal way. You can set a distribution "assuming everyone is as involved as they say" and if someone drops out, their shares get amortized heavily. Make sure to set the vesting period pretty far out, like 3 years. You don't want someone working hard for 3 months and then quitting and having to issue them any serious amount of equity.

The points about founders v employees made up-thread are also important. You want a core team that can do the things the company needs long-term and they're the ones who should get the vast majority of the equity. Just because people want to help you doesn't mean you should take them up on it, and it definitely doesn't mean they should get much equity. The more you can find other ways to pay them, you should. If you want them involved early on, one way to frame it is as a dating period. It's a big commitment to join a startup at founding and even if you're friends, you might want to make sure you enjoy working with each other. Even with your primary developer buddy, it's okay to say "lets work nights and weekends for a month or two and see how it goes and then hash out equity." People's commitment and interest is likely to change rapidly in the very early days and you don't necessarily want to spend a ton of time talking about a situation that hasn't really crystalized yet. If you already basically trust each other, you can have the conversation generally now and then get to specifics later. In the long term, a month or two of work is going to be a tiny fraction of the total energy that goes into the business so it's not going to change things that dramatically in terms of long term equity.

But above all, do have the conversation early and often. Nothing is worse than surprises, so make sure there won't be any. As long as everyone is honest and open, you'll do okay. You don't need to lawyer up immediately, but will probably want to when you put together the official documents of incorporation.
posted by heresiarch at 2:10 PM on May 26, 2011

How much of a cut do I give to my friends?

Use the Founder's Pie.

At what point is it necessary to get things on paper?

Immediately.

How do I even approach this (kinda awkward) conversation?

With a partnership agreement already drafted, either by a lawyer or from a template. Here's why:

I'm meeting with the other (committed) developer tonight, and we're supposed to start planning the project.

The first thing to understand is that the moment you sit down and start planning with a tacit understanding that profits will be shared, you have (in most states) entered into a general partnership. And that's a real legal business entity, whose liabilities you share, and which you can't walk away from and can't kick anyone out of. Without a written partnership agreement the profits, losses, and control of a general partnership are shared equally, and you cannot legally take any action which would reduce any other partner's share of the profits without their agreement.

I know this sounds draconian, but I've been in this situation twice before, with promising businesses ready to take on investment and expand but with an old non-contributing partner who had to be dealt with – on their terms. It's ugly; they have no reason to give up their equity, especially right when you're about to make it worth something! As of tonight, if you don't have another agreement, this other developer will be your 50% partner. Why should he take less later?

So, really, the first thing you should do tonight is draw up an agreement and sign it. These are just examples from my experience and you really do need to talk to a lawyer very soon, but it might say that you and he are going to form a partnership and include terms like these: that other founding partners may join at your sole invitation, that profits from the partnership are to be shared based on a Founders' Pie formula, that a partner can retain equity in the partnership only as long as they are participating in the activities of the business, and that all works created by any partner in connection with the business are the property of the partnership, so any founding partner can continue the business without any non-participating partners.
posted by nicwolff at 4:40 PM on May 26, 2011

I've done this. Some things you might consider:

Few people can operate on equity alone for very long. If your friends are not insanely committed, then you are better off viewing them (and they viewing themselves as) short-term contract work.

If they are insanely committed and you need /their skills and you think you and they could work very well on something you feel is "your idea" then give them equity that I'd a reasonable fraction of your share.

Now, I put quotes around "your idea" because, if you want committed partners, there should be room for it to become their idea as well. Otherwise, what's the incentive in the short term?

Best of luck, and memail me if you want more details.
posted by zippy at 11:27 PM on May 26, 2011

Hey all! Thanks for the good advice! And really, some very very good advice in this thread. I have since talked to a lawyer, as well as my friends. And now for the fun, hard part : building the app!
posted by Sloop John B at 6:49 PM on June 16, 2011