You are one of a group of neighborhood buddies who all share a passion for the beer business. Or you and a couple of college friends meet every Friday after work to talk about launching the company you all have talked about since your dorm room days. You are now ready to launch and the first order of business is to allocate the equity among the three of you.
Is this a 15 minute discussion where you take the easy way out and go 1/3--1/3--1/3? Studies show that this will eventually create dangerous cracks in the startup team that are exasperated in the first year of your venture.
Hopefully you took the more prudent step and spent a few hours discussing which roles each will play, how much sweat equity each was positioned to provide and any cash contributions to get the idea off the ground. It's a tough but necessary discussion. If you can't have it now it is a red flag to how you will make subsequent critical decisions later on. Suck it up, put on your big-boy pants and talk about the hard stuff now. Leigh Buchanan outlined two key themes; Consider the Contributions and Time It Right in her article last fall here on Inc.com.
Now that you have that out of the way you can breathe a little easier. All you have to do is write this up and everyone sign the equity docs. You now have an agreement that works for all of about 24 hours and erodes quickly after that. Why?
You see, one of you will not execute their fair share for any number of reasons (some of them very reasonable). You and your spouse decide to have a kid and the entire startup plan gets put in jeopardy. My favorite is that big offer that comes from a company that you have always admired from afar and you "just can't pass up this opportunity". Like I said, there are a variety of reasons why one of the founding partners fades away from the business.
Here at The Startup Factory, where we closely evaluate about 200 companies a year for our 10-12 investments, we occasionally see companies come to us where a former founder owns 30-40%. For a startup where the hard work and the companies outcome is years from being decided, having someone own that much but not be contributing is a showstopper.
We refer to this as dead equity and startups and early stage companies cannot have someone owning more than 8-10% before the next round of funding.
There are a couple ways to protect the company from this major issue. The first way is for each one of the founders to vest their founders stock over time. The longer you stay, the more you earn. The second tool is to build in a buy-back provision--very reasonably priced--where the company can buy back the earned stock from the former founder.
Not sure how to go about doing this? Talk to a lawyer or a few savvy founders. Believe me, you will be happy you did it the right way.