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I realize this has been addressed in various forms before but I feel this case is unique.

How much equity would you give to a friend who came up with the idea for a startup but is voluntarily bowing out of a cofounder role (to be an advisor only)?

A friend of mine ("Sam") came up with a good idea for a startup. He brought me (the tech guy) and another guy he knows ("Eric", expert in the vertical) together to be cofounders. He's helped us negotiate a partnership/cofounder agreement (worked on legal docs), spoken with angels/VCs (has a lot of contacts there), and kept things moving as much as possible.

Sam is in a completely unrelated field (healthcare). He realizes he doesn't have the vertical knowledge or contacts, and isn't a tech guy. So he doesn't want to be cofounder. He just wants to help in any way possible. He's been working on the idea for about 5-6 months (not full time), probably 3 months or so with Sam before I came on.

So far this is just an idea, with some software I'm writing and no investment (not even seed). Sam's proposal for equity split is about 40% each for cofounders, and 15% for him as advisor.

My first reaction is that this is high compared to other advisor agreements. However, this situation is different since it was his idea originally and him bringing us together that made this happen.

Thoughts?

vvvv Update vvvv

Currently the agreement is that Sam will be the first in line to get diluted as needed to carve out additional option pools for initial employees, strategic advisors, etc. When we get to a funding event we will see what the VCs have to say about current allocation and be prepared to adjust as necessary.

Food for thought - For comparison, here's an interesting guidepost: Accelerators like YC, AngelPad, Techstars, etc usually provide around $10K-20K of cash, physical space to work, access to experts and previous participants on a daily basis, and access to every VC and Angel in the Valley.

Their take? About 5-6%. I'm wondering (not rhetorically) how that compares to the work that Sam has done so far.

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"Sam" sounds like a great guy and a facilitation leader who is able to put his ego aside. Sounds like a great "board chair" for your new entity. And 15% of initial pre-diluted equity seems immensely fair to me for that active role. – Joseph Barisonzi Jun 14 '11 at 14:59

5 Answers

up vote 5 down vote accepted

Sam will recognize that he can't insist on anything at all. But it would be plain unethical to fail to recognise his pivotal role in getting you to this point, and the suggestion looks totally reasonable given the story.

In fact, in slightly different circumstances, Sam could be hiring Eric and you to execute on an idea of his - in which case you might be grateful to enjoy a double digit shareholding, let alone 40% or so!

In terms of benchmarking, you should consider the 15% to be made up partly from his prior contribution, and partly from his ongoing involvement. You may well want at some stage to engage other advisors, mentors or board members, so you could have a 'same side of the table' conversation between the three of you so in that event you already have an idea of the equity you would offer.

One benefit from securing Sam's ongoing commitment is that you and Eric trust him individually and as a mediator. That could pay dividends when the two of you have important decisions in future. Co-founder disagreements can wreck promising start-ups, so Sam is a great insurance policy as well as a point of connection with the original vision.

As a final comment, shareholding is rather less important than creating value. It's possible that a future investor will want to rebalance the holdings. That's achievable routinely - and you're not in the more highly charged position where one co-founder plus one advisor has a controlling interest.

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Short of Sam funding it from his own personal finances, I think it'd be difficult for him to procure money to hire anyone. Most VCs don't seem to be willing to fund a guy with an idea who can't build a product. Right now, I'm the only one putting in the sweat equity, as I'm the only one who can build the product (and have a lot of experience doing so). Both Sam and Eric have stated that this idea is just vapor without a competent developer to build it, and I'm the one they trust the most and have the best experience. – Nicely Done Jun 16 '11 at 1:05
up vote 4 down vote

It sounds like Sam did a lot of work to get the idea off the ground, which warrants cofounder status in my book.

If it's just three of you who founded the company, then 15% seems reasonable to me. There are plenty of examples of cofounders who get things going and then leave, so it's not uncommon.

It seems like a fair deal.

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up vote 2 down vote

So if Sam took 0% that would leave you with 7.5% more equity than what he is proposing. Would you risk his good will and the contacts he has and one of the driving forces for that?

You are making too big a deal out of it - you have 40%. Before he came along you had nothing...

If he had just mentioned the idea to you over drinks, and you took the ball and ran, that would be a different story. But he has done a bunch of the ground work and helped you through some initial hurdles.

I know I would prefer to lay a lot of the tasks and background work on someone for 15%. It sounds like even though he is "hands-off" he will still be providing value.

If you force him down to 10 or 5 percent he will likely resent it and then you would probably not see any more help come from his corner.

Even if it turns out to be high - you might have only gotten 5% more out of it for your end. Is it worth risking at this point?

What makes you think that 15% is too much for him?

EDIT -- after the edit in the question about YC and its stake

You can't compare YC's stake at all. It is not apples to apples. You are too concerned about "what things look like". YC is just setting some across the board policy that leaves plenty on the table and also gives them some real equity. Note that they DO NOT get any board seats or preferred shares, etc. They give only nominal help - the cost for them for all that stuff is a pittance. Do not compare your participants/investors with YC. It just isn't useful at all.

Consider also that a tiny fraction of companies even get to participate in YC (or other similar incubators) - so whatever comparisons or assumptions you try to make just won't fit.

Don't try to match your company's equity structure to VCs/Angels before you even get going - just worry about it when/IF you actually have investors willing to give you money.

You are worrying about the wrong things right now. "Sam" actually provided value already and is likely to keep doing it. You are/were trying to take away his reward without even having a real entity in his place.

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+1 for pointing out he has done more than the idea -- and the actual percentage of potential we are discussing. – Joseph Barisonzi Jun 14 '11 at 14:38
There's a wide range of numbers between 15% and 0% - I'm not proposing 0% for Sam. Not so much worried about clawing back 7% for myself. More concerned with the appearance of the deal to outside investors. There's an option pool for employees that needs to be carved out, for a CEO, strategic partners, etc. Given that everything is fully allocated at present it would require extra dilution above that incurred from the first funding round. – Nicely Done Jun 16 '11 at 0:50
Well, it sounds like you have your mind made up then. So what you are arguing over is a paltry 5%? Why not just dilute yourself then if it ever gets to it? Who cares what investors think of the arrangement? It's your company. Worry about the people who have done the work right now - cross the other bridge when you come to it. And frankly, you should be having this talk with him, not a bunch of anonymous users on some Q&A site. – TimJ♦ Jun 16 '11 at 2:23
up vote 1 down vote

Startup (the beginning) is a very delicate time (paraphrasing from Dune here). 90% of $0 is still $0. 100% of your cut of $0 is $0 too. It does seem like Sam did a lot of prep work and knows people who might help. Sometimes it takes a single connection to the right person to determine life or death for a fledgling startup.

My advice to you will be to give him what he wants and let him run with it. In the end, you may all benefit from it. Don't risk losing that important link over premature quarrels over percentages of nothing (currently).

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Interesting, as I received the exact opposite advice from a good friend of mine who's running a very successful startup (just closed a huge Series A from a household name in Silicon Valley). His recommendation was that it's very important to lay out the cap table carefully in the beginning, as weird structure can be toxic to further funding deals. Of course, that's one viewpoint, but I do place some weight on it given his experience and success. – Nicely Done Jun 16 '11 at 0:57
Actually, what's more toxic here is the 40/40 split among the two remaining founders. Who is the CEO? Who is in charge? – Alain Raynaud Jun 16 '11 at 13:42
up vote 1 down vote

15% could be worth very little if anything at all if the business does not succeed. Sounds likes he has great ideas/contacts that could be very valuable for your venture and even future ventures. If you think you can go it alone al the way further you can put up a fight.

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