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(background - few startups, business side)

This is a situation that I've encountered a few times before. Seems not uncommon among startups.

You're kicking around an idea - let's say there are 2-3 people that are heavily involved. But there are a few other people that are pretty involved as well.

The bottom line is: you don't know who in the future is going to be heavily involved and who is making a contribution now (even an important one) but is going to be a footnote later.

Ideally, you'd like to: - Form the company, get all the legal docs in order - Award the early people a small amount of equity (on order of 5% or less each, say a total of 20%) - Leave open decisions re the balance of the equity (say 80%)

Benefits - Rewards early people without having to make value judgments on contributions (ie, Sam's design was worth x%, but Jeff's domain was worth y%) - Avoids hard conversations down the road (like: 'Sorry Sue, originally we gave you 20% but you really haven't been pulling your weight, so we're gonna dilute you blah blah blah) - Get your legal house in order earlier than you otherwise might - Gives incentive for continuing contributions - Leaves the door open for other founders, leaves your structure more flexible

Complications - Decision making - obviously you can't avoid all the hard issues; the LLC agreement needs to cover how major decisions are made. Which includes the future equity distribution - Papering - not sure how you'd draw this up - Other things I haven't thought of

Encountered this kind of situation? Wish there was an answer? Curious whether this is a common issue. And of course, whether there's an answer.

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I'm wresting with the exact same issue myself. I full timer (me), 1 half timer, 3 part timers with one of them going full-time at some undetermined time in the future. I want the equity settled, but yeah, hard question. Thanks for asking! – Paul Cezanne Dec 21 '11 at 20:19

4 Answers

up vote 1 down vote

The number one question here, you answer in your paragraph 6. We're talking about an LLC.

The complications only involve the ownership of the company - not the business decisions. Your example leaves you with about 80% of the equity. By default, that leaves you with 100% of the decision making as to future ownership and shares of the company.

As a practical matter you have to work with these people and you want them to work with you. So, you need to gain agreement from them about how it will work.

If you want to make the equity decisions later, explore other options to attract the help you need. If you can't just hire the help for cash, perhaps an agreement that gives them the first returns in the form of a commission or bonus. That could mean they get paid before you do, or maybe more than you do. You can have an earn in on the equity based on future profits or some other criteria.

Basically, if you form the company, you can do what you want with the equity. Your challenge is that you have to find some way to get the help. Sometime equity is the only thing that works.

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Hmmmm. I'm not sure that I follow you (I'm not sure that I don't, either!). I don't want to leave MYSELF with 80% of the company. I want to be on equal footing with the others at this point - 5% each. So the 80% is not assigned - it's just out there and TBD how it will later be distributed. – Jeff Townsend Dec 24 '11 at 0:45
All of the equity of any kind of company is owned by somebody. It can't be 80% un-owned. The government records of the formation of your LLC say who owns it - ALL of it. Maybe you're thinking about Authorized but Unissued shares of a C-Corporation. And maybe LLCs work that way in some states too. – Patrick NY Dec 27 '11 at 18:04
Thanks Patrick. I appreciate the feedback. Will let you know how I end up structuring this. – Jeff Townsend Jan 4 '12 at 16:23
up vote 1 down vote

This sounds very similar to the challenges that a young, famous billionaire faced after his college Web-based social networking startup went viral.

We've all heard and read the stories and allegations that Mark Zuckerberg may not have been fair and equitable in his dealings with the other alleged founders of Facebook. It's been years since Facebook was founded, and this stigma still follows him around, regardless of whether or not there was real malice.

The only guaranteed way to ensure that you don't have any costly legal disputes or lose friends in the future is to sit down and work out a contract as soon as possible.

If you're in the brainstorming or prototyping phase, this is the most critical time. After all, what's to stop your so-called partners from splitting off and using your creativity and your ideas against you?

It's not a matter of if a dispute will arise, but when. Having financial, ownership, profit-sharing, liability, and responsibility details worked out early on will help to quickly resolve those disputes when they arise.

My advice to anyone starting a business with more than one person is to determine how the equity will be split, and if you feel it necessary, outline a procedure in the contract for transferring equity should one party feel the need to redistribute it.

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up vote 1 down vote

From what i understand , the people haven't asked about equity yet.The best thing you can do is find out who is really interested & who is just help if they can.

Try bootstrapping using the current people ,people who are get scare to invest more than just there part -time skill are just checking your idea out.

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up vote 0 down vote

Do you really need to get the legal docs in order now?

If you are in a brainstorming and prototyping stage, why not wait to incorporate until things have firmed up a little more? Unless and until you start doing business (taking in money primarily) with the public, you may not need to go through all the formalities.

A LLC costs money and requires paperwork and filings. Until you generate revenue, why do you need it?

Once you get to the point that people are willing to pay you money you should have a rather good idea which individuals are making that possible and who should get equity.

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I agree, it doesn't really matter until you need to incorporate. We're at that stage (ie, potential liability & taking in money). – Jeff Townsend Dec 24 '11 at 0:43
PS - I think this is still helpful even prior to 'needing' to incorporate. Knowing how a structure like this would work would help people avoid making a bad handshake agreement. – Jeff Townsend Dec 24 '11 at 0:44

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