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Here's the scenario my startup is in and I'd appreciate some thoughts on how to solve several issues we have.

We're 3 co-founders (2 biz, 1 dev) and we've been working on an idea for the past ~12 months. We've reached a point where we have differences in business plans and one co-founder now wants out. The departure is amicable, but the other co-founders want to keep going.

The two remaining co-founders cannot afford an equity buyout, so that's off the table. We're working on setting a valuation for the company as of now (roughly calculating development time and hours put into the venture, no other assets) and should agree on that soon. (Assume 100K for simplicity).

The question is how to split the equity down the road.

Suppose each founder now has 33% * 100K. If the remaining founders put in more money down the road to support further development, it's easy, the existing founders are compensated with more shares to match the funds they put in, and the departing founder gets diluted (unless he matches the funds).

But how is the calculation done when the remaining founders want to take into consideration the time they're continuing to put in? Is it reasonable to say that the departing co-founder is immediately discounted by some % of equity to compensate for the time he's not putting in? Should that decision be deferred to the next time a valuation is set?

Any thoughts, comments or references to similar cases would be extremely helpful. Thanks!

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Such situations are amazing examples of why you need vesting agreements. – dnbrv May 1 '12 at 11:42
OK, still, assuming all of everyone's shares are vested, how do we handle this? – Yuval A May 1 '12 at 13:03
Gift or buyout. If the quitter has invested only sweat, gift can be a solution, too. – dnbrv May 1 '12 at 13:19
2  
How about buy out with IOU's - put a $ value at the equity, the firm then gives an IOU to the leaving partner, with payout term linked to cash flow of business. Any future appreciation in intrinsic value of firm is attributed to remaining equity holders. – YetAnotherUser May 1 '12 at 17:15

3 Answers

up vote 4 down vote

That can be a tough situation.

Typically vesting is determined ahead of time to account for the sweat equity. What vesting means, however, is that unless the founder stays for the entire schedule, the company buys back the stock (note: legally the company loses the right to buy the stock as vesting progresses).

Given your example:

Imagine the 3 of you agree upon a 3-year vesting agreement, and the total assets are 100k. At 3 years, with a 33.3% equity split, each founder earns ~ 0.925% equity per month. By the end of the year, each founder has 11.1% equity. The company then has the right to repurchase the stock.

Now 22.22% of the stock from the leaving co-founder becomes not issued. As a result, the current total equity is only 77.7% of the original.

Here's another good answer as well: http://www.quora.com/What-happens-to-ownership-structure-if-a-co-founder-leaves-with-unvested-equity

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up vote 1 down vote

I agree with the first answer, but I should also add that I am a huge fan of deadlock provisions in operating agreements. http://en.wikipedia.org/wiki/Deadlock_provision But you are beyond that point right now, too late to add it.

I would recommend, that if you can come up with a fair market value that all parties agree to, and you see good profitability in the near future, bring in the lawyer to draft an agreement that says the company will pay him X money in Y time. If they cannot agree to business practices, they are a lot less likely to agree do a distribution agreement.

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up vote -2 down vote

Well here is what my co-founder and I have decided on our venture:

  1. if anyone backs out before profits start to come in - the leaving person loses all investment.
  2. if profits have started and one wants to quit, he will take his profit share at that time and forego any equity.

We hope this is simple enough for us but you never know! hope it helps..

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