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I am one of three founders (all part time) of a software start up which is still in early stages. Considerable effort has been logged even though no formal arrangements have been made. We have verbally agreed to equal ownership of the company though there has been no valuation. To date there have been no investments and only insignificant cash expenditures. Now we are discussing formalizing the arrangement. One of the founders intends to invest 500K of his own money in this venture. I am concerned about preserving equity after this occurs because I am not in position to invest cash. I'm not convinced such a large cash infusion is warranted at this time, and that we could grow more organically leading to a higher valuation when cash investment is required, minimizing dilution of my equity.

As I write this I anticipate the answer will be that this can be a problem and that our partnership agreement should include a requirement that all founders must approve of any equity investment or dilution. Perhaps this is always the case? Thanks in advance for your advice.

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The issue I see here is a tax issue. You need to get your equity ownership formalized asap so that you are paying (either in cash, or in contribution of intellectual property) exactly what the shares are worth. If you pay less than the value of the shares that you get, you might have to pay tax on the difference.

If you all have equal ownership, and one person contributes $500k to the company for those shares, then your shares could be viewed as being worth $500k. If you don't also pay $500k, then you'll need to contribute an asset such as intellectual property equal to $500k (minus whatever you already paid or contributed).

You could just all be issued shares for $100 per person plus a contribution of each person's IP, as would often be done when a company is incorporated. Then you could treat the $500k as a loan. (You could also take the other advice re: structuring in the responses others have posted.)

GET A LAWYER. You're running the risk of being hit with a big tax bill or having ownership % issues if you don't document this carefully. The legal documentation won't be expensive or complex, but getting it done right, by a lawyer, will save you a lot more than you'll incur in legal fees.

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Thanks, got it, get a lawyer. Should each of us retain separate legal council or can we have one guy responsible for being a straight shooter and represent us as a group? Also, regarding the 500K, I don't have that in any form to contribute. It will be an unbalanced investment made by the partner in exchange for new stock. I see it as a big problem that the lawyer can help us work out. – Mr. Anderson Aug 20 '12 at 1:13
Most people would just get 1 lawyer, representing the company. The documents that you'll need are (1) founder's stock purchase agreements and a stockholders' agreement (if your company is a corporation), (2) an LLC agreement (if your company is an LLC) or (3) a partnership agreement (if your company is a partnership). It shouldn't cost more than a few thousand dollars for that, and you don't need a super-fancy law firm. – user6492 Aug 20 '12 at 10:06
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So to summarize, you 3 are the founders of a startup that doesn't formally exist yet - but you agree that when it does, there will be some kind of equality. That may mean either that there is no actual business there yet, or (especially if you are doing business) that there is a defacto "Partnership" - whether that is what you intended or not. (But is sounds like you, at least, think it was).

The good news is that uniquely in partnerships, you can split the profits in any way you describe it in your partnership agreement - without regard to what was invested. So, at least that is solved.

The bigger question for your future success is can you all agree on how this business ownership thing is going to work. It's no more "right" for one partner to unilaterally decide how much he is going to invest, than it is for you to unilaterally decide how profits will be split.

It's a good thing you're in the early stages.

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Yes, there is no actual business at present, just work in progress. – Mr. Anderson Aug 19 '12 at 22:43
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Amidst the discussion of tax issues and equity there seems to be a piece missing. You say there have been insignificant cash expenditure - so what is this $500K going to be used for? You should make sure that there is a plan for it, and that the investment is absolutely necessary now. If it's not then get the cash-rich founder to hold off for a bit. Tell him you'll sell him more of the company when more cash becomes necessary.

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