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In The beginning

Around one year ago we build a software company, we needed to quit our jobs, get financing, a product, legal work, accounting work, clients and partnerships with providers.

we accepted to have a 50/50 equity split. we are two guys, Alfred and Bernard.

The first year

Alfred

  • brought the business idea
  • helped coding the initial product
  • Strategically, quit their previous job around the second/third month
  • got the CEO role and a salary compensation 1.75x bigger than Bernard
  • brought our two first clients
  • has brought almost 40 clients since then
  • got an important partnership with our main provider
  • brought three important players to our team
  • got commissions over the sales of the 40 clients because he's a salesman too
  • got commissions over the SaaS subscription of the 40 clients because he's a salesman too
  • got an additional commission over the sales of the 40 clients because he's a founder

Bernard

  • helped to model the business model financials
  • helped coding the initial product
  • initially lead the accounting efforts
  • registered the company as a legal society
  • protected our intellectual property legally
  • focused on improve our initial product and implement further requirements
  • managed our servers infrastructure
  • Strategically, quit their previous job around in the first month
  • got the CTO role and a salary compensation 1.75x smaller than Bernard
  • got an additional commission over the sales of the 40 clients because he's a founder
  • got no commissions over the SaaS subscription
  • brought one important players to our team

Redefining the startup

Now, Alfred feels that he brought the initial idea, clients whose sales allowed our bootstrapping, the provider partnership and other business components that he believe created a bigger value than the Bernard contribution. so he wants to reconsider the 50/50 split.

In the other hand, Bernard believes that he made a mistake by only giving incentives to the sales activities and not to the technical ones (last month Alfred got around 3X more compensation than Bernard), also, he think that the equity split is good as is -they both assumed the risk to start from scratch and do their best when the company started-. Bernard does believe that with both partners good will and hard work they could get the best value of this market, destroying any spirit of competition brought by giving bonuses to ideally cooperative tasks -sales- which would lead them to a sales-oriented enterprise instead of a product-oriented one. that as Microsoft, the old cisco's competitors and the Sculley's Apple shown us in the past never work.

What pitfalls do you find in this position?

What solutions would you propose to reach an agreement between them?

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5 Answers

up vote 4 down vote accepted
+200

Alfred needs to offer to buy out Bernard. They both assumed equal risk (which is what the initial equity is for) at the start.

Without Bernard's help that idea wouldn't have become a product.

I think Alfred is justified in his commissions. He's the sales guy, of course he gets commissions. I think his reasoning for the raise of his side of the equity (he brought the clients) is wrong. Again, he's the sales guy, it's his job. It's not the tech guys job. The tech guy needs to make sure everything is running smoothly.

To cut off Alfred's position, Bernard needs to say these things:

  1. Initial equity was distributed as we were both assuming the same risk when we came into this, we agreed on this equity at the start.

  2. Your job as the sales guy is to bring in the clients. That is why you are getting the commissions.

  3. I quit my job almost right away to devote everything to this startup, whereas you waited for a few months.

  4. As CEO you're supposed to bring in those partnerships, that is why you have a higher salary. You're basically doing everything that's not in the scope of my CTO role.

  5. An idea is nothing without being implemented. You wouldn't have been able to bring the idea to market without my help, or at the very least in the time we did.

  6. If you want me to do more of the bringing in vendors and sales people, we need to have a more equal salary and commission structure.

  7. I do not believe it is fair to ask that we redraw the equity as it is based on the initial risk we've taken. Now that we're making money, we can discuss you purchasing a portion of my equity. You have received the above compensation for what you've done when you've done it.

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2  
I would not use the term "greedy", but the rest of the suggestions are spot on. Everyone has overblown self-image of importance. It may be useful to bring in a mutually agreed to independent 3rd party to help mediate. – Apollo Sinkevicius Nov 5 '12 at 5:20
I edited the post to remove greedy. It was simply how Alfred comes off in the post to me :) – Randy E Nov 9 '12 at 16:30
up vote 1 down vote

I think that you cannot legally change the equity split, but you can buy out portions of ownership. Obviously, current value is much higher than what it was when the initial money and effort were contributed, so if Alfred wants to buy Bernard out - he'll have to pay significantly more.

As to what the people are doing now - that's what the salaries are for. Alfred does more, and gets paid more. But the initial contribution, commitment and effort were those that defined the split, not the ongoing work (unless there's some vesting agreement based on performance, which it seems there's none). If so, there's no real reason to claim that the equity wasn't distributed properly.

This is not a legal advice, and I'm not a lawyer.

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thank you. the idea about the company actually 'paying' for the contributions since foundation make sense for me. – SDReyes Oct 30 '12 at 20:02
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You certainly can legally change the equity split - as long as all the parties agree to it. That's the trick. – DJClayworth Nov 1 '12 at 20:50
@DJClayworth not retroactively. – littleadv Nov 1 '12 at 21:04
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It doesn't need to be retroactive. If you originally split the ownership of the company 50/50, if both parties agree you can say that "now you own 40% and I own 60%". You can void an entire agreement and write a new one. – DJClayworth Nov 2 '12 at 12:59
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@DJClayworth that would be "fishy". You can split income, losses, but changing the value of ownership may require deemed sale etc. Should be done with good tax and legal advisers. Note that they're talking about a "company", the type of the actual business entity is crucial here (if its a partnership, they can do it more easily, if its a corporation, I'm not sure it can be done without an actual buy-out contract). – littleadv Nov 2 '12 at 15:33
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up vote 3 down vote

A clean way to change the 50/50 equity split would be to issue a capital increase where one of the founders is allowed to buy more new shares than the other.

So, if for example there are 100 shares (Alfred and Bernard each have 50) and 100 more shares are issued, Alfred could buy 70 of those new shares and Bernard only 30. This will give a 60/40 equity split.

However I would not suggest to do this, both founders shared the risk of starting up the company and if 50/50 was fair then it should be fair now. I would nonetheless redefine salaries and bonuses relating them to the current company situation.

Also consider that a fair value for founders compensation is the one that might be given to someone else doing the same job, so it's not strange that every founder has a different salary and bonuses. Their return as being founders comes frome the equity value that should increase in time.

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up vote 3 down vote

This is a highly unfortunate situation that they both find themselves in, but it's actually more common than many realize.

I am willing to bet the root of Alfred's feelings stem from the fact that he brought the idea to the table, and that is why he had the stones to request a reconsideration of the partnership.

It happens a lot in startups when one partner feels like he is pulling more weight than the other. In my experience, the table can and usually does turn at a different stage in the business, when Bernard's strengths begin to contribute more than Alfred's.

I'd say if Alfred could start the business himself, he would have. But he chose instead to "partner" with Bernard to create this product, and he should stop being a whiny wuss and stand by this decision.

Partnerships in startups should not be based on who contributes more, but rather each party bringing a different valuable skillset to the table.

By the way, I think that arrangement of Alfred getting more money than Bernard is complete bullshit, and should not have been allowed in the first place.

I am currently in a partnership where I do much of the work, and another where I do much less of it. I am happy at both because I know I am contributing 100% of the value I was brought to the table to bring. Sometimes that means more work, and other times, that means less; but the value, is still the same.

My solution? They are both partners and they should both show some respect for each other and stop this "I did more work" rubbish. If they don't want to work together then they should cut their losses and move on.

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up vote 3 down vote

Two great guys come up with a great idea and generate revenue by sharing responsibilities that utilize their strengths. They draw up an equal compensation agreement between themselves that hinges on a buy sell agreement.
No one has asked what the legal entity is were are dealing with here: partnership, LLC, corporation? Drawing a salary from the corporation and then taking commissions that reduce the profitability of the company-- double dipping. There are corporate profits and go to the shareholders. It could be classified as stealing. It happens everyday. Yes, these partners need to sit down at the table and decide where this venture is going because partner A is getting all the money he can get while partner B is more long term. They need a more comprehensive agreement and rules about where the capital goes. Do they have a CPA?

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