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Dividing equity for cofounders - bootstrap style?


#1

Hi there,

Me and my three co-founders have been working on a product for a few months, we’ve been lagging on figuring out equity allocations, but we can’t put it off any longer.

It’s been especially tough because we’re a distributed team all working on this in our spare time, some of us have full-time jobs and some of us do freelance work, so we all have varying amounts of time we can put into the business.

No one has immediate plans to quit their job and work on this full-time, it’s also hard to say who will be committed and want to keep working on this in a year. Right now, the plan is to see what the demand/response is like once we release the beta and go from there. We’re planning on filing as an S-corp soon, and while we’re not discounting the idea of getting funding and going all out, we don’t have any immediate plans since our target market is too small.

My question - figuring out equity allocation has been a real pain since we’re not putting equal hours in at the moment and probably won’t be in the future, although the people who have been working the most will probably work less in the future and vice versa. How have other bootstrapped companies with more than two co-founders dealt with equity?

One suggestion I’m leaning towards is changing the vesting schedule dramatically where 25% of the total equity will vest in two years and the remaining 75% of the equity vests in the last two years - that way only the founders who are really committed (working for 4 years) to the business will be majority shareholders. Thoughts?

Thanks for your help!


Idea: FounderShare
#2

Seeing as you’re going to need a solicitor (lawyer) to set up and manage an agreement like that - why not get advice from them? As long as there is consensus amongst co-founders then it shouldn’t be a problem.


#3

We’re definitely planning on consulting a lawyer, but they’re not necessarily going to be familiar with the specific issues that come up when bootstrapping and I’d be surprised if they had any non-standard ideas, but maybe I’m wrong?


#4

Something you could do seeing as apparently time commitments seem to be changing every so often with you guys, is this: Every 3 months, split that quarter’s equity based on time work on the quarter, and then get the total current equity per team member based on the average per quarter so far. So you start now and each of you has 33% let’s say (or whatever you decide).

3 months from now you check and it seems like you did half the work and the other two did the other half, evenly split. So this quarter you get 50% and they each get 25%. How much (in total) does each of you have?

If we give the same weight (let’s assume so, but you can change this) to the initial equity split, then you’d have 41.5% and they’d each have 29.25%.

Say the following quarter the same thing happens. How much equity you each have at this point? Then you’d have 44.4% and they each have 27.8%.

It’s not a perfect system but it’s something you can do. Whatever you do, absolutely implement vesting for all founders. Although with this system if a founder quit his share would go down over time, it’s still not as good as vesting. Plus if someone leaves after say 1 or 2 years, also their shares would lower over time with no floor, which isn’t fair either.

EDIT: I prototyped a tool for cofounders who want to get in business together to draft an agreement of sorts. It’s not finished, and it doesn’t work in the same that whatever you do won’t be “saved” anywhere, but you can go through the steps and think together as a group about each of them, and wether you’re on the same page, because if there are any differences of opinion, this is the moment to have them discussed, not when you have revenues or something valuable. Since my tool won’t do that for you, whatever you decide, put it in writing. It doesn’t necessarily need to be written by a lawyer (although that helps), but it absolutely needs to be in writing. I myself have gone through a cofounder dispute where my best friend denied having said something I remember very clearly (regarding equity), but it doesn’t matter because it wasn’t in writing.


#5

With your current situation, I wouldn’t worry too much about some people putting in more work than others. Assuming you’re looking to build a lifestyle business and not something you’ll try to flip in a couple years, you’re looking at a decade plus of working for the business assuming it is successful, so that one of you invested a couple hundred more hours initially doesn’t matter so much. So from that perspective, I’d look to split it equally, as I’m assuming the goal for all of you is to build the business to the point where you can all work on it full time.

The biggest thing I’d worry about is what happens when one of you wants to move on before the business actually takes off. With four partners, I think this is quite likely to happen. If that happens, I’d say the person leaving shouldn’t get anything, as again, looking at their investment versus the long term of the business, it is likely a drop in the bucket. Furthermore, if the person is wanting to leave the company, they are saying they don’t think the investment of their time is worth the return, so they’re saying the company isn’t valuable from their perspective.

You might get into a situation where one person isn’t pulling their weight, and you want them to leave. In that case, you could have a Shotgun Clause that allows the partners to buy out one of the other partners.


#6

You’re smart to want to figure this out now.

I’ve been through this exercise a couple of times, and @manuelflara 's suggestion is what we settled on and everyone felt was fair. Basically, start with some kind of agreed split, and a spreadsheet, and check in every 3 months to adjust. We mapped our time to dollars, so we could also factor in material costs like paying for hosting, marketing materials, etc. (i.e., we said an hour of someone’s time = $100).

At every check-in, we set commitments (“I’m planning to put in 50 hours over the next quarter, and $100 for materials”) and reviewed the prior quarter’s actual results (“I said I’d put in 30 hours, but only put in 25.”). We’d just talk through those things for each person, adjust the equity split, and carry on with other business. It went pretty quickly because everyone agreed on the process and felt it was fair, and it gave them wiggle room to adjust their level of commitment.

We didn’t include vesting, but should have.

The other thing we should have detailed better was what @pwim mentioned: how one partner can choose to leave, or be forced out for non-performance. Those are challenging discussions, but MUCH easier to have now, while everyone’s getting along.