When most people decide to partner up for a business, they pick someone they already know. Friends, coworkers & family members. Usually they’ve known them for years, and think they know them well. That, I think, plus just a general lack of understanding of everything that can go wrong (and usually does) in a business relationship, leads people to believe they don’t need to talk much to each other about things like expectations, “what happens if”, etc. before they start working on the business. They probably also don’t think they need to put everything in writing either. “We trust each other”, they say.
This is probably the first advice I give to anyone asking me for it. Look, having a thorough and (sometimes) hard conversation with your soon-to-be partner(s) is absolutely critical. And putting everything you agree on in writing too. And the reason for it isn’t that you can’t trust them or anything, it’s to preserve the business and the friendship. If you just talk and one year down the line you each think the equity split of the business is different, who is right? The answer is you can’t tell for sure, but you’re in deep trouble (trust me, I’ve been there).
Because of some past bad experience with this topic (which I’m still paying for), I decided to build an app that’d guide people over that tough conversation they must have in the beginning, and help them also download and sign a proper agreement with everything they talk about so that there’s no doubt in the future of what was agreed to. Here’s a link to the prototype, if you’re interested. You’ll see it doesn’t really “work”, it’s just a proof of concept, and I’d appreciate some feedback on it.
Here’s a list of everything you should talk about (and agree on) before you move on to work on a business with someone. If you can’t agree on any of these topics before you’ve even created anything or invested any time and money, shake hands and DO NOT move forward with the venture. Because you will have problems down the line.
Who is getting in business together?
It sounds stupid, but it’s still worth mentioning. Maybe one of you thinks that someone else (a friend, a girlfriend, etc) will be joining in too, maybe later. Make sure who is on the founding team, and who is out (everyone else).
Define the business
Again, sounds stupid, but it isn’t. Define properly and in detail what you want to build. Because if you just talked briefly, maybe you have different ideas of what you’re doing and that will lead to disappointments, confusion and arguments later.
What will each of you do?
Define each of your roles in the company. Who’s gonna do, say, sales? Or development? And if both of you are going to work on one area, how will you split the work? It’s always good to have complementary skills (say a technical partner who develops the product and a business partner who sells and markets it). Otherwise, you’ll have to bring in someone else on board to do those things you can’t do. Or do them yourselves, which may not be the best approach if you don’t have any experience with it.
As part of this, and this is one of the many uncomfortable decisions you must make, you should choose a CEO. Yes, there are companies with two co-CEOs, but it’s not the norm, for a reason. Eventually you’ll disagree on something important, and the CEO must have final call on almost everything. Again, if you can’t trust your new partner to be CEO, and he or she can’t trust you, then you have a problem that you better address before you even start.
How much will each of you work?
You should have an honest hard look at your life and your current work load, and decide (realistically) how much time you can invest in the business. If one of you is unemployed and can work 80h a week and the other has a day job and a family and can only work ten, that’s something you need to discuss soon, so everyone knows what to expect. Again, this avoids disappointment and arguments later on.
As part of this you should also talk about whether any of you will be working on other side projects or businesses at the same time. It’s always better to focus on one thing at a time, specially if you can’t work on it full time.
How much money will you each invest and under what terms?
Is any of you putting any money? If so, how much? And how will it be spent? How about other assets like a patent, existing source code, equipment, raw materials, etc. All these are again critical to discuss upfront.
You should also talk about whether someone else is putting in money and how much. And what happens if they end up falling through or you can’t convince them to. Does the business die right there and then? Do you try working on it without that seed capital?
Last but not least, you need to discuss how those investments (assuming there are any) are treated. And this can be very simple or very complicated, technically speaking. What you shouldn’t do under any circumstances is to just put money for free (unless you all put in an equal amount). At the very least, the investment should be returned to whoever put it, plus interest, when the company turns a profit. Other options (which I personally recommend) are that that cash investment buys extra shares in the company. You’ll need to discuss how many. Again, that’s a tough conversation.
And what happens if you run out of money and you need more? Will any of you be able to? Friends and family? Angel investors? VCs? Under what terms (assuming you can dictate them)? Will you bootstrap?
How much will you each be making?
Most companies won’t pay the founders until the business turns a profit or you raise some external capital, but everyone’s situation is different. Maybe one of you has money to invest and the other absolutely needs to take a salary to be able to spend time working on the business. You need to talk about this, and how you’ll treat it. Of course, someone who gets a salary (however small) is already taking a lot less risk than someone who doesn’t (because your business will most likely fail, by the way).
And what happens when you turn a profit? Do you split them among all of you based on your equity? Do you set yourself a salary and reinvest the rest into the company? Do you reinvest it all and take nothing for yourself? Until what point? And who gets to change any of that? The CEO? An unanimous vote? Money is a touchy issue, so much to talk about in this department. Trust me, waiting until you make money to make these decisions is a bad idea. You should agree on something now, and later on if you agree on something else, then you change it. But agree on something before there’s too much at stake and a failure to decide puts the company in jeopardy.
How will shares vest over time?
To most people who aren’t on the “tech startup” circuit, vesting is usually a foreign term. Vesting means, in layman terms, that you don’t own all your shares in the business from day one, but rather, you earn them over time. Standard terms for technology companies (which I recommend you stick to, even for other industries) is 4 years with a 1 year cliff. That means that if you’re two people and each of you has 50% of the business, you need to work on the business for four years in order to fully earn (or vest) your whole 50% of the business. If you leave after 2 years, you’d only own 25% of it. I hope it’s clear. The one year cliff part means that, if you leave before you work on the business for one year, you own nothing. Not even the proportional part of those few first months.
I understand that a lot of people might be skeptic of such term. I was at first. Why would I need to earn my own shares? What if I want to leave? What if I get somehow fired, or we have a fight? That’s exactly why it’s there for. Imagine it the other way around:
Without vesting, if you and a friend split a business 50/50 and make it official, he can literally quit a week later and still own 50% of the business, even if you end up working for years on it and ends up generating millions of dollars. Your friend, who did absolutely nothing, will own as much as you. I’m sure you agree that isn’t fair. And if you do the same? Then it’s also not fair that you own any part of the business. It’s as simple as that.
Now, of course, it can get a lot trickier. Say you’re three cofounders and two of you want to fire the third one after a few months. He’s clearly done some work but there’s clearly a culture problem, or something like that. What do you do? You leave him with nothing? Well at this point is a negotiation, although you can also add terms to it into the agreement. Something you could do if he worked for 9 months and did solid work is for example vest him a full year and let him own 25% of his shares. If the company’s making money there’s also the option of a cash severance. The options can be many, depending on the individual’s and the company’s preference.
One other thing you should consider. What happens if you sell the company after 2 years when everyone’s only vested 50% of their shares? Do they still need to be work at that company for two more years? And what happens if they are fired immediately after the acquisition? That may not be fair. For such scenarios there’s something called acceleration. A standard term is 50% acceleration on single trigger and 100% acceleration on double trigger. This means that in our example above, 50% of your unvested shares would vest if the company is acquired (so it’d be like you worked for 3 years at the company when it was acquired instead of 2), and 100% of your unvested shares would vest if the company is acquired and you are fired (basically, you’ll get all of your shares).
Sometimes companies screw people with these terms. For example let’s say you’re an employee and are on year 2 of your 4-year vesting. The company is going to be acquired and they want to fire you afterwards because, who knows, they may only want the product. In order to give you less money, your company may fire you immediately before the acquisition. That way it counts as a regular termination and you only get your 2 years vested so far. Of course this is a very unethical and fortunately rare practice.
Still, let me end this section clearly saying again: you need to add vesting to your agreement, and I recommend 4 years with a 1 year cliff. Even for founders.
In what situation can a founder be fired?
Yes, even founders can be fired. Happens often. You need to understand that being a shareholder in a company (owning shares) and working on it are two separate things. Some people do just one (investors only own shares, some employees only work on it) and other people do both, like founders in the beginning. But this situation can change over time. Maybe an employee is given equity, or sells their shares. Or maybe a founder is fired.
Either way, you need to decide under what circumstances can a founder be fired. And I’m not talking about the reasons, but about the procedure. Who can make the decision? The CEO? Does a majority of the shareholders need to agree (whoever they may be)? Does the majority of the founders (this of course isn’t possible if there are only two and nobody wants to get fired). My suggestion is that, if there’s no investors and the company’s just the founders (assuming there are more than two), it should be majority of founders who agree. In any other scenario (just two founders, bigger company with investors, etc), it should be the CEO’s call.
If you’re scared that your founders will just fire you for no other reason but to get a bigger share of the pie (not that you’d want to start a business with these people if you’re genuinely concerned), keep in mind that you could always sue for wrongful termination.
How and when will the company be incorporated?
In some countries, incorporating a company isn’t trivial or cheap, so you may not want to do it right from the start. So when will you do it? Depends on your situation or preference. Some people choose to do it when they start generating revenue. Or maybe after a specific amount of time has passed. Maybe you want to wait until you raise venture capital or get accepted into an accelerator. Either was is fine, but talk about it and put it in writing.
What are your goals for the business?
This is important and not many people pay attention to this. One of you may want to raise VC and join the startup circuit, while the other prefers to bootstrap the business while retaining ownership and control. Either view is fine but you should agree on what each of you considers desirable, acceptable or unacceptable.
Do you want to always run it as a side business or at some point will you quit your job to work full time on this? When would this happen? Do you want to try and join and accelerator? Would you be interested in approaching advisors to join the company? How about selling the company, is that on the table? Or maybe, if you’re one in a million, taking the company public? Is either one of you interested in working only for a couple of years and then moving on to the next thing?
Extra terms
There are a bunch of extra terms you should talk about and add to your agreement. Some of the ones I recommend are:
- Non compete: you should agree that, whatever happens (one of you quits, is fired, etc), you won’t create or work for a competing business for at least 2 years after your relationship with the company ends.
- Confidentiality: none of you is allowed to share confidential information about the company with any third party without the consent of the CEO or the rest of the founders.
- Intellectual Property Forfeit: this means you all forfeit all IP rights to the work you do to the company. This includes whatever you contribute from the start, maybe some source code that predates the creation of the company, or a patent.
How are you going to split the business?
Last but not least, probably the most important thing to talk about and usually the one that causes the most arguments. I like to discuss this at the end because I think it’s important to talk about everything else first.
Before you decide how much of the business each of you belongs, you need to know how time you will all work on it, how much money you’ll invest, how big a salary you’ll take, etc.
As a rule of thumb , you will rarely end up with an equal split. If you do, may be putting yourself up for resentment later on. You don’t want to be thinking “Why do we own the same percentage of the company if I do twice as much work as him?”. It really is a hard place to be at, but at the very least, if you go through all the items on this list and end up knowingly accepting an equal equity split and an unequal time dedication split, then it’s on you. Also keep in mind that if there are two of you and you have an equal 50/50 split, you may end up not being able to make certain decisions. And lack of action often kills companies.
So how should you split the business? There isn’t a specific way of doing it, and eventually it’s up to you, but here are all the factors that should absolutely be part of your decision making:
- How much time is each of you going to dedicate to the business? Working full time is worth a lot more than working “nights and weekends”.
- How much money is each of you investing?
- How much experience do you each have at your role? If for example a very experienced and a very inexperienced are forming a business together, all things being equal, the former will have a bigger share of the company.
- How much market knowledge do you each have? Maybe you’re not a very experienced coder but you have years of inside knowledge at the industry your new company will be part of (say, real estate). This also counts.
- How much time and money have they invested so far? Maybe one of the founders have been working on it for a year and the other is just joining now.
- Who is CEO? Usually they have extra equity for the sole fact of being in charge of the company.
- Who came up with the idea? Usually they have extra equity too.
- Do any of you have other companies under your belt? An entrepreneur with a proven track record is a lot more valuable (and should have extra shares) than a first time entrepreneur, if they join forces.
- Other things each of you may bring to the table: good connections in the industry or VCs, a patent, certain technology…
Now some things that shouldn’t have any importance when considering your equity split:
- How good friends are you?
- Will they get hurt or feel unappreciated if they, for a good reason, have less than an equal share of the business?
Closing notes
Well at this point if you’ve talked about and agreed on all those terms, you’re more than ready to actually start a business together, knowing that your foundations are solid. Good luck!
