Disappearing Founders
When a startup is formed, the founders usually receive all the company’s stock (at least all the stock initially issued). How the founders’ stock is allocated depends on the founders’ agreement. It’s not unusual for the founders to split up the stock more or less evenly, with some extra for the person who will be CEO.
As I mention in the book, it’s not unusual for enthusiasm to overcome realism. Founders meet together, plan the company, allocate stock, plan to put some of their savings in as initial capital, and then go home and tell their partners about the wonderful future that lies ahead.
A Case That Flatlined Fast
Years ago I knew some very good techies who decided to start a company. I had worked with one of them previously and he asked for my help in exchange for a few stock options. I liked him and his compatriots and told him sure, I’d help.
He asked me to form a board of directors for them, which I did, explaining the risks to my fellow board members. The company got started, and almost immediately the other founders began to make excuses and evaporate.
One had a spouse who was admitted to grad school in the Midwest.
Another had to have a job to pay the rent and cover student loans.
A third got a terrific job offer and took it.
In the end, the founder who had come to me originally was the only one left working full time at the startup. After a few months, he realized that the venture was doomed, and let us all know. Then, in a very nice gesture, he gave each of the board members a very nice bottle of wine as a thank-you.
This sort of experience is not uncommon, although this case flatlined more quickly than most.
When Equity Becomes a Problem
When this happens, there is significant resentment against the founders who leave early yet retain a big chunk of the cheapest stock the company will ever offer.
Another case I recall involved a young entrepreneur taking a class at a local college with an instructor who gave him some advice about how to start his company and helped him initially.
The former student went ahead and built a very successful company, which was acquired by a large firm.
The instructor would occasionally come in to help out a little, but his contribution was marginal. And yet he owned a larger share of the company than the CEO did. The two of them owned much more equity than the C-level staff who had a lot to do with the company’s growth and success.
Just before the company was acquired, the board authorized the issuance of a decent-sized option pool for the key employees, preventing a rebellion. But the two founders still received the vast majority of the sale’s proceeds.
How to Prevent Founder Disappearance from Hurting the Cap Table
What are some ways to avoid inequity in situations like this? How does a company keep stock out of the hands of early participants who contribute little to the company’s success?
There are several ways to accomplish this. None is perfect, but talk with your company attorney and see if one or more of these will work for you.
First, you can build in a buy-back provision at a defined (and low) price in the case that a founder leaves the company in the very early days.
Second, you can issue stock options based on the contributions by employees to company growth—and you don’t have to do it just once. You can issue options on a regular basis.
Third, and perhaps the easiest of the options, is to build in vesting: create a schedule and issue stock or options according to the schedule only if the individual is still employed by the company.
Your attorney will know how to implement these programs and will have ideas for other possibilities which will fit your particular situation.
The Takeaway
Be prepared to lose some of your founders, and build in ways to keep equity in the right hands: the hands of those who actually build the company.