Founders, Ownership and Prenuptials

Yesterday I wrote a blog post in which I urged people to not have too many founders.

Best case scenario in my mind is just 1, but at most I recommend 2.

I knew this topic would be controversial because when I tell people this in person it always elicits shock. To be clear — it is not about being stingy with or hoarding equity — it is about having a prenuptial agreement.

Let me give you some scenarios that do happen in real life:

You start a company 50/50 with a good friend. If it becomes the next YouTube you always stay friends. 99.99% of companies do not become the next YouTube. In fact, most go through tough times at some point. Or maybe it’s not a good friend but you’re a business guy and hooked up with a technical guy you know through the network and you think you’ll work well together or vice-versa.

If you’re not an overnight success or if you do struggle what happens?

- What if one guy needs to pay bills and takes a full time job somewhere. Should he/she keep 50%?

- What if you have to make really tough calls on cutting costs, biz dev deals, fund raising and you violently disagree on direction? Who prevails?

- What if the person performs OK, but not great and you need to hire above him?

These situations are only compounded if you have 3 or more founders. I know that many people reading this will be in companies with 3+ founders and aren’t having any friction. That’s great. I have even invested in companies like this. I know that conflict doesn’t always happen. It’s just that when it does it usually comes after much time and expense.

A friend of mine used to work at Google. He started a company with others. They agreed to all be co-founders. Now nearly 2 years of hard work have been put into the company (not to mention a lot of their savings) and they have had to have the discussion about who should be CEO. There is no mechanism for deciding. They agreed to let the VC’s decide once an investment comes in. That sucks because VCs will want to know that you have all the difficult stuff worked out before you come to them. You’re just giving the VC one more reason to potentially so “no.”

Do you want to risk not finding an agreement AFTER you’ve sunk in years and hard-earned $$$?

Why does someone need to be CEO? In many businesses you end up needing to make tough decisions. Consensus does not always build.

In yesterday’s post; however, I did not advocate being greedy. To the contrary. I believe that it very important to spread the equity. I believe that you should have a “partner” or 2 in the company. I believe you should treat them as partners. They should have access to all the same information. They should be involved deciding in all the difficult issues. They should have huge upside in the economic potential of your business.

But if you set up a company by yourself and give a large % in restricted stock or stock options to a partner and for some reason you fall out of love, you have a pre-nuptial agreement in place. If they stay 2 years and then leave — great. They only walk with half of their position. I know that this could be achieved with simple vesting schemes, but there is a rub. What if you decide that they need to leave? It’s far better than you have some leverage that doesn’t end up torpedoing the company. 50/50 partnerships sometimes end with a bang.

There, I’ve said it. I know it’s controversial. But I still think it’s right for many a founder / entrepreneur. Yes, there are exceptions. No, it’s not the end of the world if you’re 50/50 or 33/33/33.

A friend and respected colleague, Bryce Benjamin (of TechCoast Angels) wrote to me after my last post. He was concerned that I had set the impression that founders should hoard their equity or that there were prescribed numbers to hand out. He authorized me to post his comments:

“We’re in sync on so many start-up/entrepreneur issues that I may have knee-jerked a bit too harshly on this one. But it is the “founding team” size and “percentage ownership” advice in this post that I feel you’re being too prescriptive about. After re-reading, I see you have qualified your comments, but one of the things readers really like about your blog is that you give specific, actionable advice in it and your qualifiers will be ignored just as I read right past them last night.

One of the mistakes I see entrepreneurs commonly making is too much focus on their ownership % and not enough recognition of the various core competencies and expertise they’ll actually need to create a successful biz. Generally a founder (or founding team) has strong core competencies in “a” discipline, but lacks the breadth needed to build the business. First time entrepreneurs, especially, tend to need more than one other “key” team member/partner to help them be successful. And to be able to attract the expertise/experience they require, they should be willing to give up pretty sizable chunks of the company. Experienced entrepreneurs who know the ropes won’t need the same kind of support and will be able to build a team by giving up less of the ownership.

In terms of %’s, my advice to entrepreneurs is to focus on value and fairness. I agree that “fairness” doesn’t always mean equal, but sometimes it does. Again, though, the key for the entrepreneur is to focus on what individual(s) is(are) essential to expanding the size of the pie and getting the right people, not specifically on the size of his or her piece.”

I agree 100%. I hope that this post clears that up a bit. I don’t advocate being stingy. I advocate, to steal Bryce’s words, “fairness and value.” Many solo founders who have spent time with me would confirm that I often tell them, “you need to find a “co-founder” to work with if you want this to be successful. And you need to be prepared to part with 10, 20, 30% of your company or more to make this happen.”