A couple students starting a company recently asked me if they had too many co-founders and if their equity arrangement made sense. When you’re in college, it’s not too uncommon to have a semi-large group of friends working together on the same project which sometimes leads to a formal company starting. It could be 2-5, and I saw one recently where there were 6 classmates all coding and designing a new mobile app concept together. When we were starting Invite, there were four of us there at the beginning.
The interesting step to figure out, and take seriously, is how you setup the co-founding group both in terms of number of co-founders, titles and equity allocations. My friend Chris Dixon wrote a good post related to this, and I’m sure there are many other posts on the topic. It’s something you need to take seriously, as it sets the trajectory of the company for better or worse. It’s all too common for startups to blow up before they’ve left the launchpad due to disagreements and poor arrangements among the initial team. Here are some “best practices” if they can be called such in my opinion related to the founding team:
- First off, do what it takes to get things started. If you absolutely need your semi-large group of friends working together to get something off the ground even if it means impending confusion, then by all means do it. I’m never a fan of stopping something before it starts and am a huge supporter of things just getting done and figuring things out later. That doesn’t mean you can’t be thoughtful and look ahead to how you’ll need to structure things if something clicks though.
- Second, co-founders are great. I am a huge skeptic of single-founder companies. I probably wouldn’t invest in one. I truly believe it’s a great thing to have a partner (or two) in the trenches together, second guessing each other, etc… I’m personally most enthusiastic about a two primary co-founder structure, with potentially 1-2 other secondary co-founders. It’s fine if they all have the co-founder title, but in terms of equity the 2 primary co-founders should own a significant portion and any secondary co-founders own a minority share. Startups work as dictatorships for a reason, and group-think and consensus decision making is for big companies. I’m never a fan of seeing three or more equal partners, for reasons explained later.
- Every founder’s shares should be subject to vesting. Your founding shares should vest. Whether you do this day 1 or as part of your first funding round is up to you, but I think it should happen. I think it’s bullshit for an entrepreneur to claim “oh well I started the company, my shares should never be able to be taken away”. Sure, maybe some portion of them can be vested day one thanks to your effort and time spent, but in no world do I see it being fair to the company and it’s shareholders for a founder to not be subject to vesting, especially if you own a significant portion. It also helps with recruiting employees if you’re able to tell them you’re vesting on the same terms as they are.
- Minimize “dead equity” in the future. Equity is precious, and in general one of the goals of a company CEO is to maximize the % of shares that are still actively at work for the company. In other words, the higher % of shares that are held (or are vesting) by an active employee building value the better. Conversely, someone owning a significant stake in the company who is no longer working on building value is “dead equity” (dead wood if you will). There’s no doubt a portion of the company that ultimately will be held by people who are no longer active, or you may have given out equity in exchange for short-term services to conserve cash. But in my experience, one of the most significant sources of dead equity is a co-founder initially getting a big chunk of equity, wasn’t vesting, and then before you know it the co-founder didn’t work out. Investors love to see active co-founders and critical employees owning as much equity as possible (the more the better).
- Engage advisors. In my experience and observation, as a company matures, no more than two co-founders will ultimately be super critical to the business, and many times it can be none. This is important to accept as you go about planning your equity arrangements. If you have three co-founders and you split things 1/3rd all the way around, it’s likely that 1 or 2 of those holders will ultimately not be with the company after 3-5 years (thus creating dead equity). Sometimes this is unavoidable, other times it’s not. So how do you plan for that? Get outside help to verify that what people are bringing to the table and if the equal arrangement makes sense. Utilize advisors to help identify the strengths and weaknesses of the team. If there’s a clear person in the group who will grow into the CEO spot or fill it from day 1, and one person who is wavering on wanting to be an entrepreneur longer-term or who’s skills won’t scale with the company, better to know that (or think about it at least) early on.
- Have the conversation early. Sometimes it’s worth it to have those serious conversations early to figure things out. Trust me, I wish I had done that in some previous companies before things got rolling. Sitting down as a team and figuring these things out early is important to ensure things don’t blow up. Call it a preventative measure or management debt or whatever you want, it will pay dividends in the future by taking care of it early.