Our technology law Link List series collects useful startup guidance from around the internet. This post discusses cofounder agreements, initial equity splits, issuing shares, and making an 83(b) tax election.
Contents:
This is advice worth reading, but it may not be advice that’s right for your startup.
Finding Cofounders
Cofounder Agreements and Initial Equity Splits
Unless both cofounders contribute exactly 50% of the seed capital and 50% of the work, the initial equity split requires careful consideration.
Allocating Equity and Founder’s Investment. Brad Feld, 2011. Hypothetical: Jane and Dick each bring a similar level of skill to the startup, but only Jane has the spare cash to invest in the startup’s initial expenses. How could they treat Jane’s cash investment?
The only wrong answer is 50/50: Calculating the co-founder equity split. Dan Shapiro, Geekwire, 2011. Shapiro offers a formula for dividing up initial cofounder equity.
Dividing equity between founders. Chris Dixon, 2009. Too many founders split ownership evenly to avoid a difficult upfront conversation. This will just lead to a difficult conversation down the road.
Founder Vesting. Chris Dixon, 2009. “Everyone should have vesting. If you have a lawyer who tells you otherwise, get a new lawyer.”
The Perils of Founder Fighting. Mark Suster, 2014. Deal with cofounder disputes early, and consider mediation. If you sweep them under the rug, they will fester and pop out down the road when the stakes are higher.
How to Divide an Imaginary Pie. Alex Blumberg, (2014). A podcast about starting a podcast-startup asks “How much of your company should you give up when you bring on a partner?”
Issuing Shares & 83(b) Election
A newly incorporated company needs to issue shares, and the cofounders then need to buy the shares of their brand new company. Founders can pay for their shares in cash, or by contributing intellectual property. This IP-for-shares deal need to be documented properly and needs to comply with section 351 of the tax code.
How many shares should be authorized in the certificate of incorporation? Yokum Taku, 2008. Issue 15 million shares of common stock, with 8 million to founders, and 2 million to the employee option pool, for a fully-diluted base of 10 million shares. The 5 million remaining shares are an “authorized but unissued” reserve. These are rough numbers, and will get adjusted at each round of financing.
The Founder’s Stock Issuance. Jose Ancer, 2012. This document should (1) ensure the company owns all IP, (2) incentivize founders to stay with the company and add value; and (3) give the company the option to repurchase the founder’s shares if she leaves the company.
Should founders pay for their stock in cash or contribute intellectual property? Yokum Taku, 2008. If you’re not buying shares with cash, you can buy them with IP, as long as you follow the rules.
What should the vesting terms of founder stock be before a venture financing? Yokum Taku, 2007. Yes, subject your own shares to vesting, especially if you have cofounders. While your first real investors will probably want to adjust the vesting schedule, starting off with a reasonable vesting timeline can be useful. Try four year vesting with a one year cliff. This means that 25% of a founder’s shares will vest on the one year anniversary, and then 1/48 of the total shares will vest every month after that.
What is an 83(b) election? Yokum Taku, 2007. When you receive shares subject to vesting, an 83(b) election lets you pay tax on the shares immediately, when the tax burden is smallest.
Setting the exercise price of stock options to avoid 409A issues. Yokum Taku, 2009. Determining fair market value of private company stock.