Legal disputes between founders can (and will) often erupt. (Even founders who happen to be best friends can quickly turn into worst enemies.) Simply sorting out a few things in the legal department before handshakes occur can help you avoid any bad blood.
One thing that needs sorting out early on is proper ownership documentation to ensure that every founder is in agreement with how equity allocates. Here are some tips to ensure fair founder equity distribution below:
1. Compare contribution based on economic value.
One co-founder may be the computer programmer, another may be the marketing director, the third may be the accountant. Determine the prevailing market hourly rate for each skill sets, and then multiply that hourly rate times hours spent. This evaluation will help you split the equity pie, so everyone has their deserved slice.
2. Reward full-time co-founders.
Give bonus points to individuals working for your business full time. These individuals will be putting their heart and soul into your new business, and you should reward them accordingly– ideally with a salary commensurate with their contribution. If there are no funds for a salary at the initial stages, recognize these individuals with equity and give them the authority to spearhead initiatives increasing business revenue.
3. Appoint a CEO and create a board of directors.
One of the full-time founders should serve as the CEO – entrusted with the economic future of the company. Bind this individual to goals and metrics needed to achieve revenue and cash flow. Provide incentive shares in the form of stock options motivating them to lead the business to success. In turn, create a board of directors consisting of the CEO, the founders, and preferably (at least) one other external person.
4. Create stock restrictions or rights to repurchase.
These terms will help ensure that if one co-founder leaves the company or otherwise does not hold their weight, there is recourse to purchase back their stock should the board of directors agree.
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5. Recognize that investors are likely to have the greatest control.
The founders bringing cash into the business are likely to demand more voting and liquidation rights in case of default, and therefore, presumably will exert the greatest control. Therefore, pick your investors very wisely.