Start-up Whoopsies

It started in Fred’s living room, and everyone was excited about the possibilities. Questions about type of entity, shares in the company, vesting schedules, equity splits, and breakups were far from their minds…until that fateful day, that nobody expected, but which always comes.

Let's Go!!!!

The truth of start-ups is that everyone is dewy-eyed and in love at the outset, but challenges are coming sooner or later. If there is more than one equity holder or founder, it is morally certain that one of them is eventually going to leave. If there are more than two equity holders, statistically, one will leave within twelve months – and want their fair share on the way out. It’s not all “bad faith” either.

Peek-a-Boo!

While bad faith actors certainly do exist in any start-up scenario, sometimes the break-up occurs just because circumstances change. For instance, people get a new job somewhere else, get married or get divorced, have a baby on the way, burn-out or just get uncomfortable with the direction of the new company. Setting up the rules for leaving is just prudent at the outset rather than trying to negotiate it down the road…and even more importantly than avoiding unnecessary conflict, well prepared legal documents increase the company’s appeal to potential investors or buyers.

Here are some key elements:

1.      How much equity is there in total? (I.E. How many shares are “issued” and how many are “outstanding?”);

2.      How much equity does each founder have? And what does that mean for control and operation of the company? (I.E. Does one person or entity have simple “majority control” or “supermajority control?” And what decisions are impacted by that? (I.E. If the original founder wants to sell, can he force that through?);

3.      Is there a vesting schedule? (I.E. When will investor #4 get his or her shares fully vested?);

4.      Are there silent partners or dead equity positions? (I.E. Is there a non-active founder who has control but doesn’t contribute to the company any longer?)

5.      Lastly, does one or more founders control the income generating property outside of the company? (I.E. The company only leases the patent, real property or equipment that it relies on to conduct its business.)

Discuss, Decide, Document!

It is essential to understand and “paper” how each of these key elements will impact the start-up. Someone will leave, someone will get divorced, someone will get upset and depart for greener pastures or just take his ball and go home. If the company has no agreed-upon mechanism to reacquire that founder’s equity or asset, the start-up will fail or face untoward heartache and expense to fix what could have been easily prepared for. Trust me, I’ve seen it happen far too often.

Curry Andrews, Attorney