Over the holiday I ended up talking to some smart people about getting equity, as in shares or options, in a high-end startup. One of these people has a very high post in a venture-financed Web company with high traffic. Two others have been involved in venture-financed Web startups and had to sue later on matters related to initial share options. 
Confusion over ownership comes with the territory. People naturally have different values for the idea, the work and the money. People are often awkward about putting these general ideas into specifics. Ownership of a company, however, is not vague at all; it is very specific. Legally it gets defined in numbers, not concepts. Whether it’s stocks, partnership shares or percentages, it’s specific. And then, to make matters worse, ownership changes as a company brings in investment in return for a portion of the ownership.
There is also a hidden problem: Company founders, the entrepreneurs, necessarily end up having to conform to investors’ rules when they bring in investors. The hidden problem is quite common. What happens next is that vague and general agreements made before the investors entered the picture are impossible to honor after the investors take their place.
So here are my three vital rules for dealing with early-stage equity ownership:
Rule #1: Get it in writing.
If ever there was a road paved with good intentions, this is it. Everybody intends to be fair, and they talk about fairness, but it’s just impossible to make it work until you get down to the actual details.
Rule #2: Get it in writing.
I know, it’s awkward. The other person says “trust me,” and you ask him or her to put that in writing. There you are in the excitement of startup, everybody pitching together, and it just feels bad to be the one who brings up the problem. It’s deflating. But it’s also really important. Swallow hard, breath deeply and explain that these things are supposed to be put down in writing. Things change quickly. One person’s idea of fairness is different from another’s, and those ideas change over time.
Tip: Set this up right, before you start talking, that it should be in writing because that’s the right way to do it. “Hey, Mabel, do you mind, but I think before we even broach this topic we should understand that it needs to be written. This is because it’s so easy to misunderstand, situations change so quickly, and sometimes you don’t have the options or control later that we both assume now.”
Rule #3: Get it in writing.
What is especially tough about all this is that so often promises, given honestly, become impossible to keep later on, because situations have changed. Investors are involved, and they have control clauses, and they can say no.
Having something in writing is a very powerful defense against this changing or cascading legal situation. Investors are 10 times more likely to have to honor–and I mean legally have to honor–a written document than a promise.
This entry was posted on Wednesday, January 2nd, 2008 at 11:36 am and is filed under startup financing, startup mistakes. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.3 Responses to “3 Vital Rules for Early-Stage Equity Ownership”
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January 10th, 2008 at 10:11 pm
Couldn’t agree more. In fact, I’d go a step further. Most people in startups don’t really know what tey want out of the venture. It allsounds like a great idea and everyone gets carried away in the excitement. But few pay attention to the detail.
‘So we’ve all got to work hard. That’s fine, we can do that.’
But who ever discusses what ‘working hard’ really means. One person might mean every weekend for the next 6 months and another might mean working 60 hours a week. It’s all in the interpretation.
Who talks about what the company was established to do AT THE START. How will decisions be made? Who will make decisions? What contribution is each person prepared to make both financially and in terms of time? Who will own the intellectual property/
And it goes on.
All the entrepreneurs should get in a room and nut out these issues. And have someone independent there, because it may get a little tense.
But it will save a lot of angst later and it may just save your business.
January 11th, 2008 at 1:36 am
Thanks Gail, that’s a nice addition. Tim.
October 11th, 2008 at 2:43 am
[...] a lack of trust. It means clarifying assumptions and doing things right in case things go wrong. Get it in writing. Assumptions are dangerous, particularly if they occur between cofounders who are close friends. [...]