More on this book
Community
Kindle Notes & Highlights
Read between
May 4 - September 25, 2020
The need to negotiate a trade-off between wealth and control, between building financial value and maintaining a grip on the steering wheel.
A desire for control might lead the core founder to add fewer cofounders, while a desire to build the startup’s value might lead to a bigger founding team.
many founders also tend to overestimate the value that will be added by redundant cofounders who might not add new capabilities. As a result, they end up with larger teams than they should, a problem that could be avoided by taking a more disciplined approach to evaluating each potential cofounder’s marginal costs and value.
it is extremely difficult and costly to undo a bad cofounder decision,
Before exposing the startup to these hazards, a founder should be reasonably sure that a potential cofounder will add an important piece to the startup puzzle.
“The best situations I’ve seen are founder teams who have worked together in the past, especially if that work was relevant to the new venture . . . . They’re friends, but the friendships developed out of mutual admiration for their commitment, capabilities, and expertise. They can trust each other. Each one knows how the others think and work. So the whole ‘cultural fit’ question is taken care of right from the start.”
“A friendship built on business can be glorious, while a business built on friendship can be murder.”
Create a disaster plan. Put in writing a plan of action for the worst-case scenarios, such as an irresolvable business conflict or a breakup in the social relationship. Also, make it clear who has the final say in an impasse. Sign an exit contract that will apply if a worst-case scenario develops.
Founders can choose to split the equity either at the time of founding or later.
putting off the split for several months or more can give the cofounders a chance to learn whose skills and connections will contribute the most to the startup, how those contributions change as the startup’s strategy and business model change, how well each founder gets along with the others, how committed each founder is to the startup, and more.
Ideally, the equity split will approximate each founder’s long-term level of contribution, but judgments about those levels of contribution will naturally be affected by the founders’ early experience with each other.
ups and downs of the startup’s evolution, it is inevitable that the importance of each founder’s contributions will wax and wane, and so may their idea of the best time for the equity split.
past contributions to the startup, opportunity cost, future contributions to the startup, and founder motivations.
Past Contributions First, each founder’s equity stake is often based, at least in part, on how much—relative to the other founders—he or she has contributed to building the value of the startup so far.
at the time of founding or several months later—but even very early on, many founders have contributed at least an idea or intellectual property on which the startup is based and/or seed money to fund the startup.
The Idea Premium All other things being equal, do idea people deserve an idea premium—a greater equity stake than other founders?
James explained that he agreed to split the equity in Lynx equally with his cofounder, but, “I told him, ‘I want you to [have to] vest, but I don’t want to [have to] vest. It was my idea and I invited you to join the company. I already earned my stake—my invention and patent are worth a lot—but you have to earn yours by working for two years.”
draw a distinction between an idea and an idea for making money from that idea.
My analyses showed that there is indeed a statistically significant idea premium: All other things being equal, idea people receive 10 to 15 more percentage points of equity than do non-idea people.
idea premium may also be a recognition that the idea person might be more likely to contribute important additional ideas in the future and to make other contributions that are linked to having been the idea person.
My regression analyses showed that the more capital a founder had contributed, the larger that founder’s equity stake.
a founder’s capital contribution may also indicate his or her commitment to and confidence in the startup.
Opportunity Cost
Future Contributions A founder’s future contributions, although often the hardest factors to evaluate, are in many ways the most important for determining equity stakes.
“when the pie is split, 95% of the work required for success remains in the future.”
potential to contribute to the startup can be estimated by considering his or her background in combination w...
This highlight has been truncated due to consecutive passage length restrictions.
specific founding experience is more valuable for startup growth than are overall work experience a...
This highlight has been truncated due to consecutive passage length restrictions.
prior founding experience was associated with a serial premium of 7 to 9 percentage points more of an equity stake.
The level of future contribution is also presumed to depend on how much time a founder can or will commit to the startup. Full-time founders tend to receive larger equity stakes than part-time founders.
Tracy Burman wanted to cut back on her workload to spend more time with her young children. She therefore negotiated two terms with her cofounders. First, rather than be the CEO, as she had been in the past, she would be the COO, reporting to the CEO. Second, she would work 80% of the time that her cofounders would work, receive 80% of the equity stake that she would normally have received, and earn 80% of the other founders’ salaries.
Founders with strong wealth motivations will place a high premium on maximizing their financial gains from the startup.
equal splits should be rare or nonexistent.
33% of the teams in my dataset split equity equally.† Why did they make this decision? Was it a good decision? Did it make the team more stable? Is it associated with higher or lower valuations when raising outside financing?
Past Contributions: How much has the founder contributed to building the value of the startup so far? a. Idea Premium: Founders who contribute the original idea on which the startup is based have made a unique contribution to the venture.* b. Capital Contribution: Founders who have made larger contributions to the startup’s seed capital should see a proportionate increase in their equity ownership.10 2. Opportunity Cost: What are the founders sacrificing in order to pursue the startup? 3. Future Contributions: Most of the work required for the startup to be successful will come in the
...more
This highlight has been truncated due to consecutive passage length restrictions.
Our quantitative results indeed showed that “close to equal” founding teams tended to split equally, while more heterogeneous teams tended to split unequally.
Our finding is also consistent with the fact that roughly equal contributions are cognitively difficult for the founders to distinguish, so that close-to-equal teams will find that an equal equity split feels more sensible.
Some founders argue that an equal split sends a good signal to everyone on the team.
it showed that “we were more concerned with the success of the enterprise than our own personal wealth accumulation; that we had the presence of mind to realize the success of the first would ensure the latter. . . . We’re all starting from the beginning, we’re all taking the same risk, we’re a team. If we’re successful we’ll all ‘get enough’ without trying to jockey for equity position this early in the game. Jockeying for position this early in the game does nothing for the effectiveness of teamwork.”
we found that equal splitters tended to spend much less time negotiating the split than did unequal splitters. Of the equal splitters, 60% of the teams spent a day or less negotiating the equity split, while only 39% of the unequal splitters made their decision that quickly.
“a quick-equal split is a symptom of a founding team that doesn’t have any experience or methodology for making the founder split so they just say screw it and do 1/N.”
“a quick handshake is a symptom of inexperience and/or lack of real preparation, or real glue to the idea, before going on the ‘tough journey.’
Our analyses showed that, controlling for a wide variety of differences across teams and startups, quick-equal teams received significantly lower valuations than slow-equal teams and unequal-split teams, lending credence to anecdotal evidence that there is a real difference between teams who engage in a serious dialogue about the split and those who avoid such a discussion and rely on a quick handshake.
Many VCs report that they do examine the team’s equity split before investing and that a problematic split could have important consequences.
in many founding teams, that additional 1% can cause major problems. It may suggest that one cofounder is overly focused on control instead of on crafting an effective partnership, or it may foreshadow a dysfunctional team dynamic.
for teams planning to raise at least one round of outside financing, the power of 51% equity will be only temporary. As soon as the team takes some outside financing, the 51% stake will shrink to less than 50% and that founder will have to build a coalition with other shareholders to have his or her way.
When the founders split the equity, they can either keep the agreement informal or commit it to writing.
the longer the cofounders negotiate to reach agreement on the split, the more likely they are to commit the agreement to writing, either on their own or with a lawyer. Teams who split quickly (within one day) are much more likely to stick with a verbal agreement (22% of the teams, compared to 11% for the teams who spend longer negotiating) and less likely, if they do formalize the agreement at all, to do so right away (41% versus 54% of longer-negotiating teams).17
overly rigid contracts can lock parties into arrangements that don’t allow for adjustments as circumstances change, and overly detailed contracts can undermine trust by preventing spontaneous displays of good intentions.
When formalizing the agreement, founders should also anticipate future tax or legal issues that could be avoided if handled appropriately.
Setting the early equity split in stone, without allowing for changes, is one of the biggest mistakes founders can make.
