50-50 “Partnerships” Only Work in Fairy Tales

Authors: Melanie G. Rubocki, StartupPercolator

One of the most common conversations I have with the founders of businesses involves how they determined a way to split the ownership amongst themselves.  It is probably the first difficult decision new partners face together in starting a company.  In many instances, the new founders decide that they are going to split ownership equally.  If there are several founders, this may work out inadvertently.  In other instances, the founders haven’t even considered who should own what percentage of the company and statutorily, by default, ownership will be pro rata by the number of owners.  When probed, I often discover that rarely have (first time) founders had a deep discussion with each other about ownership and the value of the contribution of each founder.  Founders often shockingly just avoid the topic altogether due to sensitivities or the desire not to rock the boat too early.  Founders, let me forewarn you—not resolving ownership (and valuing contributions) at the onset can lead to disastrous consequences down the road.

From the beginning, founders should sit down and seriously consider all the possible contributions everyone will be making to the enterprise.  Contributions may include investment, services, personal property, real property, and good old human ingenuity (intellectual property).  You should ascribe “values” to those contributions and consider how many of them are commodities versus unique or otherwise unobtainable contributions.  Also, founders should consider how much has been contributed already (cash in the bank, for example) versus how much will be contributed, if ever (e.g., developing a prototype that is not yet complete).  In the former category, consideration has been given for the contribution to the enterprise so those founders should receive their ownership fully vested.  In the latter category, the consideration is being given over time or might never come to fruition.  In this situation, ownership should “vest” relative to when the contribution is received or required.  Consider the situation where the original developer never completes the task but was given an equal share of the enterprise.  We see this situation daily and it causes a lot of frustration and yields questions like, “Can we get the stock back?” and ” How do we kick this founder out?”   If the stock is already granted, vested and there is no right to repurchase, then the company is left with very few options to restore “balance.”

Rarely do founders contribute exact and equal contributions to the enterprise.  Also, companies need a leader.  While academically, the idea of consensus and unanimity sounds appealing, in reality, companies need swift decision-making and someone (or some group) needs to be the “buck-stops-here” person.  Like every school project team you have ever been on, there are those who contribute more and others who contribute less while everyone gets the same “A.”  Start-ups are no different—folks bring different things to the table and often have different views about the value of such contributions.  Not addressing this or coming to a meeting of the minds early on will likely breed dissatisfaction or cause members to feel slighted. In turn, such founders may become increasingly less engaged.  And, without any kind of tie-breaker in place, indecision will become the decision. When folks are equals and cannot agree, decision-making becomes a quagmire.

By simply addressing ownership contributions and the related values up front, founders can avoid the likelihood of this angst down the road.  You may not get it exactly right, and you probably will need to revisit it from time to time, but if no one is talking about these issues, the problems that sneak up on your organization will be difficult, if not impossible, to fix.

How to Prepare for an Equity Financing

We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.

What Every Startup Needs to Know

On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.