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Welcome back! My last post explored the levers commonly used to distribute equity amongst the founding team. Skim through it if you’d like to follow the complete series on splitting the hypothetical pie in a startup. Now, let’s look at negotiating equity as a startup founder onboarding one or more co-founders.

When you’re negotiating with your founding team, keep in mind that these are people you will most likely spend more time with than your family over the following years. Of course, it’s crucial to be assertive in terms of what you need for your startup. And that also implies the outcome needs to build trust and create value for everyone on the founding team. That’s what this article is going to be about.

Analyze your Situation Outside-In

First, take a step back to evaluate your situation. One of the most crucial factors is what stage your startup is in. Is the startup just a concept, or do you already have funding, or is it in use by early adopters and ready to scale?

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When you decide to bring on a co-founder, it’s likely because you need additional skills or resources to take it to the next step. Consider how far you are from a significant milestone. Say, securing a Series A funding round. A startup closing Series A funding has an established user base and consistent figures on a key performance indicator specific to your startup. The further away you are from this stage, the more work there is for you and your co-founders. The equity you share with co-founders needs to be in line with that.

If you’re adding a member to a revenue-generating startup that’s headed towards profitability, you’re most likely bringing on first employees at this stage and not co-founders.

Now, consider the skills, experience, and connections you need to move the needle in the right direction for your venture. What are you missing? A larger gap in skills and experience will require more equity to onboard the right co-founders.

Consider other risks specific to your startup, the industry it operates in, global and regional economic conditions, social and environmental issues, etc. Do they support offering less or more equity to the founding team?

Put all of this down on paper so you have a list of considerations for when you’re ready to distribute equity to your founding team.

Determine Minimally Acceptable Terms

Now that you understand your startup’s demands, you also need to determine the minimum acceptable terms for you as a founder. It’s a concept known as Reservation Point in negotiation strategy. What minimum equity are you able to give away and still be motivated to work day and night on your startup for the next 7 to 10 years? Because that’s what it is going to take. It will be tempting as a founder to set your reservation point really low and retain most of the equity. However, go back to why you’re bringing on co-founders – you need additional skills and resources. What’s your alternative?

15% equity in a successful startup is far more valuable than 85% in an unsuccessful one.

Don’t forget to incorporate the equity you’ll be handing over to VCs and other investors further down the road. Include them in your calculations.

Now, write down your reservation point for the total equity you’re willing to share with the founding team and investors. Keep this number confidential – its purpose is only to help you negotiate and make decisions.

Consider and Strengthen your Best Alternatives

Understanding your startup needs will also help you with the next step – assessing what your alternatives are. What is your plan B if you’re unable to bring this co-founder onboard? Have you identified other potential candidates to join your startup? The stronger your alternatives, the more aggressively you can negotiate. You might be inclined to postpone this exercise until your current negotiations fall through. However, trust me, you need to understand all your alternatives and build a powerful one before you start negotiations. Continue to improve your options, even after you’ve begun discussing with your founding team. Write down every alternate possibility and select the one that seems the strongest.

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Once you know your best alternative, it’s equally important to assess your co-founder’s options. Understand what’s in it for them to be your co-founder on your startup. Are they pursuing offers from other startups? Will they quickly come across opportunities to join other promising startups? Are you able to offer something unique that they cannot get from other founders? Formulating offers based on your co-founder’s best alternative will ensure it’s competitive.

Distribute Equity Based on Each Co-founder’s Added Value

Let’s go back to the skills, experience, and connections your startup calls for. Weigh this against what each co-founder brings to the table. Assess the added value of each co-founder. A great tool to evaluate the anticipated contributions of your founding team is the Co-founder Equity Calculator. Just keep in mind that this tool cannot be used independently, as the website also admits. The calculator suggests an equity split determined by the anticipated effort-based contributions. Some co-founders might invest financially in the startup, which is another way for them to contribute. You’ll want to take that into consideration separately.

Let’s also look at how well you know your co-founders. Have you worked with them before? If so, for how long and in what capacity? The longer you’ve worked with your co-founder in comparable roles, the less risk you’re taking on.

If you like working with spreadsheets, list these factors and quantify equity for each co-founder on a scale or as a percentage. By the end of the exercise, you should have a general sense of how the equity could be split amongst them relative to each other. Remember, this is just a starting point for your negotiations and gives you data to frame offers to your co-founders.

Protect your Startup’s Equity

When I say protect, I mean safeguarding it in the unforeseen circumstance that you have a falling out with one or more of your co-founders. I do not imply that you need to hoard your startup’s equity invariably. There are several ways to formulate a strategy to distribute equity amongst the co-founders. Read this article if you haven’t already.

If you’ve worked with your founding team before in a similar environment, you can predefine the equity split upfront. Stick to the standard four-year vesting period with a one-year cliff.

If you have some reservations about your co-founders, you can establish milestones when equity is earned. In situations where there are significant uncertainties with the founding team members, you can postpone splitting equity and base it on the effort already expended. I would use this method with caution. It can work if you’ve done this before or have an advisor or mentor who can help you maneuver around the pitfalls.

Take Time to Prep for Negotiations

To create a win-win situation, you’ll want to list all of the items you could negotiate with your founding team. Have open conversations and really listen. Equity is the big elephant in the room, but you know how to tackle it. By now, you have the total minimum equity you’re prepared to share with the founding team and investors and the ratio of how you would split equity amongst your co-founders.

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Equity is also controversial because it’s essential to both sides. But there may be things important to your co-founders that don’t matter to you as much. Perhaps it’s flexibility with their work schedule or gaining work experience in a startup. You can use these to negotiate a lower equity share. Put everything on your list of negotiable items.

These negotiable items you’ve analyzed will set the terms of your founder’s agreement. During your negotiation talks, you could go through each item separately with your co-founder to draft your contract terms. However, doing so will draw out the process, make it more contentious than it needs to be, and create inefficient deals. Instead, put together, say, three packages that you can present to them. Use the negotiable items you’ve listed as levers. If you notice some have a higher priority, assign weights to make them comparable. Play around with it until you have distinct packages that roughly add up to the same score or dollar amount.

Remember to use competitive numbers that you’d like to offer your co-founders and not your reservation point. Keep all your discussions at the package-level, including any changes you may need to make as well. You’ll notice your co-founder is drawn towards a specific package. Find out why. Make it mutually beneficial and build that trust.

There you go – you’re ready to present some competitive offers to your founding team. Good luck!

I hope this article helps you navigate negotiations to build your founder’s agreement. If you’re a co-founder, the next article in this series will discuss how to negotiate from your viewpoint.

Are you a founder? What strategies worked well for you when negotiating terms with your founding team? Also, if you have feedback on the article, I would love to hear from you.

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