At the beginning of starting a business, three cofounders can come together pumped with energy and enthusiasm to build a life-changing product. They split up responsibilities and informally agree to split the proceeds of the business three ways. Then, a year down the line, one of the cofounders decides to leave the company — but still expects to get their share of the business when it exits down the line.
“If somebody’s getting something that’s not earned, at best it creates friction between the cofounders and at worst it kills the business,” says Ifty Nasir, founder and CEO at Vestd, an equity management platform.
Cofounder conflict can be avoided though, by creating a prenup early on in a startup’s journey. It’s a document outlining each cofounder’s rights, responsibilities and obligations to protect their individual interests when conflict occurs. It also means that if someone decides to leave the business, you’ll have a contract to turn to.
Here, Ifty gives his top tips for putting one together.
Identify what each person brings to the table
Decide how much each cofounder is going to contribute to the business:
- Will each of you work full-time, or will some of you work on a part-time basis?
- How long will your tenure be?
- How much will you be paid for the hours of work?
Then, consider how you are going to split responsibilities and authority. Who’ll make decisions for each aspect of the business — and how?
Set up a good share scheme
Most people go with a time-based ‘vesting’ schedule for shares (shares ‘vest’ when they become available to you). That could be as simple as saying, ‘stay with the company for at least four years to get 100% of your shares, with 25% vesting each year).
Others go with performance-based/milestone vesting — which involves setting up tangible, measurable targets for the business to achieve, against which shares vest. It could be a number of qualified marketing leads, a revenue target or investment target, for example. You could have goals like, ‘get the app to beta’ or ‘achieve 1,000 new paying customers’ etc. Whatever your conditions, make them measurable, quantifiable and fair. You don’t want to accidentally demoralise a cofounder by giving them a target they’ll never hit.
If you’re in the UK, you could also set up a growth share scheme by issuing conditional growth shares, which are tied to targets. Growth shares are a special class of ordinary shares that allow recipients to share in the future success of the business once a certain valuation threshold is reached. This is known as the “hurdle”, which could be set at £15 per share, for example. This means that when the business does well, recipients of growth shares do well as the value of their shares increases — and people are rewarded for the value they create after they join the company, rather than before. You can distribute equity based on whether those targets are reached.
It’s theoretically possible to set a growth share scheme with an accountant or solicitor, but this can be costly. There are also online platforms to help you do this such as SeedLegals or Vestd.
The type of share schemes available differ across Europe — Index Ventures has a good breakdown here.
Figure out leaver provisions
You need to include ‘Good Leaver/ Bad Leaver’ clauses in your documentation when you set up your prenup. A Good Leaver clause allows somebody to keep their shares if your relationship ends on good terms. The opposite of that, The Bad Leaver clause, protects everybody from a bad actor who doesn’t keep their end of the bargain, or leaves due to gross misconduct etc.
Outline in your prenup what equity cofounders are entitled to based on tenure. It might be that you put in a minimal period of service for cofounders to receive equity — for example, if a cofounder leaves within six months or a year they get no equity. Other things to consider are how long the notice period is for each cofounder and whether they can receive some equity as part of their severance package.
It’s also important to figure out how shares from the departing cofounder can be transferred back into the business or assigned to a person (for example, a new cofounder or C-suite member you bring into the business).
Draft in a third party
If you and your cofounder(s) are struggling to agree on the terms of the prenup, bring in a neutral third party that can mediate. This doesn’t necessarily have to be a lawyer, but someone who knows your business and the industry well and can make objective decisions. Ask them to help you with the negotiation process and identify concrete next steps.
Get something written down
Don’t leave it too long before you put down on paper the responsibilities of each cofounder and what their specific objectives for the business are within a certain time period. You don’t need to put together a 10-page document, but simply writing down two to three things that each cofounder will deliver and the reward they’ll get for that after the time is up is crucial.
That doesn’t mean to say you need everything figured out on day one — you just need an agreement that can evolve as the business grows. After six months of running the business, you can assess what’s working and what’s not, whether individuals want to switch roles or work towards different goals or whether you want to bring in a new cofounder — then, update the prenup.
On the subject of... cofounder prenups
- What to consider when breaking up with your cofounder.
- Making a cofounder prenup. The key things to include from a four-time founder.
- How to anticipate and avoid mistakes that can split up a startup. This book has become many entrepreneurs’ bible for solving founder dilemmas.
