Tuesday, October 9, 2012

The Talk: Have It Early, Have It Often

Every Wednesday night, I get to hear entrepreneurs talk about what they've learned along the way.  The single-most common theme that comes up when questions about regrets or "what not to do" surface is this: Unclear agreements among co-founders.

Here's why that's a really big deal:  Let's say four friends co-found a start-up.  Imagine that they're sitting around a table, drinking beers, gnawing on bar food, and frantically scribbling on cocktail napkins.  When the subject of equity comes up, one guy says, "That's easy.  We'll just each contribute a one-quarter share, and we'll each take a 25 percent equity stake."

To which someone replies, "Sounds good, Bro Namath," or "I like it, Brosef Stalin." [sound of glasses clinking].

Someone types that up the next day, all the "Bros" put their names to the paper, and that's it.  Right?

Well, not really.  The devil is always in the details.  What then happens under this all-too-familiar scenario is that one original partner leaves two months later to take a full-time job somewhere else in town.  A second guy ups and leaves to Seattle because Amazon comes calling, and the prospect of just north of 100k sounds better than Ramen noodles with a vague chance of future riches.  A third guy hedges by working part-time at the start-up while putting in 20 hours a week doing freelance consulting...leaving just that fourth original "Bro" running the company.

Fast forward two years.  Bro #4 was the "tech guy" and he's been plodding along building the [Super-App-Streaming-Pixellated-WhizBang-Optimizer].  A major firm peeks behind the curtain, takes a look, isn't really sure what's inside, but figures they could use Bro #4's programming talents and the IP rights to whatever the heck he's been putting together.  They call in some lawyers, some documents get ginned up, and BAM! just like that the little start-up that could has just been bought for the cool sum of $2.5 million.

So what happens to Bros #1-3?  Get ready for a legal brawl.

Because the founders never built in a vesting plan, never wrote up an agreement about even a single obvious contingency (like, uhh...someone LEAVING!), and never wanted to engage in any of this Awkward Talk back when everything was beers and pizza, they now have to call in lawyers to settle this dispute.

By a sandlot definition of 'fairness', it only seems right that Bro #4 would get the largest share of the pie, Bro #3 would get a smaller piece, and Bro #1 and Bro #2 could get whatever scraps they deserved for however long they stuck around.

But it's never that easy...and those legal fees can sure take a bite out of whatever piece of the $2.5 mill someone thinks he deserves.  And the only legal or quasi-legal document lying around that has any weight in the matter states pretty clearly that it's a 25 percent equity game all around.

If this all seems way too obvious to be believable, trust me, it's not.  This sort of thing happens to start-up founders all the time.  People even found companies, build Boards of Directors, and then get fired by those very same Boards because they didn't piece the agreement together in a way that protected the CEO from that very scenario, which probably seemed so implausible as to be laughable at one point in time.

This point is so important that when serial entrepreneurs talk about it, they emphasize how the biggest change they made going from Venture #1 to Venture #2 to Venture #3, etc. was the quickness with which they had The Talk with their co-founders.

People tend to not want to bet on single-founder start-ups, but I would say the only thing worse than a single founder is a group of founders who haven't figured out how they're going to handle basic contingencies.

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