On July 17th, Corbin Church taught a workshop to iHUB entrepreneurs on Equity Strategies. He shared numerous instances – that happen all too often – of young entrepreneurs partnering with their roommates, mission companions, best friends, etc. when that individual did not bring a strategic advantage or skillset to the partnership. Rather, they brought the founder comfort in having a friend along for the ride. Worse still, they split the company 50-50.
“Seldom is your roommate or your best friend your partner,” he taught, “and you should never split your company 50-50. The founder starts with 100% and issues performance-based equity (more on this later) to experts or partners who strengthen the founder where he is weak or lacking experience/knowledge.”
When such equity is granted, it should be in smaller amounts – think single digits – and should be given because the founder does not have the capital or the resources to pay to have the work done. “Hold onto your equity. Anything you give away early on is usually deeply regretted later.” But sometimes due to minimal resources, trading equity for expertise is a necessity for young entrepreneurs.
In circumstances that warrant issuing equity, be certain that it is performance based. For example, you need software development work done for your company, but you lack the $100K to complete the task. So, after carefully vetting this individual’s skills, you decide to exchange equity for your MVP. The agreement is a 8% stake in the Company for developing your MVP. In this case, the agreement might look something like this:
2% of the equity will vest upon delivery of the MVP within 90 days from both agreement to the Figma or framework and after a small beta test proving that the product is fully functioning. Because in this case, if the MVP is not delivered and is not functional, then it has zero value. The developer may have spent hundreds of hours working on the product, but it is worthless to the entrepreneur unless it functions as designed.
After a period of successful testing and debugging, perhaps another milestone is reached and the developer vests another 2%.
12 months from launch, the software is debugged, fully functional and the developer has been a good advisor to the Company in regard to the software, then the balance of his/her equity (4%) shall vest.
This is an example of performance milestone vesting. Another option where decisive measurements do not exist, would be a time-based option. In this option, the recipient of the issued stock would have such ownership vest based upon achieving certain milestones of time. For example, you come up with an idea with a few of your friends. It is truly a scenario where each of you shared equally in the creation of the idea. It is decided that you will share the ownership equally, third/third/third. In this circumstance, it would be prudent for everyone’s ownership to vest based upon time. Here is how that might look:
After 12 months, anyone still actively engaged in the Company will vest 5% of their stock.
After an additional 12 months, anyone still actively engaged in the Company will vest 5% of their stock.
After an additional 12 months, anyone still actively engaged in the Company will vest 5% of their stock.
The remaining 18.33% of each founder’s stock will vest upon a liquidation event of the Company and assuming that person is still actively engaged in the Company.
“Mark my words, seldom do each of the founders make it to the end of the first year, let along the finish line,” taught Church. “Those first years are a tough grind, and few have the mettle to stick it out. Which is okay, just don’t let them walk away with the Company’s equity. Equity is for those who make great sacrifices early and are with the Company to the very end.”
Lots of mistakes are unknowingly made by young entrepreneurs early on and they are often very difficult and/or costly to undo later. Please seek advice from a knowledgeable expert or legal counsel before making agreements regarding your company’s equity. Corbin Church and others are available at iHUB to help young entrepreneurs facing such challenges.
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