Co-Founder Equity Mistakes to Avoid | Startup School

Summary

This video, presented by Michael Cybal, provides advice on equity splits and co-founder dynamics for tech startups aiming for VC funding. The key takeaway is to be generous with co-founder equity, focusing on long-term motivation rather than short-term considerations. Topics covered include the importance of vesting and cliffs, the need for essential contributors, and guidelines for handling co-founder breakups. Cybal emphasizes that co-founders must be motivated for future work, and CEOs should ensure equity is used as a tool to inspire commitment and collaboration over the startup's journey.

Takeaways

• 😀 The video focuses on co-founder equity splits and breakups, specifically for tech software startups expected to be VC-funded.
• 🤔 Generosity with co-founder equity is encouraged to motivate the founding team, especially during the early, challenging years of a startup.
• 💡 The speaker advises against stinginess with equity, as it can lead to team members leaving when the startup is still in its nascent stages.
• 📉 The 'Jedi founder' and 'dumb founder' are both characterized by their generosity with equity, while the 'midwit' overcomplicates equity calculations.
• 🔄 Vesting and cliffs are important tools for equity distribution; they ensure equity is earned over time and protect the company if a founder leaves.
• 🛠 The founding team should be small but capable of building an MVP and getting it to customers, emphasizing the importance of essential co-founders.
• ⏳ Equity is meant to motivate future work, not just reward past contributions; the bulk of the work in a startup is often ahead, not behind.
• 🚫 The CEO should have the authority to let go of underperforming co-founders, regardless of equity split.
• 🤝 Co-founders should discuss and agree upon the terms of equity and potential breakups before they occur, especially pre-product market fit.
• ❌ Unequal equity splits due to reasons like 'I had the idea' or 'I started working earlier' are discouraged as they reflect short-term thinking.

Q & A

What is the main advice given for co-founder equity splits in tech startups?

The main advice is to be generous with co-founder equity, aiming to motivate the founding team to work hard, especially during the early, uncertain years of a startup.

Why is it recommended to avoid stinginess with equity in the early stages of a startup?

Stinginess with equity can cause key team members to leave during the critical early stages when the startup is still trying to achieve product-market fit, potentially derailing the entire venture.

What is the typical recommendation for equity distribution among co-founders?

It is recommended to go for close to equal equity splits, as this can help maintain motivation and commitment among co-founders.

What is the purpose of vesting and cliffs in equity distribution?

Vesting and cliffs are used to ensure that equity is earned over time and to protect the company in case a founder leaves before a certain period, typically one year, by allowing the company to reclaim unvested equity.

Why is it important to consider the essential nature of co-founders when distributing equity?

Equity should be distributed to those who are essential to the founding team, as defined by their contribution to building an MVP and getting it to customers, to ensure that only those who are truly necessary to the startup's success are included.

What should a CEO consider when deciding on the equity split for co-founders?

A CEO should consider how the equity split will motivate co-founders not just in the present but over the entire expected duration of their commitment to the company, which could span several years.

Why is it not advisable to have performance-based equity in early-stage startups?

Performance-based equity is not advisable because it's difficult to set clear goals in the early stages, and startups often pivot, making predefined performance metrics irrelevant.

What is the recommended approach if a co-founder leaves or is fired before the one-year cliff?

It's typical for a co-founder who leaves or is fired before the one-year cliff to receive only a token amount of equity, often between 2% to 5%, and may have to give back some equity.

How should a CEO handle the situation if they themselves are not performing or wish to leave the company?

If a CEO is not performing or wishes to leave, they should understand the expectations and processes similar to other co-founders, including potentially resigning from the board and relinquishing certain rights.

What is the rationale behind not considering part-time founders as full co-founders?

Part-time founders are not considered full co-founders because the commitment required to build a successful startup is significant, and part-time involvement is often incompatible with the level of dedication needed.

Why is it important to be generous with co-founder equity even if one founder stays with the company longer?

Being generous with co-founder equity is crucial because the early years of a startup are critical for value creation, and co-founders provide the initial momentum needed for the company to succeed, regardless of who stays longer.

Outlines

00:00

🤝 Co-founder Equity Splits and Motivation

Michael Cybal discusses co-founder equity splits in the context of tech software startups expected to be VC-funded. He emphasizes the importance of being generous with equity to motivate the founding team during the challenging early years of a startup. Cybal warns against being stingy with equity, which could lead to team members leaving when the company is most vulnerable. He introduces the concept of 'vesting' and 'cliffs' as tools to protect the company's equity structure, suggesting that equity should be earned over time with a significant portion only vesting after a 'cliff' period, typically one year. The goal is to ensure that co-founders remain motivated and committed to the company's long-term success.

05:00

🚫 Avoiding Common Pitfalls in Co-founder Equity

The paragraph addresses the reasons why some co-founders might be tempted to give out equity too liberally or unequally. It stresses the importance of ensuring that co-founders are essential to the founding team and that the co-founder title is not given out indiscriminately. It also highlights the CEO's role in having the authority to let go of underperforming co-founders. The paragraph provides guidelines for handling co-founder breakups, suggesting that if a co-founder leaves before the one-year cliff, they should receive only a token amount of equity, typically 5% to 2%. It also touches on the expectation that co-founders should resign from the board and relinquish certain rights if they leave or are fired.

10:02

💡 The Importance of Long-term Thinking in Equity Distribution

Cybal argues against short-term thinking when it comes to equity distribution, advocating for a long-term perspective that considers the future needs and contributions of co-founders. He challenges common but flawed reasons for unequal equity splits, such as one co-founder coming up with the idea, starting work earlier, needing a salary, or having more experience. The paragraph emphasizes that execution is more critical than ideas and that all co-founders should be motivated to contribute to the company's success. It also cautions against performance-based equity, part-time founders, and dynamic equity agreements, suggesting that these can create uncertainty and are not in line with best practices for startup equity distribution.

15:02

🌟 Recognizing the Value of Early Contributions in Startups

In this final paragraph, Cybal reflects on the long-term success of companies and the role of co-founders. He points out that while one co-founder might stay with the company longer and appear more valuable, it's crucial to recognize the importance of all co-founders' early contributions. These early efforts are often what give a startup the momentum it needs to succeed. Cybal suggests that even the co-founder who remains with the company the longest should be generous with equity, as it's the collective early efforts that set the stage for future success. The paragraph concludes by reinforcing the idea that equity should be used as a tool to motivate and reward co-founders for their critical role in the startup's initial stages.

Keywords

💡Co-founder Equity

Co-founder Equity refers to the ownership stakes given to the individuals who start a company together. In the context of the video, it is emphasized that these stakes should be generous to motivate co-founders to work hard, especially during the early and challenging stages of a startup's life. The video suggests that equitable distribution of equity is crucial for maintaining motivation and preventing resentment among team members.

💡Equity Splits

Equity splits are the division of ownership shares among co-founders. The video discusses the importance of fair and generous equity splits to ensure that all co-founders feel valued and motivated to contribute to the company's success. It warns against overly complex calculations and recommends close to equal splits to maintain harmony and commitment within the founding team.

💡Vesting

Vesting is a process where equity is earned over a period of time, typically four years in the tech startup world. The video explains that vesting is a tool to ensure co-founders stay committed to the company for a significant duration, as leaving before the vesting period ends means they won't receive all their equity. This concept is central to the video's theme of long-term motivation and retention of co-founders.

💡Cliffs

A cliff in equity vesting is a period at the start of the vesting schedule during which no equity is earned. The video uses the example of a one-year cliff, meaning co-founders must stay with the company for at least a year to begin earning their equity. Cliffs are highlighted as a protective measure for the company, ensuring that co-founders are committed and not just leaving after a short period.

💡Pre-product Market Fit

Pre-product market fit refers to the stage before a product has been validated in the market and proven to meet customer needs. The video focuses on this phase, emphasizing that equity discussions and decisions are particularly critical during this time because it's when the company's future is most uncertain, and co-founder motivation is key to survival and growth.

💡Co-founder Breakups

Co-founder breakups refer to situations where co-founders leave or are asked to leave the company. The video provides guidelines on how to handle such breakups, including the return of equity and the treatment of the departing co-founder. It stresses the importance of having these conversations upfront to avoid conflicts and to ensure the company's continued success.

💡Token Amount of Equity

A token amount of equity is a small percentage of ownership given to a co-founder who leaves or is fired before the one-year cliff. The video suggests that this is typical and reasonable, as the company is still in its early stages and the departing co-founder has not contributed significantly to the company's value creation.

💡Severance

Severance in the context of the video refers to a small financial package given to a co-founder who is fired, typically for 1 to 3 months. This is presented as a reasonable practice to acknowledge the co-founder's contributions and to facilitate a smooth transition, though it's noted that it's not typical for co-founders who voluntarily leave.

💡Proxy Voting Rights

Proxy voting rights allow one party to vote on behalf of another, which in the context of the video means that departing co-founders may be asked to give their voting rights to remaining founders. This ensures that the remaining team can make decisions without the influence of a co-founder who is no longer actively involved in the company.

💡Performance-Based Equity

Performance-based equity is an approach where equity is granted based on achieving specific goals or milestones. The video argues against this practice in the early stages of a startup, as it can be too complex and may not align with the fluid and changing nature of a startup's objectives. Instead, the video advocates for straightforward equity分配 that motivates co-founders without the need for complex performance metrics.

Highlights

Co-founder Equity splits and co-founder breakups are crucial discussions for tech software startups expecting VC funding.

The core advice is to be generous with co-founder Equity to motivate the founding team during the challenging early years of a startup.

The biggest mistake is being stingy with Equity at the startup's beginning, which could cause team members to leave.

Generosity in co-founder Equity is key to keeping a strong founder motivated and committed to the startup's success.

Co-founder Equity should be distributed with the intention of keeping team members motivated over a four-year period or longer.

Equity is typically vested over time, meaning it's earned progressively, and a 'cliff' ensures that founders commit to the company for at least a year.

Co-founders must be essential to the founding team, contributing to building an MVP and getting it to customers.

The co-founder title should be reserved for those who are indispensable to the startup's early success.

Equity is meant to motivate future work, not just reward past contributions.

The CEO should have the authority to let go of underperforming founders, regardless of Equity splits.

Co-founders should discuss potential breakup scenarios to understand how Equity would be handled if the relationship sours.

If a co-founder leaves before the one-year cliff, it's typical for them to receive only a token amount of Equity.

Unequal Equity splits can be detrimental, and the reasons for such splits should be carefully considered.

Idea origination is not a valid reason for a significantly unequal Equity split, as execution is more critical.

Equity should not be reduced because a founder requires a salary; these should be considered separately.

Experience and prior work do not justify a large Equity disparity, as the bulk of the work lies ahead for a startup.

Fundraising success does not warrant unequal Equity分配, as the real work starts post-funding.

Performance-based Equity and dynamic Equity agreements are not recommended as they can create uncertainty and are not best practices.

Long-term thinking is crucial when distributing co-founder Equity; the early years are pivotal for a startup's success.

Even in successful companies, the early co-founders' contributions are invaluable, and they should be generously rewarded.

Transcripts

[Music]

hello I'm Michael cybal and today I'm

going to talk about co-founder Equity

splits and co-founder breakups to be

clear we want people who are building

tech software startups that they expect

to be VC funded you know this is advice

for you I can't really comment on other

types of businesses there are many types

of businesses that have that have equity

and and to be clear this is not really

about them also this is really focused

on conversations that Founders are

having in the beginning of a company for

pre-product Market fit companies you're

really talking about the beginning of

companies all kinds of interesting and

crazy things happen later on and I it

would be a misuse of this video and this

advice to apply to companies that are

later on or to apply to companies that

are not tech companies so here's the

tldr the core advice we want to give is

be generous

with co-founder Equity what you're

trying to do is motivate your founding

team to work extremely hard when it

looks for many of the first couple years

like things are not working the biggest

mistake is to be stingy on Equity during

this very very very delicate time in the

beginning of a startup causing people to

leave while it's still possible you

might make something big so the Jedi

found founder and the dumb founder

they're both generous with co-founder

Equity the uh midwit oh they're thinking

about skill sets and contributions and

time commitments and the network and

futurals and D thinking about all of

these things and trying to do a really

complicated calculation I'm going to

argue today that's not required let's go

over what we're talking about first

co-funder Equity spits then co-founder

breakups bad reasons for very unequal

Equity splits bad advice and then some

final thoughts all right co-founder

Equity um in my experience the mistake

that Founders make is they don't think

about how to motivate their team their

founder co-founders today and tomorrow

typically you're giving people Equity

over that they're going to earn over the

course of four years and you don't want

them to be thinking in year 2 year three

year four I don't have enough equity I'm

not motivated or or I have this amount

of equity and the CEO has four times

more but I'm grinding every day and I've

been here since the beginning which

would create resentment so the job of a

CEO when Distributing co-founder Equity

is to not just think about what's going

to convince your co-founder to work on

your company today is to think about

what's going to keep them motivated over

the course of all four years and

hopefully much longer in that situation

our typical advice is to go for close to

equal Equity splits don't have to be

exactly equal but the more generous you

are the more you can expect a strong

founder to stay motivated

next vesting and cliffs most often when

you're giving Founders Equity that

Equity vests over a period of time which

means it's earned over a period of time

and if you

leave during that period of time you

don't get all of the equity in addition

a cliff is essentially designed to say

if you don't make it to this moment in

the company's history if you don't make

it through year one you don't get any of

your Equity Grant both of those tools

are extremely valuable and they should

apply to all founders I have to be

honest sometimes Founders ask me why are

we doing this like we all like each

other we're not going to break up

nothing's going to go wrong I would just

say this giving away founder Equity is

not something that you should be

innovating on

and the best practice is that all of

equity comes with vesting and cliffs

when it's given to Founders life happens

crazy happens sometimes people have

to leave and they don't even want to

leave sometimes family circumstances

change sometimes people get sick

sometimes people don't

perform so by having vesting and having

a cliff that gives Founders the ability

to let other Founders go or for those

Founders to leave without destroying the

cap table so you should be using vesting

in Cliffs what's extremely typical is

four-year vesting you earn your stock

over four years and a one-year Cliff you

don't earn any stock until you've hit

one year of working at the company NeXT

your co-founders must be essential to

your founding team one of the things I

think about with a founding team is like

it's the smallest number of people who

can get an MVP built get it in the hands

of customers and start learning one of

the reasons why we tell people one of

the other reasons why we tell people to

be generous with their Equity is it

helps them remove quote unquote

co-founders who are not essential who

really shouldn't be on the team or

perhaps should be employees instead of

Founders you should understand that like

the co-founder title is not something

that should just be given out

willy-nilly you know teams that come

into YC with you know five six seven

co-founders clearly there's something

weird some conversation hasn't happened

it's almost always the case seven people

are not essential to getting a product

up and out in the hands of customers

next always remember

that once again in almost every case

when you're giving out co-founder Equity

most of the work in your company hasn't

been completed so this kind of comes

back to the first point Equity is about

motivating people for work they have not

yet done as opposed to rewarding people

for work they have done last things

which are kind of negative one the CEO

should have have the ability to fire

Founders who are not performing and so

however you set up the equity split the

CEO should Reserve this right and

honestly there has to be a captain of

the ship there has to be someone who's

ultimately held accountable and they

need to be given the responsibility to

let people go who aren't performing if

you're not willing to join a team under

these

circumstances that's tricky I would say

that you're you're not understanding the

seriousness of a company or maybe you

should go start a company and be the

CEO um but the CEO should have this

responsibility they should um regardless

of the equity split and then finally

what's most responsible is if

co-founders have a conversation about

what will happen if things don't work

out now let me give you some guidelines

at least YC's thoughts on how that

should go if you have a co-founder

breakup and you are pre-product Market

fit here are some guidelines that YC has

seen work over the years and these are

things that perhaps you should consider

talking amongst the co-founders so first

if a co-founder leaves or is fired

before their one-year Cliff it's

extremely typical for them to get just a

token amount of

equity 5% to 2% remember this is

pre-product Market fit so there's no

evidence that the company is going to

work and the vast majority of work still

has has to be done after the onee near

Cliff but pre-product Market fit we

recommend that if a Founder leaves or is

fired they leave with no more than 5% of

the company which often means they have

to give back some Equity now this can be

a tricky conversation but when a

company's pre-product market fit once

again so much work is left to be done

and you want to motivate the people who

are remaining at the company to

distribute that Equity to people who can

actually help continue to increase the

value of the company employees and

Founders the founder who's leaving can't

help increase the value of the company

anymore so if they're holding a whole

bunch of equity they're basically

reducing the chances of the company

being successful and therefore reducing

the value of their Equity so that's why

I recommend if a Founder is leaving or

is fired after their one-year Cliff they

should retain no more than 5% of the

company NeXT if a Founder is fired it's

extremely reasonable for them to give in

a small Severance you know 1 to three

months but if a founder

leaves that's not typical um you can do

it but it's not typical and finally

every founder regardless of whether they

leave or they're fired should be

expected to resign from the board sign a

release um and often give proxy voting

rights to the founders that are

remaining basically allowing the

founders that are remaining to vote

their shares more often than not it is

the

non is a Founder that's not the CEO who

is going to either leave or be fired but

I will say this um sometimes it's the

CEO right life happens and so if that's

the case whoever the new CEO is has to

kind of arrange this breakup accordingly

and even the CEO the previous CEO should

understand these expectations because

you know like I said sometimes CEOs

screw up and they or sometimes CEOs

choose to leave so with the expectations

on how equ Equity should be distributed

and

um what happens with the breakup let's

talk about um some cases where we see

unequal Equity splits that uh let's just

say don't make any sense the first and

most common bad reason for a massively

unequal Equity split is well my

co-founder agreed you know I own 90% of

the company I asked my co-founder if

they're willing to own 10 they said yes

so everything's good right I would say

as a CEO this is a perfect example of

optimizing for today and not optimizing

for tomorrow you should be thinking not

what is your co-founder going to be

happy with today you should be thinking

about what's your co-founder going to be

excited with when it's year three of the

company and everything sucks what's

going to keep them motivated to stay and

work extremely hard then and as CEO you

always have to be thinking about

tomorrow regardless of whether your

co-founder does and you probably should

be more generous with your Equity to

compensate for when those bad times are

happening how do you keep keep that

co-founder motivated next well I came up

with the idea so I deserve more Equity

right it was my idea they're just

building it we get almost 30,000

companies apply to YC every six months

and we see every idea that exists it's

extremely obvious that ideas are a dime

a dozen and execution is the game here

and that co-founder is going to be

essential in executing the company and

if they're not they shouldn't be a

co-founder so I come with an idea is not

a great reason for a 99010 equity but

next I started working 6 months before

my co-founders so I deserve a lot more

Equity they weren't there at the

beginning well you still have to ask

yourself how much work is left to be

done if this is a traditional tech

software startup then 99% of the work is

left to be done this could be a 10 20

30y year Journey if it's really

successful and a difference in starting

date of 6 months probably is not that

significant when it comes to it next my

co-founder needs a salary and I don't I

would argue that you should be thinking

about salary and Equity differently

salary is the money that someone needs

to live to pay their rent to buy food to

literally give themselves the ability to

work in your company Equity is what's

going to motivate them to work extremely

hard and do extremely well and often get

a below Market salary so I never like to

think about reducing someone's Equity

because they need more salary I always

like thinking about giving every person

on the founding team the salary they

need so they can live for some people

that might be zero if they come in with

some money and then giving people the

equity they need to be motivated to work

extremely hard all right next I'm older

and much more experienced than my

co-founder you know this is a tricky one

um certainly people who are more

experienced can contribute to the

company can help fund raise often there

are many things they can do that a

younger less experienced co-founder

can't but if you're making this person a

co-founder that means that they're going

to have to be a key contributor to the

team that should mean you couldn't do it

without them so you should be very

careful about how motivated that

person's going to be you should be

generous with Equity as a result next

well I hired my co-founder after raising

some

money well once again you know

fundraising I think people are surprised

that fundraising doesn't massively

change your chances of being successful

there lots and lots and lots of startups

that raise money and very few that go on

to generate a billion dollars in Revenue

so I would argue that even if you have

$100,000

$500,000 in um in investment 99% of the

work is still left to be done then

finally I hired my co-founder post

launch same

thing that first launch of MVP is just

the beginning of the journey so to sum

up I think that all of these answers are

a flavor of the same thing it's a flavor

of short-term thinking the best founders

are long-term thinkers the best Founders

are not only thinking about today but

they're thinking about tomorrow and the

best Founders are thinking about their

co-founders needs even if those

co-founders are not thinking about them

it's the best Founders the best CEOs

understand that this small team has to

accomplish a lot or else the whole

Endeavor isn't going to work the best

Founders is using Equity to try their

best to motivate people to work

extremely hard they're not thinking

about Equity as something that should be

hoarded they're thinking about Equity as

a tool that can produce maximum

motivation for a small number of people

so let's move on to some common uh let's

say bad advice that I see right so if

our advice ISS hey you should be

generous with your co-founder Equity um

you want to motivate people for the long

term and you should protect yourself by

have investing in Cliffs some bad advice

that I see is like oh we should have

performance-based Equity um you know if

my CTO writes this number of lines of

code or if my you know if the founder

that's doing sales like generates a

million dollars in Revenue will set

their Equity based on that needless to

say at the beginning of the Journey of a

tech startup it's really unclear how to

set those types of goals um and those

goals change we see companies pivoting

and thinking that you can kind of

measure things so precisely at the start

is a really big fallacy furthermore uh

this is probably not an area that you

should be innovating should innovating

on your product and how you interact

with your customers um Distributing

Equity there are best practices that

tend to work so that's why Performance

Based Equity is not something I would

consider well what about part-time

Founders um I would argue that a

part-time founder isn't a founder and

shouldn't really be considered in this

equation I know there are some edge

cases where there are some part-time

Founders or like you know people who

swop in and swop out and y y y but I

think if you look at the most viable

companies in the world you don't see a

lot of prevalence of part-time Founders

so I just don't think they should be

considered if you want to be a Founder

you should be working full-time and then

like what about other kinds of like

Dynamic Equity agreements like oh if the

company accomplishes this or if y y

happens and like the equity is not

really set if you're trying to motivate

people it's really nice for them to know

what they have and especially Founders

they're going to be a lot lot more

motivated if they know what they have

when they're starting versus some weird

kind of thing that's like hard to Define

in the rules might change Etc so I think

you know these options are too fancy and

oral advised often times they're created

because people don't understand the

value of vesting in a cliff if founder

relationship isn't working out that

founder should leave or be fired and

that should happen before the cliff

that's your protection that's your

protection if things aren't working out

not fancy formulas and weird kind of

madeup stuff and to be honest if you

don't have

the

wherewithal to ask a co-founder to leave

if they're not performing or as a

co-founder if you realize that you're

not able to perform if you don't have

the wherewithal to leave on your own

accord you shouldn't be doing this like

you're not respecting how hard this is

and how much work your co-founders are

putting into it that's why vesting

Cliffs work that's your downside

protection and that gives you the

ability to be generous with your Equity

um as opposed to create fancy schemes so

to wrap up um one common thing that you

see among successful companies is that

over the long term over 10 over 15 years

um one founder will often stick with the

company a lot longer be more responsible

uh for a lot longer and you could argue

was more valuable to the company right

you know you see these famous companies

like Amazon and Jeff Bezos or uh Mark

Zuckerberg at Facebook etc etc that's

true and you would think that that means

that those

people should deserve vastly more Equity

than their co-founders who might not

have stuck around for you know a decade

Etc here's the tricky bit about that it

turns out with tech startups the

beginning is extremely important those

first four to six years is where a lot

of value is being created and those

first four to six years is when most

companies

die so I would argue that even if you're

in this lucky situation of your company

being massively successful and you know

you being the one who stays around the

longest you still want to be extremely

generous with co-founder Equity because

those co-founders actually got you the

energy of activation your company needed

to even be in the game and without them

maybe you're not in the game at all and

you don't get to see this company scale

to something great you should really

understand how important the early years

are and the co-founders are and

co-founder motivation is to making

successful products happen and you

should use your co-founder Equity to

give yourself the best chance of

building something that people want

after

that hey man you're Off to the Races

you're doing better than 99% of other

startups and of course the rules change

[Music]