Co-Founder Equity Mistakes to Avoid | Startup School
Summary
TLDRThis 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
🤝 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.
🚫 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.
💡 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.
🌟 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.
Mindmap
Keywords
💡Co-founder Equity
💡Equity Splits
💡Vesting
💡Cliffs
💡Pre-product Market Fit
💡Co-founder Breakups
💡Token Amount of Equity
💡Severance
💡Proxy Voting Rights
💡Performance-Based Equity
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]
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