Co-founders need a pre-nup agreement
By Ray DePaul
We see it all the time. Two (or three or four) friends come up with an idea and based on the fact that they were both present when the lightbulb went off, they become equal partners in turning the idea into a business. In a matter of months, even weeks, it’s clear that there’s a discrepancy in the effort, commitment, and value provided by each of the partners. The individual who is adding the most value becomes bitter and the future of the company and the friendship is now in serious jeopardy.
A couple of truths to consider when starting a venture with someone:
- Ideas are free.
Unless you’ve invented and patented a truly novel way to do something valuable, it’s unlikely that your idea isn’t already being pursued by dozens of others at the same time. So why would you divvy up the company based on who was in the room when the idea was born?
- Execution is everything.
Execution is a multi-year, challenging process that will determine success or failure, and usually involves pivoting away from the original idea. It makes more sense to reward execution than the founding idea.
- The founding team is rarely sufficient.
It is very likely that you will need to bring a third or fourth key member onto the team. These individuals will be as critical and often more critical to the success of the company as the founders. They will expect equity and you will need to make room for them.
- People are created equal, but partners may not be.
It’s hard to swallow, but sometimes one partner cannot add the same value to the company as the other partner. A partner who creates a logo or a simple cashflow spreadsheet is not adding the same value as one that builds a prototype or secures the first customer.
The solution to this challenge is actually quite simple - a pre-nup agreement. This document between co-founders acknowledges the limited value they’ve created at the beginning of the relationship and rewards equity in the company based on the ongoing value that is created. For example, each founder could immediately get 10% equity in the company but the remaining 80% is earned (or vested) over time based on committing effort and/or hitting milestones important to the company. If one partner is unable or unwilling to commit the time, then they are left with a small but fair piece of the company and the other partner can recruit someone else on to the team with the available equity.
The time to make this agreement is before you get too far into the “marriage”. It’s a very easy conversation when everyone feels that they are equally committed. It’s one of the hardest conversations to have when you are one year into an inequitable relationship.
As you probably know, I’m not a lawyer and I can’t even claim that some of my best friends are lawyers. If you are serious about your venture, you should talk to someone who knows what they’re doing. But at the very least, have a conversation with your partner and document how you will each earn equity in the company. It might save your business and your friendship.