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Right equity amount for exited co-founder/friend?

I've been working on my venture for two years. My original co-founder, a good friend who worked with me for the first year, exited amicably with 11.5% equity, before we ever tested our product or had an investor. Now that we're testing and are close to finishing our $1 million seed raise ($4 million valuation), that co-founder and I are discussing readjusting our agreement. He's willing to lower his equity stake for a relatively modest amount of cash. I'm not looking to get greedy though, I want him to have as much equity as he can without setting off redflags from investors now or when we hopefully go for our Series A or B. What's an appropriate amount of equity for this co-founder?

6 Replies

Ron Warshawsky
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Ron Warshawsky Advisor
Founder and CEO of Enteros. Years of successful experience in startup business and database technology.
Greg,

This is my personal opinion and in no way a legal or any kinds of professional advice. You should get advice from a corporate attorney with the angel/venture investment experience.

IMHO, up to 2.5% would be a reasonable amount of equity for him to hold. Considering that he will be diluted by coming investment rounds, this should be acceptable to investors...
Mike Moyer
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Mike Moyer Entrepreneur • Advisor
Managing Director at Lake Shark Ventures, LLC
His equity is valued at 11.5% x $4 million pre-money = $460,000
Barry Burr
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Barry Burr Entrepreneur
founder, Barry Beams llc, a startup to re-light your night.
Sounds like he took you for a ride already. Give him nothing. Just my opinion based on the small amount of information you described. Helmet Side Up, Barry
Andy Freeman
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Andy Freeman Advisor
Product Management and ... - Looking for new opportunities
What do your potential investors think about you spending "their" money this way?

I ask because many early stage investors want to see all their money going to the business, not increasing your ownership share. (Yes, they may see see some increase as well, but I suspect that you're getting the bulk of the benefit.)

They might be happier buying him down themselves. I suspect that you'd object to that, but "shoe on the other foot" and all that.

Yes, you can argue that you're entitled because you did the work, but that's like arguing that they should take the hit because you paid a contractor too much.
Tom DiClemente
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Tom DiClemente Advisor
Management Consulting | Interim CEO/COO | Coach
How important was his contribution to future free cash flow?

Might you need his help again in the future?

What does he think is a fair reduction in equity and payment for past services?

What do your investors think about this transaction?

Does he have anti-dilution rights?

If you do go through with this transaction, please consider not making a payment in current cash but instead making a conditional payment in the future based on the company successfully reaching certain free cash flow criteria, and then only a payout over time. Talk to your investors and get their advice. They may have other suggestions that fit their objectives. Remember, that in taking in new money, assuming he does not have anti-dilution rights, you can also structure the deal in a way that he becomes diluted to the percentage you think is fair. This can, or cannot at your option, be combined with some fair future conditional payout.

There are many ways, it is a common situation.
Michael Barnathan
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Michael Barnathan Entrepreneur • Advisor
Co-Founder of The Mountaintop Program, Google Alum
The investors would likely prefer that you buy him out of his share if possible. I disagree with the people who say he should receive nothing, assuming he helped build/sell the product and hit the agreed upon vesting milestone (if founders aren't vesting, expect the VCs to ask for that as well) - if he contributed and there was an agreement in place, it isn't equitable to try and screw him out of the equity he's earned according to the agreement without offering fair compensation in return.

I'm sure the two of you can negotiate a fair buyout. If you'd like him to keep a small amount of equity and he's motivated / performed well / has useful knowledge, you could offer to retain a 1-2% stake, buy out the rest at FMV (or at least something he's happy with), and keep him on as an advisor - investors should be OK with that.
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