The importance of vesting

Image courtesy of FreeDigitalPhotos.netYou most likely heard about vesting. VCs often talk about it in their blog posts. Somehow startup founders still find it tricky to understand what vesting is about.

We’ll try to explain it here in the easiest way possible. It’s hard to overestimate the importance of vesting. If you are a founder you need to get used to this concept as early as possible in your entrepreneurial career.

Otherwise, you may find yourself in a situation Mark Zuckerberg talks about: He didn’t know what vesting was at the point when he started the company, and it cost him billions of dollars because of his co-founder Eduardo Severin.

The notion of vesting comes from a legal universe. Vesting is a common provision in equity schemes. Vesting means receiving the right (to the shares of equity).

To put it simply, if founders agreed to divide equity with a vesting condition, what they get at the beginning is unvested equity, which is just a promise. A promise that they will get their shares of equity as agreed only if they certain vesting conditions are met. The most common vesting condition is to stay with the company long enough for the equity to vest. Vesting conditions may include various milestones important for the company. An example would be getting 1 mln. of registered users – if this happens, founders may agree to have accelerated vesting of 25% of their shares of equity.

Vested shares are the shares the founders already earned. Founders can walk away with those shares if they decide to leave the company. That will be fair, as they received those shares for all their hard work.

Vesting is important even for teams with unequal equity splits. In fact, vesting has little to do with equal or unequal splitting. Imagine there are three of you, you split your startup equity 45%-35%-20% and get to work. In a month a founder with 35% looses interest in the project and leaves… taking 35% with him! The other two work hard, get VC money, become famous and in 6 long years launch an IPO. Of course, over those years 35% get diluted to, say, 7%, but that’s 7% of a billion dollar company – not bad for a month of work, heh?

That’s a made-up example, of course, but if there were a vesting provision in place the founder who left in a month would get no equity. And this would be fair to those who stayed and made their company a huge success.

Image courtesy of FreeDigitalPhotos.net
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What it takes to build Facebook

To continue our series of weekend videos, here is a nice one from Y Combinator in which Mark Zuckerberg talks about early days in Facebook. Highly recommended to watch. For those who don’t have time for a 36-min. piece, here are our favorite lessons-to-learn from the video:

– On motivation: Stay inspired by what you are doing. There will always be skeptics saying that your thing can’t be a business. Just care about what you are doing, and that’ll drive you forward.

– On hiring great people: The only way to determine whether a person you are hiring is really good is to realize if you would want to work for that person.

– On making decisions: Out of a hundred things that you can potentially go do, pick up the one that actually matters.

– More on motivation: In the early days Facebook had a serious competitor called “College Facebook”. Every time the competitor would launch at a new school, the whole Facebook team would literally not leave the house and work until they address the problem. They still have this concept of “lock-down” at the company and many teams do it themselves.

– On founder equity (we couldn’t miss this one!): All founders must be on vesting schedule. Mark heard nothing about vesting at the time when they started the company. They just divided equity, and then his co-founder Eduardo left. “That mistake probably costed me billions of dollars” – says Mark. But even when things like this happen, it’s important to move forward.

Two real-world stories: a good and a bad decision on equity split

This video is definitely worth watching. It’s a case study of two startups and their decisions about equity splits between founders. Two real-world stories with lots of wisdom to learn from them.

In short, the first story is about a 50/50 handshake (the equal split!) the Zipcar founder Robin made with her co-founder – and how much angst and regret it caused her shortly afterwards. “It was the stupidest handshake to make” recalls Robin.

The second story is about Ockam co-founders and their decision to split unequally. The decision was very logical because, for instance, one co-founder had worked for the other one for seven years as a junior before they decided to start a company. It was clear that their contributions to the startup wouldn’t be the same. And they did a great job of evaluating different scenarios of how much they would be involved with the startup (what if one of the founders wouldn’t quit his full-time job to work for the startup and so on) and identified different equity splits for every scenario.

Here are the key lessons to be learnt from this video:

  • if you don’t want equity split issues to ruin your startup deal with them early
  • when you deal with them, keep in mind that a 50/50 split is almost never a good solution
  • it’s better to find out early whether you are compatible with your co-founder. Equity talks are the best time to do that.
  • go through several scenarios of how your startup is likely to evolve. Decide how your equity split will be changing depending on the scenario.

The First Win

pitch

The FounderSolutions got into its first ever pitch competition – and WON it!

Thanks go to Pankaj Saharan, our co-founder, who outcompeted around 10 other excellent pitch makers in a contest “Pitch and Beer” held in Helsinki.

Pankaj’s presentation of the idea and vision behind FounderSolutions won appreciation of a panel of strict judges, including a serial entrepreneur Ilkka Lavas (w3.fiilmainensanakirja.fihttp://deitti.net).

Congrats, Pankaj!

The Facebook effect

Do you know how Mark Zuckerberg split equity with his co-founders in the early days of Facebook? Bear with me and read this post to the end, as this story teaches the importance of dividing equity fairly – which almost never means equally.

Zuckerberg was from the very beginning a true leader of the project destined to become Facebook. He was the “idea guy”. He gathered the team around himself and inspired them. He wasn’t focused on money, but “content to make something cool”. His idea and execution attracted great mentors and investors.

Zuckerberg’s early team included Eduardo Severin, who knew business stuff and who gave Mark Zuckerberg $15,000 to pay for the servers needed to run Facebook site, and Dustin Moskovitz, Facebook’s first CTO.

At the beginning Facebook shares were split between them, with Zuckerberg owning 65%, Severin owning 30% and Moskovitz owning 5%.

If you watched the “The Social Network” movie, you should be familiar with the rest of the story. Severin made some false steps failing to perform his duties at the company and even trying to promote his side-startup at the expense of Facebook. Luckily, his share was smaller and Mark Zuckerberg had enough control to do things his way and fix the problem.

What would happen if their team had divided shares equally at the start, with each of them owning 33,3%? Zuckerberg then wouldn’t own the majority of shares and wouldn’t be able to force Severin out of the company. And Facebook would probably never become the successful giant we know today.

Now, think again in the light of this story – will equal split be good for your startup?

This story is based on a much longer, but insightful article from BusinessInsider.com

An exciting day!

Today we’ve come live! Come celebrate with us!

If you are a team of founders ready to divide equity for the first time, or you want to check how fair is your current agreement on equity split, or you are just interested in founder equity issues, you are welcome to visit us at foundersolutions.com and try Founder Equity Solution (FES) model. It’s free and easy to use!

We get many questions from founders why they should use the model if they can always split equally. Well, equal split doesn’t always mean fair. And it actually can harm the startup. If founders split equally and then one of the founders feels that she contributes more to the project, that may cause tension between founders and result in a less stable startup performance. Investors, so the research says, tend to give lower valuations to teams splitting equally, because they suspect that such teams lack entrepreneurial negotiation skills.

FES has everything to help you decide on a fair equity split for your team. Go to the website, open the model, answer the questions and get the recommendation on how to divide equity within several minutes! You may agree with it or not – that’s fine. You may adjust it further with your team. Important is that you can use this recommendation as a starting point in equity negotiations with your co-founders and turn uncomfortable conversations into a fun teamwork!

We hope you’ll enjoy using FES! We’d love to hear your feedback here or at http://foundersolutions.com

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FounderSolutions team

Five things you should know about founder equity (before you split it)

Founder equity (same as founder shares) is how much of the company (or soon-to-be company) belongs to its founders. We listed five most basic – and most useful – facts about founder equity to help you look at it in a new light before you split it with your co-founders.

1. It is an unlimited resource

Founder equity is not a limited resource. It’s an unlimited resource. It’s growing along with your company. Don’t be afraid to share equity with your co-founders, employees, advisers, investors. If you start working on an idea and own 100% of it – that’s 100% of nothing. It has no value yet. Value is created by people you’ll be able to attract and inspire by your idea. If at the end you have 10% of equity, that may be 10% of a billion dollar company. Isn’t it better than 100% of nothing?

2. Treat it as remuneration

At the very early stages of startup lifecycle founders are typically not paid salaries. Equity is then used as remuneration to the founders for the work they do. Similarly to remuneration, shares of equity should be aligned to founders’ performance, their contribution to the project, even the actual time spent working on the startup.

3. No payouts, at least in the short-term

In contrast to remuneration, however, equity is not “paid out”. It is a promise for founders that they will get the right on future company profits, if there are any. While the company is being built and has no real value, the founding team may want to regularly review their fair division of equity to make sure each founder gets a share corresponding to what he or she did relative to other startup co-founders.

4. Fix it when there is funding

The best time to get your division of founder equity fixed is when your startup is ready to raise funds or incorporate the company and use a real shareholder agreement. At that stage founders, if they take on executive roles in the company, usually start receiving salaries. From that moment on equity is a measure of how much control they have over the company and what is their share in the company profits.

5. Vesting is good for it

Founder equity may be subject to vesting. Vesting means that although founders already have certain shares of equity assigned to them, they still need to “earn” them by staying with the company long enough (standard vesting schedule spans over 3 to 4 years). Vesting prevents founders who lose interest in the project and leave from walking away with half of the company – which is good for those who stay and continue working hard to get things done!