Should You Have Co-Founders?

This is a difficult question, and has no easy yes/no answers. Most likely, circumstances will dictate the decision. But the real point of asking the question is, if you do have one or more co-founders, make sure you do it right. Many founders haven’t.

Someone in your new small business will have to be the Chief Cook and Bottle Washer – the CEO, President, CFO, COO, CTO, CIO, V-P of Business Development, V-P of Sales and Marketing, Director of Personnel and HR, Contracts Administrator, plus someone who does all the rest. That someone could be you; it could be a combination of you and a spouse; it could be you and one or more co-founders. However you structure it, these positions represent substantial tasks, and few first-time entrepreneurs are prepared for it, and don’t even a clue what each task entails.

Besides that, the genesis for your new business venture might have begun over a beer or glass of wine one night – or many nights – with a friend who is bringing as much to the table as you are. It might have been cooked up in a college dorm room, where one person has the technical skills, another has the family money, and a third has the time on his/her hands to run interference (think Facebook). The point is, developing your business idea might have several brains – and they might be just the right brains (and brawn) to pull it off – whereas going it alone might not be feasible.

Almost by definition, a co-founder will be a co-owner of the company, meaning there’s an owner’s split between the co-owners (or shareholding split if it’s a corporation). While this obviously brings additional capability for a shared workload and commitment, it also means more than one mouth to feed when dividends are paid out, or when the company is sold. If you take in a 50/50 partner, but you’re the one who created the idea – and then you put in 75% of the work to make it successful, you’re getting the short end of the stick if you later end up with the 50/50 split when the company is sold.

Should you or shouldn’t you?

Let’s boil it down to fundamental questions you should be asking near the outset of thrashing around your business development idea.

• Are you the sole originator of the product/service ideas behind the company? If you aren’t, it doesn’t preclude you from going it on your own, but you need to be very careful with how you work forward with the business idea (or product idea) from the discussions you’ve already had. If you have concerns around this area, early on is the time you want to get legal advice. The last thing you want is a squeezed-out co-founder who sues you over it, and you lose. Or, after you have the business up and running and someone else lays a claim that it was all their idea and you stole it. According to cnn.money.com, Uber founder and CEO Travis Kalanick has been slapped with a $1B lawsuit by another entrepreneur who claims the idea for Uber is “an exact replica” of a car service the two had discussed years earlier. The claim is that Kalanick pilfered “intellectual property, trade secrets, and years of research”. Whether the suit has any merit is yet to be seen, but in any case, having to defend against a lawsuit can be incredibly distracting, not to mention costly for a start-up.

• Are you ready and capable to take on all of the management aspects of this new company all by yourself? If not, are you willing to share some of the tasks, plus a corresponding percentage of the company ownership in exchange for that help?

• Do you have the capital – both real money and sweat equity – to go it alone? Some businesses have little barrier to entry; others have large barriers. Some businesses require significant up-front capital (or significant up-front time) for product development – long before any revenue comes in the door. If you can’t raise the necessary launch money, or if you can’t manage all of the product development challenges on your own, you might have no choice but to bring in a partner who has the financial or manpower resources to assist.

• Do you have the personality and temperament to work with a partner, to put up with their differences in opinion/work ethic/skills/foibles in a business venture? As a rule, one of the co-founders will have to be in overall charge of the big company decisions; the other co-founder(s) can still be in executive-level positions, but it should be worked out ahead of time how differences of opinion will be settled.

• Is this person compatible enough with you to share ownership of something as important in your life as a business? Business partners will be like marriage partners in many ways – almost to the point of spending more time together than with a spouse. They can be like-personalities or unlike-personalities – there are no rules or suggestions on it – but whatever it is, there needs to be a decided level of working relationship if you’re going to succeed.

• And the most important question might be: Is it really necessary for the person you’re thinking of as a co-founder and partner to actually co-own the company with you, or would you be better served to hire him/her as an employee? Many people simply aren’t cut out to be business owners – with its attendant financial and liability risks, increased workload, increased stress – and who would just as soon be a hired hand in your business. If that’s the case, by all means, sign that person on as an employee – you’ll never regret the decision. (The downside is, that person might have put heart and soul into it as a co-founder, but only 9-5 as an employee.)

This situation is particularly true when you have someone for an immediate need – such as initial design work on a product, or part of a software development project – but once that’s over there isn’t further value to the start-up. Rather than giving that person a share in the company, figure out how to hire them as an employee or pay them for their work and say goodbye.

However you resolve these questions, the important thing is, make certain that you do!

If you decide to have co-founders – get it right.

Co-founder situations often start out nice and friendly and cooperative – and they often don’t end that way. There’s no rule of thumb, and there’s no way you’ll ever know ahead of time. Statistically, over half of all business partnerships fail, most often because they weren’t set up right from the get-go. Here are some ideas that might help you get it right:

• Know your co-founder well. Before you settle on a co-founder decision, pay close attention to how this person behaves. Check for signs of character flaws that won’t fit in with the company culture you have in mind. Is the person cool under pressure … treats other people well (including yourself, vendors, future customers, future employees) … trustworthy and holds up his/her end of the bargain … shares your ideas of financial management (i.e., handles own personal finances well) … shares your ideas for how to divvie up management and control of the company … shares your ideas for the goals of the company. If any of these areas send up red flags, it’s important to deal with it now rather than later.

• Discuss and agree on long-term goals. All co-founders need to understand and be on the same page about the company’s long-term goals – and importantly, have bought into whatever that entails. If the goal is to reach a particular business objective by such-and-such timeframe, or conquer a specific marketplace, or reach a certain product level, then everyone in the co-founder group needs to be in agreement. This isn’t something that can just be assumed. It needs to be specifically laid out in a business plan, including how the company is to get there, and who has to do what to achieve it (this can be a single-purpose, internal-use only business plan, just between co-founders). If one co-founder is intent on reaching the gazillion dollar profit level, but the other just wants to get home to watch TV and relax, the situation isn’t going to hack it and you need to know that before you ever sign up with the other co-founder.

• Understand each co-founder/co-owner’s exit strategy. This is a follow-on to sharing long-term goals, and should also be fleshed out in the co-founder’s business plan. The goal could be to quickly build the company up for a cash-out sale in five years. It could be to make it a long-term business – essentially a lifestyle business – that you’ll jointly run for the next 25 years. It could be a combination, where one co-founder wants out in five years and the other wants to continue, so the goal is for a cash-out sale of one co-founder’s ownership. Whatever the planned exit strategy, working towards it as a shared goal is a lot more productive than an unexpected announcement after you’re moving down the road.

• Communicate well. Two people never communicate the same way, nor do they always see eye-to-eye. One might be more introverted and the other extroverted. One might prefer written communication and the other face-to-face. You might even be in physically different locations. One person might never carve out enough time to communicate, or one person might be in the other’s face so much that it creates friction. You should get an idea of how this is going to work out before actual start-up, and whatever early wrinkles you see in it, get them resolved, discussed, and resolved before patterns set in that can destroy your company.

Another big difference is how much you communicate – not necessarily how often you communicate, but how much you actually say to each other, and the level of detail you get into. In today’s Twitter-type world, where the concept of fewer words reigns supreme, if one of you is a communications minimalist – and maybe not even in full sentences, but rather, in disjointed thought streams – this needs to be worked out.

One person I regularly communicate with has a mind that races so much faster than he writes – and heavily uses Twitter, and writes e-mails in half-thoughts – leaves me bewildered after almost every communication. If we co-owned a company, I’m sure our frequent communication – but lack of understandable content – would have us at each other’s throats in no time.

On another level, as co-founders and co-owners you need to work out the who, what, and when of communications to the rest of the company. In an overall sense, the whole company works for both of you, but in a reporting sense some might report directly up to you and others might report to your co-founder. There will certainly be communications that each of you make directly to (and only to) those who report to you, but there will likely be communications that cross boundaries. Before either one of you communicate across these boundaries, you might want to advise the other of what’s coming, and even consider whether it should be done in both of your names – particularly company aspects that both of you had a hand in.

As co-founders and co-owners, there shouldn’t be any secrets between you, and you’ll need to work out how and when to bring each other in on business challenges and difficulties. If opinion differences arise between you, this can easily lead to less communication, mistrust, and animosity. It’ll be a fact of life that squabbles crop up – any two people have opinion differences – and if you’re going to be successful you’ll need to work things out. It might even get to the point where a trusted outside advisor can be a mediator, called on in these situations to sort out your differences. Whatever you do, don’t let things fester, or the lack of communication can lead to a total disaster.

• Establish roles and lines of authority. A management situation that almost certainly won’t work is for two co-founders to have the same roles and equal decision-making authority in the company. It’s OK for there to be co-CEO’s for example, particularly in situations where you want it known that both co-founders are essentially equals in the company. But it will only work if there’s a demarcation of responsibility and authority, and the two of you spend the majority of your working time on different aspects of the business. For example, one could concentrate on business development and sales and marketing, and the other on day-to-day operations and financial management. In each area, one person would have the primary say in decisions, although if push comes to shove in a thorny situation you’d fall back on a joint discussion for a decision. If it really comes to push and shove, owner equity levels might need to be voted between you to make the decision.

Another example might have one co-founder as CEO and the other as Chief Technology Officer. The CEO could have all the responsibilities for day-to-day operation of the business, and the other co-founder – maybe the person who has the primary insight in product development – is responsible (and has authority) for product design, development, and manufacturing.

Whatever works is OK, provided the roles are well understood documented in a fair amount of detail in the partnership agreement/business plan.

• How will you make major decisions and resolve disputes. Establishing this understanding goes hand in hand with the previous one – having defined roles – but it often goes beyond that. You can each be operating quite well within your own boundaries, but overall company considerations arise that are above and beyond that.

For example, how will you reach agreement when a major decision has to be made about increasing the company’s debt load (such as financing for new equipment, or a bank line of credit)? How will you reach agreement when the company needs to move in a major new direction (some serendipitous circumstance has just entered the picture, and it could have profound benefit for the company to chase off after it)? Or equally important but more mundane – such as changing the name of the company? Or bringing in a new partner? Or aligning with a new alliance partner?

To keep your co-founder/co-owner partnership on an even keel, you (a) first have to settle between yourselves which decisions (or types of decisions) need joint discussion and approval, and (b) establish how you’ll reach a decision if the answer isn’t obvious or unanimous. The first is a matter of spelling it out in your partnership agreement/business plan – with a caveat that it doesn’t represent the entire list of such decisions. Assuming your ownership percentages aren’t equal, the obvious resolution for the second is to put it to a vote, weighted by ownership percentage (and if there are more than two co-founders/co-owners, it will likely be decided by alliances). A big factor might have to do with who has experience and knowledge about the specific area of what’s being considered.

You probably can’t foresee all circumstances, but the more you cover the greater the odds that you’ll be able to reach a consensus on the outliers.

• Lay out a partnership agreement/business plan. When you have co-founders/co-owners, this could be the most important document in your entire company. There’s just no way multiple founders/owners are going to think exactly the same, or have identical outlooks on how the company should be run. As much as you’d like to have clearly defined and complementary skillsets between each founder/owner, there’ll be overlap, with competing opinions on how to do things.
To the extent possible, write up a document that outlines all of the bullet points above, make sure you have agreement across all parties, and get everyone to sign it. When you have a gazillion other start-up tasks swirling around in the days, weeks, months leading up to Grand Opening Day, it’s hard to see how you’ll have time to do this, but you must. There’s too much at stake for this to be left to amicable talk over a glass of wine – the only way you can have something to point to in the future when all hell breaks loose is a document that everyone agreed to ahead of time.
Lastly, have the agreement clearly spell out the conditions on which a co-founder can be forced to exit the company. This is basically your pre-nuptial agreement, establishing ahead of time how you will go through a co-founder/co-owner breakup when things don’t work out, or one partner decides it’s time to get out.

Ownership split – get that right too!

Let’s start with the best ownership split of all – 100/0 – i.e., 100% to you, and 0% to anyone else. From a financial and control perspective, it doesn’t get any better than that. Most importantly, in making your personal life and business clean and simple, it also doesn’t get any better. Keep that thought firmly in mind as you go through your start-up planning – not to have co-founders unless you can’t see any other way around it.

But what to do if you end up with co-founders – how is everyone’s ownership split worked out? In a word – negotiate … negotiate … negotiate. Given how important this will be to you later, in quite a few ways, and some unexpectedly, it could be the single most important agreement you’ll have in your entire small business career. The negotiation should not be a quick discussion and handshake, and you shouldn’t just dive in and say, “gee, let’s make it simple and divide it up equally”. So, don’t rush the decision, don’t negotiate it in an hour, but get it done early.

Once the ownership percentages are established, you’d have to be one silver-tonged devil to negotiate them further in your favor at a later time. (Bill Gates managed to do this with Paul Allen – starting off with a 60/40 split when Microsoft was first incorporated, then changing it to 64/36 at a later time (before it went public) – with little explanation about how Gates talked that one through.)

A caution – when the co-founder’s ownership split is typically being negotiated, everyone is in the honeymoon stage, anxious to get things going, pulling together hard in a hundred different direction – and it’s difficult to see the difference that 5% … 10% … 15% one way or the other can make. You just want to get this puppy going, and hey, you’re all going to be rich, so let’s just treat this like old friends. Bad idea.

Here are some things to consider:

• Have a serious discussion among all co-founders. A discussion where each co-founder sits down with the other(s) and discusses this question in detail, Each should argue specific points for whatever percentage they think is fair, and this can then lead to a negotiated settlement that’s fair for all concerned. Don’t be lulled into ideas that your co-planners throw out and just blindly give in. This will likely be your one and only chance to get what you deserve, and you need to be prepared and stand up for your rights.

• Sweat equity is at least as valuable as capital equity. This is a hard one to quantify – because it’s an apples and oranges thing. You’re thinking, if I bring all the hard work to the table – the one who actually got the company up and going, and responsible for getting the product and service ready to go out the door – am I worth more than a co-founder who provided the initial capital that enabled me to do my part of the bargain?

It’s also a hard one to argue, given that venture capitalists typically operate on the principle of “whoever has the money rules”, and for financing your company they’ll ask for (and get) more than a 51% shareholding. But that’s different – it’s money that’s come into the equation after the company is up and running, and usually not at the very early planning stages. Here, we’re talking about the equity split between the co-founders who are putting this idea together from scratch.

Sweat equity embodies all of the hard work that goes into the hundreds of details necessary to bring a business plan to fruition. Based on this, the person who puts in the sweat deserves more of the pie than the bankroller.

I recently advised a first-time entrepreneur – a furniture designer/maker – who was at the precipice of company formation and struggling with the ownership split percentage with a partner. The partner – who was not a first-time entrepreneur – was bringing start-up financing to the table, and proposed a 70/30 split in his favor (and when questioned about it, readily admitted that he was just throwing out a negotiating point to start the discussion). I strongly advised that a number closer to 50/50 (or maybe even slanted a bit towards the designer/maker) would be more equitable. As I write this it’s still in negotiation, but I think it will end up nearer to my proposal than to the financier’s.

• Don’t overestimate the role of coming up with the idea. Dreaming up the original idea might be very important, but lots of people come up with business ideas pie-in-the-sky business ideas every day, but then can’t bring any of them to a successful business start-up if their life depended on it. If it takes another person to actually bring the idea to fruition, that person is more responsible for its success – and should be correspondingly rewarded for it. That person will also be the one who continues with the success after start-up and is critical to the business.

• Level of commitment and risk. If all co-founders are jumping in full-time at the start, that argues for a higher percentage than one who is putting in part-time effort and sticking with a current day job while everyone else gets the company up and running. It can only argue otherwise if the part-timer is specifically doing that to generate cash flow that is contributed to the company to keep it afloat during start-up.

• All ownership stakes should be subject to vesting. No one knows what a co-founder before start-up is going to do after it’s up and running. If the amount of work before-start-up argues for 15% ownership, but they then walk away right after Grand Opening Day and don’t continue their effort, they really should end up with 0%. It’s imperative that all ownership carries with it a vesting schedule, and only after the vesting period/performance is met is the actual ownership granted. A vesting schedule of four to five years is pretty common, with partial vesting in the earlier years. You can also tie vesting schedules to company performance (a really good idea), as an incentive towards the company reaching its goals.

• Document the percentage split. As soon as you’ve worked out the ownership split percentages, get it on paper and agree to it with a full round of signatures. Don’t wait for your attorney to draw up company formation paperwork that spells this out – that could be considerable time after you’ve reached an understanding on what the split will be, and who knows what could change by then.

Setting the numbers.

So when you finish the discussion above, all you have is a bunch of opinions, but what’s the best way to actually assign numbers to the equity split?

The first suggestion is to schedule a meeting – maybe an all-day meeting – with all co-founders. Be prepared to have a frank and open discussion. Get things out in the open (and written down) about what each person is bringing to the table – including the original business idea, who is going to do what, who is best suited for what, how much effort each person is able to devote to this, how much sweat and/or capital equity each will bring, and who is going to run this small business after it’s open for business. Be objective and try to keep emotion out of it – that may be difficult, but make sure everyone in the room is an adult.

Another option is to work through an equity split calculator as a basis for coming up with starting numbers to kick around. There’s a very good blog post, titled “How To Split Equity with Co-Founders” at the Founder Institute website, http://fi.co/posts/6061. The post describes a specific situation that two founders faced when starting their small business. The authors created a spreadsheet that’s downloadable from the blog post (the link is at the end of the article), with instructions for how to fill it out (comments indicate one or more spreadsheet errors, but I’ve never encountered any). As you might expect, though, inserting actual numbers for the various founders into the spreadsheet is similar to throwing a dart at the wall. But when you’re finished there’s an actual percentage number for the equity split each founder that can further your discussions. The intent isn’t to fill out the spreadsheet as a group, but rather, for each co-founder to fill it out ahead of time, then bring it to your meeting.

Good luck with your discussions.