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A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
August 10th, 2007

By Brent Holliday
Greenstone Venture Partners

Founder vs. Founder


“My hands are tied,

My body bruised.
She's got me with nothing left to win
And nothing else to lose.” - U2, With Or Without You


First, I want you all to know that I am working on a Club Penguin story, especially given my column from June and the apparent happy ending to a great ride (Disney buys them for $350M plus an earn out of another $350M.  If all of the deal gets earned out, they would be the 3rd largest acquisition in BC technology history).  Given that Disney now runs the shop, it is even tougher for a part time columnist to get a formal interview… but at least they return my calls now.  Baby steps.

This week I wanted to talk about a classic start-up problem that emerges at the very beginning: who gets what and why. {I thought I had written on this topic before, but neither my Google Desktop nor a cursory surf through 220 or so columns in the archive could locate the topic.  Hmmmm.}  This idea was spurred by the recent and ongoing news that Facebook founder Mark Zuckerberg is being sued by his former classmates at the Harvard MBA school.  They argue that he stole their collective idea (hatched in an entrepreneurship course) called HarvardConnection, which sounded to me a lot like a rip off of Classmates.com, and created Facebook.  Read about the story here

The first thing that jumps to mind is the fact that the other members of the group that weren’t part of Facebook have conveniently waited until Mark turned down $1B from Yahoo and may be considering an IPO valuing him closer to $10B in the near future.  In other words, they didn’t bother suing him when he left their group, but now their is gold in them thar hills.  In fact, they probably sneered at him for even trying to “copy” their idea on his own. Forget the fact that HarvardConnection and Facebook are not entirely new ideas and therefore were not really protectible intellectual property.  The real issue is that an idea is worth nothing and the commercialization of that idea is worth a lot more.  But another interesting point is that a group of students came up with a business plan and didn’t bother to draft any sort of agreement that would define who gets what if a company was actually started.  I have an eerily similar story from 13 years ago.

In the MBA program at UBC, we had to create a company and write a business plan as part of one of the courses.  Like most projects in business school, you had to do this as a group.  The idea for the company was mine.  That was never in dispute.  I had been to a convention on the new “multimedia” wave in technology in 1993 (about 18 months before I saw the WWW for the first time, so this will sound a little ridiculous).  I had seen how education was adopting the idea of CD-ROMs full of integrated information for teaching.  I had the idea that as CD-ROMs penetrated new PCs, home users would need access to information in a multimedia format.  The first idea for the content was the university and college marketing area.  So the plan was to arrange for the collection of content from universities and colleges in North America (we would even do short videos ourselves for the major locations… road trip!!!) and sell the collection to parents of high school aged kids.

The short story is that four of us aced the course based on the plan and the professor asked us to go to a business plan competition in Texas (called Moot Corp.) all expenses paid (road trip!!!).  All of a sudden, a fun project became a serious proposition.  We decide as a group to pursue a company.  Two of the four decided that this was not their career path and, while they were happy to go to Austin, they were not willing to spend a little money to incorporate and then raise some seed money.  That left two of us arguing over how to split the pie.  Fifty/fifty sounds fair, right?  Well, whenever the greed gland starts squirting, people’s brains become irrational.  Over a series of charts, my partner decided that he had put more effort, in terms of hours, into the venture and therefore deserved more.  So here we were, with nothing but an idea and some minor validation, arguing over how the billions would be divided down the road.

Anyone who has started a company knows how this works and what pain it can cause.  Local examples that I am very familiar with include a company that has a huge idea in social networking that got to the seed investor stage and nearly fell apart (well actually, it did fall apart and re-constituted itself without one of the founders) over one man’s insistence that he gets more than the others because of his role and effort.  These are not business school students.  These are men with 20 years of successful business experience.  The newly formed company is just waiting for the lawsuit from the ousted founder which should arrive any day because they have successfully launched.  The stress of this nearly caused one of the other founders his marriage.

A local company that has successfully raised VC money had a similar fight when it was raising its first round.  In this case, the founder and major shareholder rightfully had a lot of the company as the idea and subsequent commercialization was his. His initial three or four hires were instrumental in helping him get there and he shared a good chunk of the company with them.  After a couple of years, in his view (and perhaps the incoming investors view) the initial hires were not the guys to move forward with.  So an ugly fight ensued when their initial promised chunk of the company disappeared.

When you start a company and you work out of someone’s basement or sub-let a tiny office and work off ping pong tables for desks, you dream big, but the reality is that there isn’t much of anything.  It is hard to foresee a day in which the five guys in the start-up might not even work for the company. It’s impossible to guess what their “fair” share of the company should be.  Easy in hindsight, impossible looking forward.  As some success comes, the weaker players start to emerge.  Now, the horrible reality sets in of letting someone go who is a friend or at least a co-warrior from the start-up trenches.  Like Pete Best in the Beatles being replaced by Ringo Starr, sometimes the founders just don’t work out and they exit painfully

So, what’s fair when it comes to splitting up the equity when you start?  On what basis do you share?  How do you claw back equity from founders that don’t work out?  Not easy questions to answer, but here’s a primer on what to try and do to avoid the ugliness:

1)     Talk to a corporate lawyer – as much as we all hate paying the lawyers, they know how to structure these things. But don’t talk to Uncle Benny’s divorce lawyer. Many lawyers have no experience in this area.  Talk to an experienced company starter.

2)     Make The Deal Early – Decide early who is in and who is out and have the conversation about sharing the pie as soon as the company forms.  The longer you put it off, the worse it’s gonna get.  The HarvardConnection gang should have put their share down on paper early.

3)     Base The Equity On Fairness and Role – Here’s my formula: Split the whole company into two chunks of equity.  50/50.  On the first 50, split it among the identified founders equally.  On the second 50, split it un-equally based on role going forward. Like a mature company, the CEO gets more, the CTO and CFO a little less and the engineering/sales teams even less.  If you are still going to have a fight, then follow this: Of the 50% left, give 20% to the CEO, 10% to the first CTO, and share equally the remaining 20% among the remaining founders.  So, if there are only two founders you get the CEO with 55% and the CTO with 45%.  Remember, you will all get diluted, so forget the idea of who has “control”.  It is immaterial.  Also, notice how none of this is based on how hard anyone worked.  If you are founders, you all have something to give going forward.  Look forward, not behind.

4)     Vest The Founders Equity- the only fair way to make sure someone who you need to let go give some of their equity back is a legal agreement that looks a lot like an Employee Stock Option Plan.  Take all of the equity doled out according to the formula above and state the following: Everyone gets one quarter of their founders shares forever the day the company starts (no vesting).  The remaining 75% of their founders shares vest over three years of working at the company in quarterly installments.  Now, you can play with the length, whether there is a cliff, etc., but if one person leaves after a year, ½ of their stock is then cancelled by the company.  This also means you have to have employment agreements that stipulate how a person is let go from the company.  All of the above in legal bills will cost you at least $1500, maybe twice that, but it is a lot less than the tens of thousands in legal bills down the road if not done up front.

“Success has many fathers, failure only orphans”.  A Russian proverb that rings true for Mark Zuckerberg these days.  If you are successful in your start-up, the skeletons in your founding closet might show up and claim part of your success.  If you structure your start-up correctly from the beginning, the pain will be minimized down the road.  Take my advice from the beginning… get the deal down on paper and then you won’t waste so much time-sucking energy fighting amongst yourselves.

What Do You Think? Talk Back To Brent Holliday

Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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