Tag Archives: founders

Lockdown Lost-Founder IP

If you won the lottery today, how many long lost relatives (that you don’t recall) would come out of the shadows of your family tree to test the generosity of their favorite relative? I’m willing to bet a few.

Now if your startup received a $5MM Series A investment from a venture capital firm, how many developers (that you can recall) would come out of the shadows of the internet and claim to be your startup’s long lost founder? The answer to this question depends on how well your startup secures its intellectual property.

Lost Founders

You may not consider a developer that worked 1 day on your startup 2 months before you incorporated a “founder.” But if your startup becomes a wild success, the developer will. Even worse, this lost founder will have more leverage now with your startup than if you had acquired his intellectual property at the outset.

Even if you aren’t worried about long lost founders laying claim to your startup’s intellectual property, your potential investors are. The status of your startup’s intellectual property, including whether you have signed agreements with all developers, is typically among the first set of questions your startup will receive from a potential investor. Thus, it’s wise to lock down your startup’s IP early to prevent the lost founder problem.

How to Lock Down the IP

One of the most important aspects of a startup incorporation is the ability to transfer intellectual property ownership from the founders to the startup. Each founder is issued shares in the startup in exchange for the founder’s intellectual property (and usually a small amount cash). In other words, the startup issues shares to the founder as consideration for the founder’s intellectual property and small check. This element of consideration is required for the formation of a valid, binding contract. The exchange is typically handled via a “Technology Assignment Agreement.”

But what about developers who work for the startup that aren’t founders?

Consideration for services rendered should be given to all developers and consultants that work on anything IP-related at your startup. This includes whether the developer or consultant worked prior to your startup’s incorporation or afterwards. Like the incorporation, the intellectual property transfer will be executed pursuant to a Technology Assignment Agreement.

The consideration given to developers and consultants does not have to include your startup’s equity. Consideration can also be cash. But since cash tends to be a scarce resource at startups, such consideration typically takes the form of restricted stock or stock options.

Conclusion

Like the lost-relative problem occurs only upon a winning lottery ticket, the lost-founder problem only occurs if your startup is successful. To avoid lost founders from showing up on your startup’s doorstep, take proactive measures to lock down your startup’s intellectual property.

How to Split the Startup Founder Equity Pie

Founders frequently ask me to provide guidance on how their startup should split equity between co-founders. My answer is always: (1) It Depends, and (2) Quickly.

(1) IT DEPENDS

If you’ve ever hired a lawyer, you will (unfortunately) hear the phrase “it depends” several times. In this situation, the “it depends” hinges on the respective past/current and future contributions of the founders:

Past/Current Contributions:
– The Idea
Business Plan
Intellectual Property
– Cash (Consider structuring this separately from the founder split.)

Future Contributions:
– Time
– Opportunity Cost (i.e., Is one founder making a larger sacrifice?)
– Industry Expertise

After taking the above items into consideration, a startup team will rarely end up with an equal split. And for what it’s worth, a startup team should rarely end up with an equal split. On the other hand, I don’t recommend the startup team create a complex methodology to come up with the solution. Save the fanciness for the code.

(2) QUICKLY

Rather than pushing forward with development & implementation, co-founders run the risk of spending too much time on the equity-split decision. In addition to multiple startup-wide meetings and emails about the split, the individual co-founders will spend time wrangling with the matter as well. However, it’s not going to “kill” the startup if this decision takes a bit of time.

The main reason to have this determination done very quickly is that the startup team gets to have — and conclude — its first difficult conversation. There’s no avoiding difficult conversations at a startup. Don’t start with the first one.

Regardless of how you decide to split the intial equity pie, seriously consider vesting your founders shares.

5 Common Founder Mistakes

This is a re-post of an article that I wrote about common founder mistakes for StartupLucky.com and Killerstartups.com (not sure if it went out yet).

1. Spending Too Much Time Keeping Your “Unique” Idea Top Secret. Some founders attempt to have everyone within 25 feet of them sign an NDA. Instead of spending time drafting and then obtaining signatures on a NDA, a founder should use that time to implement the unique idea. It’s highly likely the idea isn’t unique, and a founder could turn off some good investors/partners/mentors by asking for a NDA signature.

2. Not Vesting Founders’ Shares. It’s easy to believe that vesting your own founder shares doesn’t help you, but take a look around the founder table. Now think how you’ll feel if your co-founder decides to try out for American Idol and take his 33% of his vested ownership with him to Hollywood while you and the rest of the founders pound keyboards all day and night.

3. Forgetting to Make the 83(b) Election. If you decide to vest your founder shares, don’t forget to make an 83(b) election with the IRS. You have 30 days to do so after purchasing your founder shares, but there’s not reason to wait more than 1 day post-purchase.

4. Issuing Preferred Stock to Minor Seed Investors Like Your Uncle Bob. Sure, Y Combinator and TechStars get preferred stock for their $18,000 seed investment, but your Uncle Bob (probably) is not Paul Graham or David Cohen, Uncle Bob is not running a startup mentorship program for your team, nor does Uncle Bob have a massive amount of relevant startup industry connections.

5. Concentrating Only On Valuation When Raising Capital. There’s a reason why term sheets are several pages long. Keep reading after you get halfway down the first page to “pre-money valuation”—there are many important terms on subsequent pages. Also, consider whether the investor or investor group is a good fit for your startup. Don’t choose an investor group solely by the highest pre-money number, if you are lucky enough to have a few term sheets in front of you.

Don’t Create an “Issuance Pool”

“We want to have 30% of the startup company at exit.”

-Anonymous Startup Founders

Occasionally, founders will plan out their startup’s lifespan to the point of pre-determining their final equity figure after all hires and investments have been made. Usually, a set of founders want to end up with a final equity percentage in the 25% – 51% range. I call this number founders (mentally) reserve for future issuance the “Issuance Pool.”

While an Option Pool is a key tool for a startup in order reaching the next level, creating an Issuance Pool is of no tangible benefit.

First, the Issuance Pool creates the potential hazard that founders will operate and make equity issuance decisions, whether for a developer or angel investment, as though the Issuance Pool is pre-authorized like an Option Pool. A common mistake made by founders is acting as though they own the 25% to 51% they plan on owning instead of the 100% they actually own as a group after incorporation and before any other equity issuances. Thus, there is the tendency for founders at future issuances to think “This 10% issuance leaves us with 39% left for our (planned) future issuances.”

Your startup could over-issue equity to consultants, advisors, employees, and investors simply because you believe there’s a large amount of equity left in your Issuance Pool. Alternatively, your startup could turn off new hires and investors if you attempt to under-issue equity because your Issuance Pool is running low.

Second, the Issuance Pool should not be used as a barometer of success. Is your startup any more successful because it only issued 75% of your Issuance Pool? Maybe. But the goal should be that all equity issuances work to increase the value of the startup and generate great returns– not that your equity percentage is greater than what you planned months, if not years, ago.

While the Issuance Pool doesn’t show up on your startup’s cap table, it can still be harmful to your startup. There’s nothing wrong with planning, but an Issuance Pool should be discarded quickly after incorporation.