Allocating Founders Shares

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One of the more difficult initial questions an entrepreneur faces is how to allocate founder shares in their company. I have seen all sorts of allocation proposals from entrepreneurs and lawyers, from the most complex to the simple. My advice?  Keep it simple.

The initial "allocation temptation" is to "please" anyone who has had an impact on bringing a company into being, from Uncle Jack who put up a few bucks, to the 'rents who paid the rent for a year, to the girlfriend who had some useful insights, or to the alpha (read: free) customer who provided feedback on the product.  Forget it.  These allocations can be a huge mistake, as they give ownership to a bunch of people who really will not provide much help going forward.

Here are a few useful rules on who should get founder shares:

1. Early Decisions; Minimal Owners--founder shares should be allocated before the company is actually formed and limited to just a few key contributors.
2. Initial Rewards; Long Term Incentives--founders shares should compensate for work done up to the point of incorporation and give founders a key incentive to contribute to the long-term success of the venture.
3. Percentages Matter; Not Number of Shares--focus on the right percentage ownership for key participants, and be sure you keep at least 51% for yourself.
4. Restricted Stock; Reverse Vesting--founders shares should be restricted and subject to reverse vesting, with the right to repurchase the stock at the original prices in the agreements.
5. Forward Vesting; Timing--restricted founders stock should vest over three to four years, with perhaps 25% up front and the remaining 75% at a 25% yearly vest. The Founder's founders shares can vest immediately, although some may disagree with me.

Under any circumstances, get your corporate lawyers and tax consultants involved early in this process.  They know the federal and state laws around granting founders shares and how to structure allocations to avoid nasty tax consequences in the out years. As for Uncle Jack and other early money sources, consider a convertible debt instrument that will let them convert that loan on the same terms as your first-round venture capital investors. The girlfriend and alpha customer?  Buy them a nice dinner as thanks.

Comments

[Matt Mireles]

Could you explain "Reverse Vesting" ? I'm a lil' confused. I'm also a lil' unclear about the original price you're referring to which founders can buy back their shares.

[dave]

Matt

Sorry for delay...been on holiday.

Check out http://www.venturechoice.com/glossary/reverse-vesting.htm

for a good definition of reverse vesting.

Original price refers to the price at which the shares were initially granted.