When the Three Musketeers Become Two: Early-Stage Founder Equity and Vesting

When a startup is founded among partners, equity usually gets divided over a handshake. Most founders want equal partnership. All for one and one for all! Right?

But what happens when the Three Musketeers become two? Or one?

Founders’ Agreements are designed to address this question, and should be an integral part of the startup formation process for multi-founder companies.

While a 50/50 split on day one assumes both partners will contribute equally for years, real life has other plans. One founder burns out. One takes a salaried job. One has a kid and goes quiet for a year. The work doesn’t stop, but now one founder is left holding the bag, and the others may own the majority of shares. It’s a recipe for disaster, and ultimately, failure.

Those inactive shares sit on the cap table, they don’t just go away. Investors will see that, and will not want to fund a company with zombie founders owning the majority of the company. Even operating the company itself becomes very difficult with inactive founders who own large stakes of the business.

Therefore, a good founders’ agreement typically will provide for vesting of equity over time.

How vesting works

Vesting means you earn your shares over time. You do not own them all on day one. You own them as you stay and work.

The standard is four years with a one-year cliff. Leave in the first twelve months and you get nothing. Stay past the cliff and your shares vest a little each month for the rest of the four years.

So if your co-founder walks after eight months, they walk with nothing. Their shares go back to the company. The people who stayed are protected. That is the whole point.

Founders’ Agreements will also cover questions like whether unvested shares pay out early in the event of an acquisition or exit. Single trigger and double trigger are the two common versions. Decide now, not in the middle of the deal.

While we’re negotiating Founders’ Agreements, there are other important bases for the company to cover.

IP Assignments

Every line of code. Every design. The logo a friend made for you. The company does not own these automatically. Without an Agreement covering this, such IP may belong to individual founders. Each founder has to assign their IP to the company in writing.

Do not treat this as paperwork. Every investor and every buyer checks for it in diligence. A missing IP assignment can stall a deal or kill it. Sign the assignments when you form the company.

The 83(b) election and its 30-day clock

When you get stock that vests over time, the IRS gives you (the individual founder) a choice as to when to pay taxes on stock issuances. You can file an 83(b) election and pay tax now, while the stock is worth almost nothing. Or skip it and pay tax each year as the stock vests, on a higher value every time. In most instances, startup founders want to pay the tax now.

The catch is, you have 30 days from the day you receive the stock to decide whether to make that tax election. Miss it and you cannot go back. This is a short filing that can save you a large tax bill. Talk to a tax advisor and do not let the window close.

The Moral of the Story

Three documents do the work:

• A Founders’ Agreement that establishes the expectations for each Founder, the circumstances under which a Founder is considered “out”, and what happens when a Founder leaves.

• A Stock Purchase Agreement that includes your vesting schedule.

• An IP assignment signed by each founder.

At the end of the day, split the equity however you want. Then build vesting, IP assignment, and exit terms around it.

Do it early, while everyone still likes each other. The conversation is cheap now. It gets expensive later, when one of the Musketeers is gone and still owns a third of your company.

This post is general information, not legal advice, and it does not create an attorney-client relationship. Every company is different. If you are splitting equity with a co-founder, talk to a lawyer about your facts, or set up a consultation with us to discuss your options: https://long.law/intake