Partner pre nups

I got burned by a partner once. He flaked out after just a few months, keeping a big chunk of equity while I did all the work.

So when I took on a partner for my latest venture (coming soon), I insisted on a partner pre nup. There are a lot of ways partnerships can go sour, and it’s tough to protect against all of them. Also, it’s a bit awkward to be talking divorce during your honeymoon. But better safe than sorry.

The core of our pre nup is a partner vesting mechanism. It works like this… Both partners start with slices of the equity pie. Let’s say we each get 50 shares out of 100 total, to keep things simple. Over the coming years, we’ll work hard to turn our respective equity stakes into something valuable. But we’ll have to earn our rights to that equity.

We’ll earn a bit more every quarter (three months), over a four year period. With four quarters per year over four years, there are a total of 16 vesting periods. So, we’ll each earn 50/16, or about three shares every quarter (we’ll make up for the rounding issue during the last period).  At the end of the first quarter, we’ll each earn three shares. At the end of the second quarter, each of us will have earned a total of six shares. And so on, until we reach 50 each.

If one of us leaves to do something else, or otherwise stops contributing in a positive way (e.g. gross negligence) we’ll only walk away with the equity we’ve earned so far.

Suppose we’ve been working on the startup for 13 months, and we’re struggling. At that point, one partner wants to stick it out, and another decides to pursue other opportunities. The partner who leaves keeps four quarters of equity, or 12 shares. The other partner gets the remaining 38 shares. So now the partner who leaves owns 12 over 100 shares, or 12%. The partner who sticks around gets the remainder, or 88%.

Flake factor be-gone.

Working through the numbers on ownership

One of my clients is raising a seed round of financing. Of course, she’s a smart cookie, and bootstrapped her way to some impressive results before raising the money. In case you go about something like this, I’ll show you how the ownership structure gets impacted.

First, she starts with some (arbitrary) number of shares – or units if it’s an LLC.

Then she issued some more units to key employees and advisors.

After that, she raised the round. The price per share is simply the pre-money valuation divided by number of shares before the round ($900,000 pre-money valuation / 10,640 shares = $85.59 per share). The investors put in $250,000, so the company issues an additional 2,956 units to them ($250,000/$85.59 = 2,956).

Everytime the company issues more shares, the previous owners are left with a smaller fraction of the total shares (barring anti-dilution provisions). They are effectively “diluted”. However, as long as the valuations keep rising, they’ll own a smaller piece of a bigger pie, so the value of their ownership will increase.