I’ve advised over 700 early-stage startups in one-to-one free advisory sessions in the last six years, and one issue that always crops up is founder shares.
Many times, all founders have equal shares in the company and are all part of the board, regardless of their role. This really irks me. Our firm, TRi5 Ventures, often deals with early-stage startups and regularly encounters first-time entrepreneurs who are uncomfortable talking about shareholdings amongst their co-founders. This often results in an equal split between all founders on the directorship. In these situations, the decisions these founders make become democratic and they have to get a majority consensus before proceeding.
Being one of the accredited mentor partners of Spring Singapore, I’ve noticed that this issue has gotten more pronounced, and I feel it must be addressed.
Implications of a democratic startup
Some entrepreneurs have told me that there is nothing wrong with providing equal shares. After all, everyone is putting in the same amount of hard work regardless of what role they play. This is especially true when a startup is new and a consensus is necessary for direction and decision making. Founders also come in as friends and don’t want to rock the boat with such a sensitive topic.
So, what’s my concern with this?
1. A startup needs strong leadership in the early stages to grow
Every ship needs a captain. The captain’s orders dictate the direction of a ship, how fast it moves, and how resources are managed. In times of harsh weather, the crew relies on the captain’s orders to bring them out of harm’s way or abandon ship.
It’s the same with startups. One founder has to be the CEO and take leadership. He can listen to his co-founders’ perspectives, but ultimately, he makes the decisions and sets the vision and direction of the startup.
In the case of equal shares, the lines are blurred as to who is actually in charge. Even if one person is placed as the CEO, he can’t dictate matters that require shareholders or board approval without taking time to convince a majority to approve.
Let’s get real. Everyone has their own opinion on how a company should be run. And because these companies are literally like democracies, they end up being unnecessarily bureaucratic instead of nimble.
2. The CEO takes responsibility
A team that I used to advise had four founders with equal shares and were all directors in the startup. One founder, who was the front-end developer, asked me, “I put in the same amount of time and effort as my co-founder who is the CEO. As co-founder, I am equally responsible for the future of my startup. So why do I not deserve equal shares in the company?”
I’m sure you’ve read about Travis Kalanick’s resignation by now. As you know, Uber had a string of mishaps that prompted this. The responsibility for any failure or success lies with the CEO. This is why the CEO has the authority to dictate the company’s direction. How the company moves, what products it makes, what markets it enters, and its policies and vision are all the CEO’s call. The other co-founders may provide advice and insight but the person responsible is the CEO.
This is why the CEO must have a significant share majority. He must be well-motivated to take the company ahead. I find it unfair for a CEO, who faces heavy responsibilities, to end up having equal shares with others who have fewer responsibilities.
This is also a big concern for investors, as they will want to know who the CEO is. This is especially true for early-stage investors like ourselves. The CEO is the most critical element, as a business idea can pivot very quickly at this stage. Ensuring that the CEO has majority shares and control assures us that decisions will be made in stride.
3. A startup founding team is not a lifelong commitment
Startup co-founders always think they’ll stick together through thick and thin. But the reality is far from it.
In our experience observing our 38 grant incubatees from a previous incubator, we found that co-founders can split as early as six months from starting up. The reasons can range from disagreeing on how the company should be run to a founder getting married and requiring financial stability. In one instance, a founder was poached to join another startup.
Startups will also usually pivot after understanding the market better. And in the new pivot, not all co-founders have the right skills or agree to continue in the new direction.
I remember a case where two founders held equal shares in the company and were both appointed as directors. They had a serious disagreement, and founder A disputed the actions of founder B. Their bank ended up freezing their account, putting the company on hold. A new investor was keen to invest but was unable to because founder A thought he would side with founder B. Although the latter wanted to continue, the former refused to budge. They eventually dissolved the company.
A lesson from this saga: When a co-founder leaves a startup, it’s not likely they’ll sell their shares or step down as a director. Remember how a failed partnership in Facebook caused a great deal of trouble? Eduardo Saverin benefitted from a successful Facebook at the expense of Mark Zuckerberg.
How to properly structure your startup
Building a startup is not a lifelong commitment. Founders must realize that there need to be proper guidelines in place to ensure that a former founder reduces his role and ownership in the business. Giving shares and seats on the board freely are not the wisest decisions.
People are so excited to start up that they forget to discuss sensitive topics like shareholdings.
The main founder, who will likely be the CEO, should think very carefully who he calls co-founder. These people should be qualified, trusted, reliable, long-term thinkers, and able to handle strategic management roles.
A person may be very good at what he does, but unless he is taking serious responsibility for the survival of the company, he shouldn’t be holding significant shares or taking directorships.
Because startups tend to be formed quickly, many go without a proper shareholders/partnership agreement. Founders forget to spell out roles and define clauses in relation to disputes.
Always prepare a partnership agreement before coming together. Even if it’s a simple agreement, it’s still good to set down expectations and understand boundaries. Once that’s been done, the team can then focus on growing the startup.
This is the 18th article of the “Startup Advisory Clinic” series.
This article first appeared on Tech in Asia.