Questions

How can I structure a contract to bring on a co-founder to help my business when I can't pay them?

I am the founder and only person running my clothing for teens with autism business. Another designer wants to come on board to help. She knows I can't pay her but we both want it to be more official and cover our bases. Is there a template that I can refer to?

5answers

Disclaimer: I am not a lawyer nor an accountant, and this is not "professional advice."

I have, however, set up a few businesses and had partners.

What you need to do is incorporate and then write up an Operating Agreement that lays out the terms of your partnership.

Who owns what.

How the new partner will "buy into" the organization with their sweat equity.

What happens when revenue targets are reached.

And how exactly you separate when it's time to move on.

Lay these details out and more in your operating agreement. You'll be so happy you did, later.

When you incorporate, you may do this on your own...or you may want an attorney or accountant to help. They will know how to set up an operating agreement, but now that you know the term it's likely you can google a template. There'll be a lot of technical mumbo jumbo in there you probably won't need, but the section headers will guide you in the right direction.


Answered 6 months ago

I would suggest reading "Slicing Pie" by Mike Moyer. It may not be for you but it will at least shed some light on some of the pitfalls you may encounter so you can form your thoughts and approaches for how to handle those.

It's a quick read and lays out a simple, transparent formula for calculating equity, valuing cash vs sweat equity, and sets up a system that keep it fair and protects all parties involved.

One example the author raises is that you have no way to know how much effort your new partner will put in; will they give up after 3 months? If you gave them all of their equity up front, or a disproportionate amount, what incentive do they have to keep helping the business grow? Or what happens if some family emergency or need impacts your ability or their ability to contribute. How do you make that fair?

I personally like the approach he lays out. I have used it on one business only. That business ended up not going anywhere, but no one felt slighted. I'm not using it in my current businesses but I do use some of the concepts.


Answered 6 months ago

I am a corporate strategy consultant with a focus on operations, corporate governance, and have been a direct or indirect investor (as an angel and VC), operator, founder, officer, Board member, advisor or consultant to 30+ startups. Cap tables and the impact over time are a particular area.

The question that first must be asked is "why do you need a co-founder?".

If you are seeking a true partner, a person who will be in the trench with you that has skills you do not have, and will keep you sane when you are not keeping them sane. it is one approach. Every startup has bleak times when this emotional, albeit business and mission-based, period occurs.

If this is for optics alone, meant to influence investors who see you need a team to make an investment, the approach is very different, but with similar implications.

If this is just as an incentive to get them to work for "free" while the product is developed and funding is in doubt, it is another approach.

A true partner/co-founder should have a stake in the firm that will reflect what the expectations will be from both of you. You may have cultured this firm to its current level, yet you need more hands and thinking to get it further. In that version, while you may retain the controlling interest, it is difficult for a co-founder to put in 80 hour weeks without a meaningful outcome for them. Should you hold 95% and they have 5%, the economic imbalance will affect the dynamic.

If it is for optics, not only does the economic imbalance apply, but investors know it and will act accordingly. They do not want a "decorative" co-founder; they want to know there is someone else there who can lead the company when the times get rough, as much for your sanity as for business reasons. If they see a 95/5 split, they treat that co-founder as an employee, not a co-founder.

If it is for economic reasons alone, you must first deduce the input/outcome expectation of the person. Assume a full partner is a 50/50 split (e.g. the two of you had teamed up at the beginning) that implies 80 hour weeks, credit card financing, and zero early compensation, you can model the equity based on the amount of time and for what period the person can commit. Commit is the key word. For example, If they can commit to 20% of a full, all-in role, you could set 10% as the target (20% of 50%).

Finally, LLCs are easy but messy for investors. You can do it, but you need a compelling business or they will force you to convert to a C-Corp (interim you can elect Sub S election). You can do multiple classes of shares and an option-like class, but this is a complexity that, unless you have a CFO and/or a crack lawyer, is more complexity that you need while building a business.

Hope this helps.


Answered 6 months ago

Without knowing more details, here are some things to think about:

Equity: What you have to offer is partial ownership in the business. Unless she will work for free as an intern (the value of working for you is getting experience).

You would want to form a business (LLC or C-Corp for example - are common).

Give her some equity. You said she wants to "help". How much she's helping wold drive how much equity to give.

I highly recommend vesting schedules. She has to earn into equity over time. For example, a couple ways I have done this:

1) Is she a co-founder? Meaning, will she contribute substantially to the idea, launch, and growth of the business?
Then you could offer 2% to 50% depending on how far along you already are and her contribution. For example if you have sold nothing then that's an argument for giving her more equity. Vesting for this in the startup world is standard - 4 year with 1 year cliff (google that).

2) Is she more of an employee?
Then I would consider a smaller % ownership with a shorter vesting schedule (For example .5% - 5% ownership, all vesting monthly over 1 year for example) In the time the ownership is vesting, you should be executing on a plan to make money so she can get a salary.


Answered 6 months ago

No.

There's not a good template you can refer to, as there is not one single right way to do this well.

Putting aside jurisdictional variations on how the rules for partnerships and corporations (or limited companies, depending on where you are), there is a simple and effective way to do what you want to do.

Sit down with this designer, and go over these important details:

1. what is your business currently worth?
While this can be a 'big' and complex conversation, keep it simple. Review all major assets the business owns, and look at the past year or two of revenue and profit for a benchmark of what to expect for revenue in the coming year(s). If there are special circumstances that may change next year's revenue from yester-year's - i.e., a lucrative new contract, a potential new distributor, etc.), then discuss how that changes the projections for revenues going forward. Go through this same analysis for profit (which requires reviewing your costs).

2. agree together what your business is worth today, and what it will be worth in 1 year, 2 years, and 5 years. Write this down, including the specific reasons why you (two) think so, from 1, above.

3. what is the designer's contribution / work going to be worth?

agree on an hourly rate along with set number of hours per month he/she will be putting into the business, OR agree on specific deliverables (focus on results with metrics rather than broad descriptions of what you hope will result from his/her efforts) - and then put a dollar value on those delivering them. IMPORTANT: write down what the cost to the business (or to you) is IF each deliverable is NOT delivered. This will be deducted if not fulfilled - and not more, nor less.

4. now you have the approximate value of the business, and how that may change in the near to mid term future. You also have the value of the designer's work or contribution, as it is proposed. Now, since you won't (can't) be paying him/her cash, agree on what percentage ownership of your business is a fair replacement of the cash he/she should have been paid. Keep in mind that the right number is the cash equivalent plus some alpha - some amount to compensate the designer for getting paid later (hopefully) AND for taking the risk inherent in any business (of failure, and therefore not being paid at all). Write this down.

5. Write everything down related to 1-4 above on a single document. Now add some boilerplate legalese - here's how:
(a) if you are not incorporated (or registered as a limited company), then look up some partnership agreements FROM YOUR JURISDICTION (i.e., your country, or State if you're in the U.S., or Province if you're in Canada),
(b) if you are incorporated, or the equivalent, look up share/stock option agreements and/or share/stock option plan documents - again, FROM YOUR JURISDICTION.

6. Add the appropriate boilerplate legalese from the documents you find per 5, above. For example, you will want a clause that describes what jurisdiction's law applies to your agreement, a clause that lists what venue you (two) are restricted to if bringing a lawsuit because of a disagreement, a clause about your document being the full and final expression of your agreement, a clause about the agreement being void if certain acts of God occur, a clause about each of you paying your own taxes, a clause about whether and how alternative dispute resolution will work, etc., etc.

7. print two copies of the document you two have now come up with, and both of you can sign both copies. Each of you take one, and voila - you now have the ideal structure for a contract that allows you to bring on a co-founder, without having to pay them cash right away.

Best of luck!


Answered 6 months ago

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