Negotiation over founder equity can be a particularly challenging task. But it’s one of the key decisions that a founding team must take beforehand in order to avoid future disputes and disagreements, broken relationships and the company’s paralysis. So, once you’re all set, it’s time to sit down with your co-founder or employee for the “serious talk”.

When it comes to defining the legal framework of your startup, things can get messy. Let’s start at the beginning: how does equity splitting and structuring work?

In order to address equity structuring, we first need to understand how vesting works. Vesting is a contract clause commonly defined as the process by which a founder or employee gains non-forfeitable (you cannot be deprived of them) rights over shares. Simply put, you gradually earn the stock over a scheduled period of time (this “timetable” is also known as the vesting schedule). Most vesting schedules come with a cliff, which is the period of time that must pass before your shares can start vesting. The common schedule formula is the 4 years vesting with a 1 year cliff. This means that after the first year mark, the shares will vest monthly over a period of 4 years.

Other equity allocation-terms you will see around a lot and that you might want to become familiar with are:

Transfer restrictions: these establish when you can sell or transfer your shares

Right of first refusal: it implies that when the shares are being transferred, the company has the right to buy them first

Repurchase rights: the company has the right to buy back shares at specified price (fair market value if it’s vested stock) or at cost (which depends on the company’s value, if it’s unvested stock). This usually occurs when someone is leaving the company.

Board control/Voting: it determines who controls each board seat and generally comes along with voting agreements (founders use those promise to support each other’s choices)

Termination provision: when the employment ceases, the stocks stop vesting.

Accelerated vesting: unvested stock becomes vested when specific events occur, such as an acquisition or an unjustified termination.

Now, unless you want to split 50/50 with your co-founders, when determining equity allocation there are several factors you may want to take into consideration in order to to accomplish a fair distribution. For example, who came up with the business idea? Who is working full time in the startup? Who is contributing with capital? Who is providing contacts and clients? Who in the company is critical for revenue and profits growth? Experience, seniority, risk taking, execution and many other variables are worth considering. So, think it through thoroughly, find a fair agreement with your partners, put it on paper and execute it.

In writing down this post, I incorporated info and tips from Legal Hero’s video on equity splitting and structuring and what you need to know about it. The lawyers from Legal Hero have also developed a framework to walk founders through the process of equity allocation. The framework works with points, all co-founders start with the same amount of points and you get extras depending on whether or not certain factors and circumstances are present. You can find plenty of other formulas in the web that can guide you through this process. Among those is Slicing Pie which also provides an interesting formula and software for equity splits and Buffer’s Open Equity Formula.

Giorgia Vulcano, Lawyer.

Picture: Kace Rodriguez (CC0)