Founder stock basics
What is founder stock and who gets it?
In most startups, the founders are the people who conceived the idea for the business and actively work to get it off the ground. Founders get founder stock–the first shares the corporation issues. This is almost always designated as common stock, and is usually issued for nominal value (US$0.0001 per share). Founder stock is a precious and limited resource. It should usually be reserved for founders who have made, and will continue to make, major commitments to the business. Avoid using founder stock to reward occasional contributors or advisors as this complicates the cap table and the company’s decision-making abilities.
How much founder stock goes to each founder?
There is no rule that founder stock has to be divided up equally between the founders. However, founders often think of themselves as equally important to the success of the business, and from that premise, want the founder stock to also be divided equally. In some cases, founders do end up making equal contributions, but in others, one or two individuals are the real driving force behind the business, with the remaining founders in a supporting role. Resentment may ensue if founders who are merely hangers-on get an equal share of the founder stock. If possible, try as a group to objectively assess each founder’s expected contribution, including the time they expect to commit, whether the founder is willing to give up outside jobs and interests, and the skills and experience the founder will bring to the business.
Once founder stock is issued, the founders as a group are diluted by any future stock issued, meaning their collective percentage of the corporation’s equity will decrease with each new issuance of shares. So, founder stock positions should be understood and communicated as the actual number of shares issued, rather than only a percentage of the corporation’s equity. For an example, see Startup valuations and cap tables.
How do startups effectively incent people with founder stock?
A free rider problem in inherent in corporate law: the default rule is that shares are fully earned the moment they are issued. Founder stock cannot be re-allocated to other founders, even if the founder leaves or stops contributing to the business. This is addressed by putting a contract in place providing that founder stock will vest based on continued service to the company. These agreements generally give the company the right to buy back founder stock if a founder leaves the company, either voluntarily, by resigning or involuntarily, by getting asked to leave. To avoid disputes, vesting and buyback rights should always be captured in a signed, written contract between the company and its founders.
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