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A reader asks: I’m a first-time entrepreneur, and I’ve been working on a new e-commerce site for about six months. I outsourced the development work, but now I’m thinking it would be better to bring on a technical co-founder to handle those duties. What do I need to watch out for?
Answer: Picking the right co-founder(s) is arguably the most important step you can take in starting your business. But the decision isn’t always an easy one. Keeping in mind that I’m an attorney – and have a different perspective than, say, a serial entrepreneur – here are four of the most common mistakes I’ve seen:
Jumping in too fast – Ideally, your co-founder should be someone you know really well and whom you trust. At the very least, it should be someone you are confident that will be in the trenches with you fighting it out when the going gets tough.
Some first-time entrepreneurs make the mistake of hiring a co-founder whom they have just met (e.g., at a conference) or who is a stranger. Simply put, that makes no business sense. A business partnership has a lot in common with a marriage. Respect isn’t enough. You need to trust them completely and have absolute confidence in them in order for it to work.
Issuing too much equity – Some entrepreneurs make the mistake of giving their co-founder 50 percent of the equity. This may be appropriate in certain circumstances, but usually it’s not the right business decision, particularly (as here) where it’s your idea and you’ve already spent six months on the venture.
The splitting of equity is a significant business decision, which must be negotiated between co-founders based upon their respective contributions to date and their expectations going forward. In this context, you should probably be thinking in the 20-25 percent range, assuming the co-founder will be adding significant value.
Not imposing vesting restrictions – Some entrepreneurs make the mistake of issuing stock to their co-founder without imposing vesting restrictions. This becomes a huge problem if the co-founder leaves shortly thereafter. Indeed, it would be inherently unfair if your co-founder quit after six months and kept all of his equity.
To prevent this, make sure your co-founder executes a restricted stock purchase agreement, with a vesting schedule which grants him ownership of his stock over a four-year period (typically on a monthly basis). If you don’t know your co-founder very well, you should also think about a “one-year cliff” – meaning he would not be entitled to his first 25 percent tranche until he has worked for the company for at least one year.
Not requiring the execution of employment documents – Some entrepreneurs make the mistake of hiring a co-founder, but not requiring him or her to execute an offer letter agreement and/or a confidentiality and invention assignment agreement. The offer letter sets forth all of the co-founder’s rights and obligations, including that the relationship is “at will.” The confidentiality and invention assignment agreement is designed to prevent disclosure of the company’s trade secrets and other confidential information. It also ensures any IP developed by your co-founder is legally owned by the company.
Non-competition provisions may also be appropriate in certain circumstances. However, such provisions are unenforceable in California other than in the context of the sale of a business (though California courts may enforce contractual provisions that prohibit employees from soliciting the company’s employees, provided that such provisions are reasonable in scope and duration).
Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.
Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.
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