Cofounder or not a cofounder: Making the case for equity or not

Editor’s note: Joe Procopio is the Chief Product Officer at Get Spiffy and the founder of teachingstartup.com. Joe has a long entrepreneurial history in the Triangle that includes Automated Insights, ExitEvent, and Intrepid Media. He writes a column exclusively for WRAL TechWire. His columns are published on Tuesdays.

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RESEARCH TRIANGLE PARK – Being a cofounder is about more than just being there at the beginning. And handing someone the wrong role can turn into a costly mistake.

Let’s talk about how to avoid that.

Yesterday, I got a very eloquent email from “Julie,” the client manager at a small consulting firm that does high-tech software development in and around the Valley. The company is early, but scaling up pretty rapidly. Julie was there at the beginning, helping the founder get his act together to parlay his super-strong coding skills from a solo gig into a full-service development shop.

Joe Procopio (Photo courtesy of Joe Procopio)

Julie was struggling with whether or not she should be given cofounder status and equity. She was worried about missing out on what could be millions of dollars down the road.

Her boss established the company, and it still trades on his reputation. Thus, he believes that without him, there is no business, so the company should be his and his alone.

Julie was driving herself crazy with these three questions:

Shouldn’t she be a cofounder?
What’s her best argument?
Should she walk if her boss doesn’t make her a cofounder?

Why the cofounder role can be tricky for any startup

Julie’s questions are totally legit

Julie is struggling with these questions because it feels selfish, if not greedy, to ask for more at such an early stage. The equity is worth nothing at this point, so why quibble over how much you have?

She’s also up against a phony precedent. Conventional wisdom will tell you that the founder or founders are the ones who legally establish the company.

That’s garbage.

What cofounder really means

If you had a major role in building out an idea from the beginning to viability to initial version, you’re probably a cofounder. There are two mistakes in how this plays out, both based on vague words in that definition.

The first mistake is what is meant by “the beginning.” Cofounders don’t have to be there at the establishment of the company or even in the early company lifecycle. A company can flail for months or years before they a) hit on a viable idea and b) take steps to execute that idea.

Sometimes a single person is doing all the flailing, and maybe they go ahead and form the legal company entity during this time, so by default, they become the sole founder. They might even make some progress. But then, one or more people contribute to the idea and drastically change it, and in doing so, dramatically increase its chances for viability. But since the company was already in existence, they’re not given cofounder status.

The second mistake is what is meant by “major role.” It’s the same scenario, but this time two or more people are riffing on the original idea, they form the legal entity as cofounders, but they get nowhere. Eventually, they go back to their jobs and grow apart. Then one of them pivots the idea to viability, and it’s a completely different take on the original idea. Problem: There are one or more legally named cofounders out there.

Julie’s situation is the former, so let’s talk about that and save the latter for another post, because there’s no quick fix for that scenario either.

The case for Julie being a cofounder

Julie’s best argument to be made a cofounder is that she has singlehandedly turned this founder from a solo into a CEO. If it were any other way, I’d say no cofounder option here.

Julie also deserves and needs the motivation of equity. And since motivation comes from ownership, it’s hard to feel ownership when you’re building the company and you have no equity.

That said, her company is a service company.

Founding and equity is different for service vs. product

Service models work differently than product models. I’m dumbing it down a bit, but a service model requires perpetual genius for growth and success. It is constant execution. A product model requires a bunch of genius put into the thing up front, before execution, and the people that “invent” that thing are rewarded for it in terms of cofounder status and equity.

Therefore, in a service model, equity is rare, bonuses are more prevalent. Cofounders are rare, partners are more prevalent.

One of my past startups was a technical and product consulting firm like Julie’s, doing over $1 million in annual revenue. No one had equity because we were only worth 1X the receipts, if that. Once there was profit above and beyond what I had to put back into the business to scale it, I would start an equity and partnership plan.

So in Julie’s case, there’s not a lot of value in any equity other than that feeling of ownership. Yet. No money has been invested into the legal entity. And if the company is still indeed landing new business mostly because of the founder’s reputation, there’s still a major risk of that company folding when the founder gets stretched too thin.

Julie has more scaling to do to get to a point where the equity will have more value than the revenue coming in. But if that happens, it becomes a different story.

He has the talent, she has the tools. This is a perfect cofounder scenario. So it stands to reason that Julie deserves a chunk of what she’s building, and even deserves cofounder status.

That said, there are no rules. Truth is, all of this is totally up to the founder. There is no rule or law in terms of who gets cofounder status and who gets equity. It’s all ethics, decisions, and agreements.

So it’s going to be what he wants vs. what she wants.

Whether or not she walks away shouldn’t be a matter of founding status and equity. It should have everything to do with whether or not she can love her job in a non-cofounder-no-equity role.

But that doesn’t mean she can’t negotiate.

Solution

Julie loves her job and she likes the founder. They work well together. She’s worried about breaking a good thing to get to a better thing. I get that. But that’s also a concept that actually kills most startups — they get a good thing going, they realize they have to pivot and break the good thing to get to the better thing, and they get fearful and freeze. Then they die.

If I were Julie, I’d try to work out an equity plan that vests over time and at certain milestones. Like I said, a service company requires perpetual execution, and so it’s much more susceptible to feast and famine periods all through its life.

So maybe after a year, she gets a certain percentage of a total capped stake, provided the company hits a $1M run rate by the end of that year. Each successive year and at higher run rates, she gets more of a stake until she hits the cap, at which point she makes partner.

I’d also suggest a variable compensation plan in addition to her base comp, so the better the company does, the bigger her bonus. That’s daily ownership and motivation right there.

Julie is right to wonder, she’s right to question, and she’s right to negotiate. Founding status and equity aren’t rights, and sometimes you have to fight for them. But sometimes, all you have to do is make a solid case for something that’s within the parameters of your unique situation. You’ll be happier, and what’s more, you won’t have any regrets.

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