Sharing ownership in start-ups

In part one of a series, Peter Rouse discusses the concept of shared ownership in new businesses.

Sharing is tricky. We expect it when others have what we need and feel we deserve. We resist it when we have what others want and fear we may be left with too little. Our willingness to share is said by cultural evolutionists to be rooted in reciprocity. Times of lean, times of plenty; fortunes change and the time may come when we are in need so best help your neighbours now. It is an essential part of the non-zero sum game of ‘win:win’. Sharing is essential to and an expression of relationship. If we can agree in principal that sharing is necessary and mutually advantageous, how then do we do it in the world of business which is characterised by competition and ‘winner takes all’?

Business is rooted in the exchange of value and relationships fall into relatively few basic categories: between business and business; business and customer; owner and owner; worker and worker; owner and worker. What I want to examine is sharing between owners, particularly in the start-up context when those would-be owners are also called ‘founders’.

More businesses are being started than ever before. However, according to this article being a UK start-up is a risky business with one in three companies failing within the first three years. A fifth of businesses fail within the first year, and in the next three years 50 per cent of those fail. My suspicion is that a common reason for business closure is that the founders have fallen out, primarily because they shared out equity at the start and someone has not lived up to their side of the bargain. I believe there to be a material deficiency in our start-up culture in the UK and it relates to the lack of sophistication and method in the sharing out of ownership and rewards among founders.

Henry Ford said ‘You cannot build a reputation on what you are going to do’. Founders commonly decide who will own what proportion of the business they co-create largely based on what they are going to do and so I would like to paraphrase Ford and say ‘You cannot sensibly allocate shares in a business based on what the founders are going to do, unless you have a vesting schedule’.

Vesting schedules are a little complex so I will deal with them in Part 3 of this article. First, let me build on my premise a little more. Information abounds, as do support services and apps and any number of groups and networks. Yet no one seems willing to address perhaps the most difficult and sensitive issue of who gets what when a start-up is founded and, more importantly, how and when they should get it.

Perhaps it is considered something private that has to be sorted out between the founders and one should not pry; or if it is to be discussed then it will be sorted out by lawyers when a company is formed. On the contrary, we are failing ourselves and others if we don’t grasp this particular nettle. By contrast, there is plenty of ‘know-how’ around what happens when outside investors get involved concerning valuation and the allocation of stock. Of course it is a matter for negotiation where investors are involved and the transaction is ‘at arms’ length’, as is the relationship that does not truly begin until the deal is done and the investment is made.

The way these deals are done is talked about and studied and improved upon so that everyone comes to understand how investment is done and what must be discussed. The starting point for many who have a business idea is to involve family and friends.

Even if founders are only acquaintances, perhaps met through work, one or more may seek to involve a friend or family member as ‘someone they can trust’. In the initial flush of excitement that provides the energy to get a business off the ground, more time is usually spent choosing a name than is ever given to deciding how ownership and rewards should be shared. We all prefer to avoid the tricky stuff if we possibly can and the results can be disastrous.

All but a very few of those I have spoken to have been remotely familiar with the subject of vesting schedules or experienced in the allocation of shares among founders. The subject is well known to the likes of lawyers involved in VC funding no doubt; but how many startups would even think, let alone afford, to obtain that kind of advice. The value to be assigned to prospective contribution by founders and the corresponding allocation of equity and reward is relatively unknown and therefore unused in the UK and it is time we did something about it.

Read Parts II and III here

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