Co-founder equity mistakes to avoid

1. What will keep my co-founder motivated across all four years, not only convince them to join today?2:41
2. Will they still feel they have enough equity in year two, three and four, or will they resent a CEO holding four times more while they grind?2:18
3. What will keep my co-founder motivated in year three, when everything is going badly?10:00

• It covers the conversations founders have at the very start, before product-market fit.
• Applying it to later-stage companies or non-tech companies would be a misuse of the advice.

• Be generous with co-founder equity. The aim is to motivate the founding team to work extremely hard through the first couple of years, when it often looks like nothing is working.
• The biggest mistake is being stingy with equity in this delicate period, which pushes people out while the company could still become something big.
• Both the very experienced founder and the naive founder are generous. The middle group works through skills, contributions, time commitment and network in a complicated calculation. The speaker argues that calculation is not needed.
• The talk runs in this order: equity splits, breakups, bad reasons for very unequal splits, bad advice, final thoughts.

What was discussed

• The common mistake is not thinking about how to motivate co-founders today and tomorrow. Equity is usually earned over four years.
• The risk in years two to four is a co-founder who feels they do not have enough equity, or who has been there from the start and sees the CEO holding four times more. That creates resentment.
• The CEO's job is to think about what keeps a co-founder motivated for all four years and beyond, not only what convinces them today.
• Typical advice: close to equal splits. They need not be exactly equal, but the more generous you are, the more a strong founder stays motivated.

What was discussed

• Vesting means equity is earned over time. If you leave during that time you do not keep all of it.
• A cliff means that if you do not make it through year one, you get none of your grant.
• Both should apply to all founders.
• Founders sometimes ask why bother, since they like each other and nothing will go wrong. The reply: founder equity is not something to innovate on, and best practice is that all of it comes with vesting and a cliff.
• Life happens: people leave when they do not want to, family circumstances change, people get sick, people do not perform. Vesting and a cliff let founders be let go, or leave, without destroying the cap table.
• The typical set up is four-year vesting with a one-year cliff: no stock until one year of working at the company.

The four years and one year are the talk's typical terms. The 25% at the cliff and the monthly pace after it come from YC's article on splitting equity.

• A founding team is the smallest group that can get an MVP built, put it in customers' hands and start learning.
• Generosity with equity also makes it easier to remove people who are not essential or who should be employees, not founders.
• The co-founder title should not be handed out freely. A team arriving with five, six or seven co-founders signals that a conversation has not happened. Seven people are not essential to getting a product out.

• In almost every case, most of the work in the company is not done when equity is handed out.
• Equity motivates people for work they have not yet done. It is not a reward for work they have done.

• However the split is set up, the CEO should keep the right to fire founders who are not performing.
• There has to be a captain of the ship, someone held accountable, and that person must be able to let people go.
• A founder unwilling to join on those terms does not grasp how serious a company is, or should start their own company as CEO.

The conversation

• The most responsible step is for co-founders to talk about what will happen if things do not work out. The speaker offers YC's guidelines for pre-product-market-fit breakups as points to discuss together.

YC's guidelines

• Leaves or fired before the one-year cliff: typically a token amount of equity, 2% to 5%. There is no evidence yet that the company works and most of the work comes after the cliff.
• Before product-market fit, a founder who leaves or is fired should leave with no more than 5%, which often means giving equity back. The remaining team stays motivated and the equity goes to people who can still add value. A departed founder holding a lot of equity reduces the company's chances, and so the value of their own stake.
• Leaves or fired after the cliff: should keep no more than 5% of the company.
• A fired founder getting a small severance of one to three months is reasonable. For a founder who chooses to leave it is not typical, though it can be done.
• Every departing founder, fired or not, should resign from the board, sign a release, and often give proxy voting rights to the remaining founders.
• Usually the non-CEO founder leaves or is fired, but sometimes it is the CEO. The new CEO has to arrange the breakup accordingly, and the previous CEO should understand these expectations too.

Each reason, and the reply

Summary of the section

• All of these are short-term thinking. The best founders think long term, think about their co-founders' needs even when the co-founders do not, and use equity as a tool for maximum motivation of a small number of people, not something to hoard.

• Over 10 to 15 years, one founder often stays longer, carries more responsibility and arguably becomes more valuable. Bezos at Amazon and Zuckerberg at Facebook are the examples given.
• That does not mean they should hold vastly more equity. The first four to six years create much of the value and are when most companies die.
• Even a founder in that position should stay generous. The co-founders supplied the activation energy to get into the game at all.
• Co-founder motivation is central to making a successful product. Use co-founder equity to give yourself the best chance of building something people want, after which the rules change.