Designing equity structures that motivate founders to push through when it gets hard
I have been asked to talk about how we design ownership of a new company, especially when working with organisation founders (such as corporates or research organisations) in Startup Science companies.
Understandably, people are looking for a number here. A norm. How much equity should a research organisation get? etc. All companies are different and I believe it is important that no one feels their ownership is driven by a norm, but by what is fair.
Here are some of the ways we think about that.
Equity is for what is to come, not what is done
Equity is a form of compensation that rewards a founder for a long term commitment to bringing something to life which external forces will resist.
It is a mistake to design equity around what has been done. It is common to see companies spin out of organisations with the idea that $ have been invested and that organisation should own the majority of the company. But that organisation is not participating in the company any more. Most of the stock is owned by a passive owner who only acts to protect the past.
Founder equity should vest
Because we allocate equity around effort and impact that is to come, we vest founder equity. This means that the founder earns the right to keep their shares over time — usually over three years. If they leave the company after 1 year then they only get to keep one third of their shares.
Vesting should not be done against performance because startups need to be able to change strategy. Founder vesting against performance targets hard codes resistance to change into the company.
Equity interacts with cash
There is a connection between the cash that flows out of a company to pay founders and their ownership in that company.
All founders are acting in the best interests of the company and it is not sustainable for a founder to be the biggest equity owner and the destination for most of the investment capital in the company.
Where one goes up the other goes down. For example, It is not reasonable for a research organisation founder to want 40% of the company and take most of the investment capital in fees for science delivery. Equally, it is not reasonable to give 1% equity and expect work to happen for free or at a discount.
Don’t be greedy
Imagine a difficult day in the future and imagine the founders making a choice about how they will act. How much should they push with everything they have to achieve the biggest outcome with what they can bring to the company?
Imagine that moment when you think one part might have ‘too much’ and ask yourself how you want them to act in that moment.
Play the tape to the end
What happens after 5 rounds when everyone has diluted? Are founders still motivated? Is their equity motivating them to continue pushing for leaps in value?
Founders are the beating heart of a company. It will likely be a 10 year process to make the idea become real. Over this time there will be many moments where founders want to give up, or commit with less than they could.
Make sure the design of your ownership creates conditions for the right decisions to be made.
How do you design your equity when co-founding startups with corporates or research organisations? I’d love to discuss that with you on Twitter. I am @philmorle
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