How to Restructure Co-Founder Equity

Navigating the complexities of restructuring your co-founder equity can be daunting. You’ll often hit a wall while looking for advice online due to the inherent confidentiality of equity restructuring negotiations.

As a mediator with eight years of experience guiding co-founder teams and business partners through equity realignments, I can attest to the critical nature of discretion in these processes. However, despite each situation’s uniqueness, there are recurring themes and considerations vital to any co-founder team embarking on a negotiation for a new equity arrangement.

In this article, I’ll guide you through five pivotal questions you should ask yourself individually and as a team during any restructuring of your co-founder equity. Drawing from my extensive experience mediating these discussions among startup founders and business owners, I’ll provide insights and resources that bring objectivity to these otherwise complex conversations.

Key Insights

1. The Five Essential Questions for Equity Restructuring

• Delve into five critical questions that every founding team should contemplate during equity restructuring conversations.

2. Centering the Dialogue on Value Contribution

• Direct the discussion toward the business’s needs, emphasizing the past and future contributions each founder has made and will make.

3. Strengthening the Founder Relationship Through the Negotiation

• Leverage the equity distribution talks as an opportunity to reinforce and enhance the collaborative dynamic among the founders. This process isn’t just about numbers — it’s also about fortifying the team’s unity, motivation, and commitment going forward.

4. A Structured Approach to Equity Negotiations

• A practical tool tailored assist founders in navigating the negotiation for their new equity split, streamlining discussion and facilitating more equitable outcomes.

1. Why are you restructuring your equity split?

Restructuring co-founder equity isn’t a decision to take lightly. It often comes into play during these scenarios:

• Introduction or Departure of a Founder: Adjustments are needed when a new founder joins or an existing one exits to reflect the evolving team composition.
• Changes in Roles and Contributions: Significant shifts in responsibilities or the value of contributions, primarily if the initial equity was distributed quickly or without deep deliberation.
• Preparing for Funding Rounds: Before rounds like post-seed or Series A, it’s crucial to ensure equity reflects the actual contribution of each member, making the company more appealing to investors.
• Attractiveness to Investors: Reassessing equity distribution can also make your startup more enticing to potential investors and other key external parties.

Consider the case of Groupon. Originally known as “The Point,” it was a platform aimed at collective problem-solving. It wasn’t until Eric Lefkofsky stepped in, transforming the concept into a group-buying site and injecting $1 million in seed funding, that The Point evolved into Groupon. This pivot in business model and funding likely led to an equity restructuring, though the public knows little about the specific details behind the scenes.

This case highlights how external changes, be it capital injection or strategic shifts, can significantly influence a co-founder’s cap table and the broader business framework.

This is a scenario filled with complexities, from potential pitfalls to legal intricacies that must be carefully navigated. And it is also one that most startups may encounter as they go through various growth stages.

2. What are the legal and tax implications?

Securing expert legal and tax guidance is crucial in restructuring co-founder equity. The nature of your negotiation hinges significantly on the newly proposed equity split. Vital legal questions to consider include:

• Buyback Options: Are there any buyback clauses in your founder agreement that could influence the restructuring?
• Vesting Schedule Impact: How will the restructuring affect your negotiation if all equity has already vested, according to your current vesting schedule?
• Anti-Dilution Provisions: Do your agreements include anti-dilution clauses, and how might these influence the equity restructuring?
• Shareholders’ Agreement Review: What stipulations, if any, does your shareholders’ agreement include about such changes?

On the tax front, altering co-founder equity or engaging in share buyback and selling activities can trigger specific tax consequences.

While I am neither an accountant nor a legal expert, whenever I facilitate equity negotiations, the teams that get better outcomes are those that are fully prepared with answers to the legal and financial aspects of their negotiation. I have found that inadequate preparation in these areas can create significant obstacles and delay negotiations.

Pro tip: it’s vital to understand how these changes might affect future funding rounds, acquisitions, tax liabilities, or the allocation of employee option pools. These can be areas where you negotiate to create a potential win-win later. For example, if selling shares may cause a significant tax liability, founders can agree that the business pays for any said tax liability.

As you make changes, ensure that anything you agree upon is solidified through a legally binding document, safeguarding all parties involved and maintaining clarity in your business agreements.

3. Are you able to have an open and honest conversation?

A crucial element in equity restructuring is engaging in frank and transparent dialogue. I recall facilitating discussions for a trio of founders preparing for a Series A funding round. They wanted to realign their equity to more accurately mirror each member’s contributions but found themselves at a deadlock over the extent of each founder’s impact on the company’s growth.

It was only through fostering more profound, candid discussions that the underlying reasons behind their perspectives emerged. One founder’s dedication extended to working tirelessly, even during vacations. Another leveraged his personal network for a successful angel investment round. The third undertook the less glamorous operational tasks vital for scaling the business, yearning for recognition of those efforts.

Armed with this understanding, I navigated them through a series of challenging conversations, assessing how each contribution fueled the company’s growth. It wasn’t easy, but it was necessary. And as they eventually reached a consensus on a new equity split, they recognized that each wanted to feel valued for what they brought to the table — and those conversations did just that.

Equity restructuring negotiations are inherently challenging, often stirring intense emotions and ego. This is where the role of a mediator, or an impartial third party agreed upon by the team, becomes invaluable. They can create a conducive environment for overcoming stalemates and moving towards agreeable solutions.

Yet, the foundation of successful negotiations lies in open, honest exchanges. That’s why I say that emotional intelligence and empathy amongst founders are just as crucial as the legal and financial considerations in reaching a satisfactory outcome. The key is to make the negotiation about the value each person has brought to the company and will continue to bring.

Pro tip: Ensure that the mediator or advisor you choose possesses expertise in equity restructuring negotiations. Their specialized knowledge can be pivotal in guiding the process toward a successful resolution.

4. Is there a formula for helping evaluate a new potential split?

In my work with founding teams, I introduce a structured method to evaluate potential new equity distributions. This involves a comprehensive spreadsheet designed to quantify each founder’s contributions across five key dimensions:

• Idea/Intellectual Property: Assessing the impact of both past/present and future intellectual contributions.
• Commitment & Risk: Evaluating the levels of dedication and risk each founder has undertaken.
• Responsibilities & Duties: Analyzing the scope and impact of each founder’s tasks and roles within the company.
• Business/Domain Expertise: Considering the value brought by each founder’s industry-specific knowledge and skills.
• Capital Invested: Accounting for the financial contributions made by each founder.

Objectively measuring contributions and performance is crucial. Metrics such as time invested, milestones achieved, or financial input provide a common ground for discussion, making the process more transparent and less subjective. To facilitate this, you can utilize various tools and methodologies, like ‘Slicing Pie’ or ‘Dynamic Equity Splits.’ Additionally, custom frameworks tailored to your industry’s specific needs can also be highly effective.

This is the formula sheet that I use with co-founder teams when they’re renegotiating their equity split:

You’ll see each dimension listed, with each founder receiving a score from 1–10 based on their value contributions.

The goal is to go through the sheet individually first. Everyone fills in their numbers. And then, you compare and contrast your numbers, seeing where there is agreement and where you’ll need to flesh out alignment. You can use this formula by clicking here, which will automatically save a copy to your Google Drive.

By adopting a systematic approach, you can ensure that the negotiation process is grounded in fairness and measurable contributions, leading to a more equitable and agreeable equity split.

5. What is the long-term vision and exit strategy of the business?

In the final stage of your equity restructuring discussions, ensure that your decisions align with the company’s long-term vision and exit strategy:

• Public Offering Considerations: If the business aims for an IPO, how does the equity structure account for the potential dilution in subsequent funding rounds? Are the founders equipped with sufficient equity to maintain significant stakes?
• Acquisition Prospects: If acquisition is a potential goal, how does the equity arrangement cater to this scenario?
• Founder Exit Plans: Are any founders planning to leave the business early? How will their departure impact equity distribution, and what mechanisms, such as share buybacks, will be employed to manage this transition?

The equity structure must be adaptable enough to accommodate these varied scenarios. It’s particularly important to address the implications of early founder exits. Shareholdings of departing founders can significantly influence the company’s capitalization table and impact future acquisition discussions or other strategic negotiations.

Bottom Line

These five key questions provide a framework for startup teams embarking on a co-founder equity restructuring negotiation. Embrace open and honest communication, utilize objective evaluation methods, seek legal and financial advice, and crucially ensure that the conversation is about what has been contributed to date and what will be expected of each person moving forward.

Wishing you success as you navigate this vital process!