I'd be inclined to have the company write you an IOU for your cash contributions so far, and split it 50/50, perhaps with one of you getting a tie-breaking share. The company can dispose of your IOU like any other short-term debt of the company at some point in the future when it has the financial wherewithal to do so. [See below about IOUs.] Your vesting clock starts 3 months ago, your partner's starts as of the day when he becomes full-time.

I cannot emphasize enough that your equity split is not nearly as important as "Does bringing this guy on uniquely make this business successful and do I have confidence that we will both be happy with this arrangement 5 years from now?"

Edit to add: As I get older and wiser, I am coming to appreciate the discipline of separating one's personal and business finances and explicitly receiving written acknowledgment for transfers of money into one's company. These feel like moving money from one pocket to another in the early days, but they are not, and explicit written confirmation of that fact will make your life easier in a lot of futures.

For example, I know one entrepreneur who, like many, tightened his belt, ran up substantial personal debt, and put blood sweat and tears into building a company. Professional money came into the company. Without documentation that he had loaned the company money, the best resolution would have been asking the other stakeholders to approve increasing his salary so that he could cover his "personal" debts. Had that documentation existed, he would have had ample authority to extinguish that debt in the ordinary course of business, and it would have likely had favorable personal tax consequences.

This is something I tried to suggest to my former cofounder. His contribution was merely financial, and he wanted an exorbitant share of equity plus the title of CEO. I tried negotiating with him, but somewhere in the course of it I realized he was not the right person for any startup, and the venture was bound to fail with him onboard. I resigned and now have a startup that is quickly growing with loads of customers.

It's commonly asserted that ideas are worth next to nothing, the difficulty is all in the execution, etc. I don't think that's entirely true. If your idea is just a vague one-liner like "facebook for pets", then sure, it's not worth much. But as you start building out a prototype, you're forced to be more specific and refine the idea, and it becomes more valuable. If you've got a handful of users and you've gotten some feedback, that's yet a bit more value. And if you've thought about the problem for a long time, you will probably have a good sense of what are the main challenges and what approaches won't work. That's valuable too.

I don't think there is a well-defined line between refining your idea and "executing" on it. Obviously there is a limit to how much you can accomplish in the planning and prototyping stage. However, I suspect it is a lot higher than is commonly believed. Working for 3 months may sound like not very much on the scale of a startup's lifetime (let's say 2-5 years before it either fails or grows big), but consider this: maybe the OP did 4 or 5 failed 3-month projects before he or she got to this one, which seems somewhat promising. Suddenly that looks a lot more significant than 3 months.

For this specific case, we don't have enough details to assess whether the OP has really hit on something big, or if there is still a lot of uncertainty about whether the idea will pan out. So unfortunately, after all that discussion, I don't really have an answer to the original question. I think what I would do in your situation is to make my best guess as to the "fair split" based on what I've contributed and the expected future value (let's say I decide it's 70/30), offer the friend that split, and if he/she accepts, I would immediately change it to 65/35. That way, they should be happy, but things are still close to fair from my perspective.

This is a very important point you make. I guess the exact dividing line between an idea that's worth something and an idea that's worth nothing is whether time or money has been invested into the idea or other forms of personal risk by the time it was just an idea. It is the investment and commitment that makes an idea valuable, not the idea itself.

With regards to documentation of loans to company and things like that is having it recorded as a company liability (to the named entrepreneur) in the accounts sufficient or was it more formal than that?

For example, my LLCs have 10 million shares issued at par value 1/100th of a cent each. I own them outright. If for some reason I wanted to do a vesting agreement, I'd agree to the company having the option to purchase up to XYZ shares from me at par, with XYZ being any number up to and including the number defined by $VESTING_FORMULA_GOES_HERE.

With regards to documentation of loans to company and things like that is having it recorded as a company liability (to the named entrepreneur) in the accounts sufficient or was it more formal than that?

I figure as long as you're going to write it in the books of the company you might as well write a piece of paper saying

"$COMPANY agrees to, at a date of its choosing within 10 years of the inception of this agreement, repay to $FOUNDER the sum of $SUM plus 5.0% annualized interest." Sign twice (once in personal capacity, once as authorized representative of company), date, file for later.

Cliffs are, of course, negotiable. If someone suggested one to me with regards to my business, I'd accept it contingent on the clock starting at either launch or incorporation, either of which would result in the cliff being moot.

This gets very complicated very quickly. That's why you should consult lawyers (or legal documents available online, but unless you're a lawyers you should consult one anyway).

I'm actually not sure how this gets resolved in most startups. Oftentimes there are clauses like Shotgun clauses that try to solve this in a catch-all manner, providing a way of forcing people to sell their shares.

Also, being new to this, excuse my ignorance, what does vesting prevent? what does it encourage? First things that come to mind is if there were to be a fall out, the equity would remain under the one who stayed. On the opposite side, it encourages a long term commitment?

However, if you "loan" the company $4,500 to pay a designer for something, it absolutely owes you that money back.

Trust me on this one, you want to test risk tolerance as soon as possible.

Second question, will he work full time? If he doesn't work full time, you should give him very little equity, or just relative to the amount he invested in the company with maybe a little extra relative to the value he brings.

If he doesn't want to work full time and doesn't want to put money, just pay him by the hour. Pay him by the hour can also be a way to start the business relationship and build trust.

Third question, how much can you pay him if he works full time? For example, if he works full time but you can only pay him $ 50,000 instead of $ 100,000 the first year (assuming $ 100,000 is what he could get), he's putting $ 50,000 into the company.

Now, the last part: value your company. The best indicator is profit, when you reach it and how long you hope to sustain it (for ever, possibly). There are many tools and formulas, your accountant can probably help you. Because you have an accountant right? And a business plan, right? ;)

Another approach is that if he puts a decent amount of money (enough to give several months of runway) into the company and works full time for a well below market salary you can give him 49% (or 50%, up to you).

http://www.businessinsider.com/how-to-allocate-ownership-fai...

tl;dr as far as I remember from that book: Make sure it is fair, and enough equity for both to be motivated. You have to discuss with each other to find out. It can be everything between 95/5 to 50/50. If you value the friendship more than you value the company, you should go for 50/50. Otherwise 50/50 is not a good option according to Wasserman's research.

*Partners are working full time on this.

Here is a good summary of how to pick a cofounder http://venturehacks.com/articles/pick-cofounder

This is the key sentence. Work together for a month, with no equity. See how much this potential co-founder actually accomplishes. You'd be amazed by the gap between what you dream may happen and what actually happens. Success is hard.

If after a month, you are still super-excited about this co-founder, start discussing an equity split. Always with vesting. No cliff (or very short, that was what the 1-month trial period was for).

If a co-founder doesn't receive a salary, then the minimum equity split would be 90/10, all the way to 50/50. FYI, at 90/10 I would behave like a super-adviser, but not a fully committed co-founder. 75/25 is the first "true co-founder" deal I can think of.

Having someone who worked for you for a couple months walk away with tens of basis points of ownership is a pathological situation, not something you should deliberately optimize for.

Read the reviews for Slicing Pie. It's about maintaining a dynamic model that eventually vest into shares (if the company works out). I read it. It's great quick read. Ideal for your situation, I think. And it may preserve your friendship.

http://www.amazon.com/Slicing-Pie-Company-Without-Funds-eboo...

EDIT This moves around so much I uploaded to Scribd: http://www.scribd.com/doc/234962516/Entrepeneurial-Death-Tra...

An LLC would require to define terms of ownership, decission and cashout in its charter beforehand. A Corp is much more flexible, especially if you do not know how much your "partner" will contribute in the future. So you might want to copy the unusual way Wizards of the Coast did: 1 share = 1 hour = $50

So you own already 600 shares, and your partner owns zero. If he invests money or time he earns share and dilutes you, if you invest money or time you earn shares and dilute him.

WotC shares later sold to $1400, iirc - so it was a good deal for the artists who painted those tiny pictures for magic the gathering.

PS: Peter Adkison later wrote that he had no clue how a normal Corp works, and did not consult a lawyer because he had no money for it, and just handwaved a way, that sounded fair to him, to pay the artists without having any money. It worked out, thats all that counts.

No matter what your corp structure is, this is an issue you need to spend a few hundred dollars on an attorney on.

Why?

He has not done anything yet.

This sounds like you are afraid of sales/marketing/biz dev/something and you think he will solve your problems.

I warn you: he will not solve your problems, you will have more on your hands.

This doesn't seem fair. The founder who takes an IOU rather than cash bears the very real risk that he never gets paid back. There should be an interest rate attached to the IOU: something like 15-25% to account for the risk.

I think we are in agreement on the first part, i.e. that a rate of 15-25% should adequately compensate the individual for both the time value of money and for the large risk of default.

I don't agree that it's unfair to the company. Consider:

- The company has no alternative, cheaper sources of debt financing

- The capital and interest will be deferred until such time as the company has money to pay (e.g. from a Series A) so will not cause any hardship by constraining cash flow

- These IOU are non-participating, i.e. they don't get any of the upside should the company do well.

If you think about it, it's similar to an investment by an angel: you want to compensate for the risk, you don't know when you will be able to return the cash, you don't have a reliable way to come to consensus on valuation.

Perhaps the right way to structure these IOUs is as a capped note with a low coupon (2-5%) but a reasonable conversion discount. That way the equity-like element of the note compensates for the risk, instead of requiring a large coupon on the debt-like part.

If it's "just like cash", then you've made a significant early investment in the company. How is getting paid back what you put in fair?

http://blog.saasu.com/2014/03/28/ceo-insights-webinar-record...

Disclosure: I work at Saasu but think this is relevant.

The point is: why split the pie before it gets done or after? why not dynamically split based on the actual resources (money, time, equipment, whatever) people put in in the early days?

For example, when the company hits a rough spot, it may be best for a team of N to be thinking, "We all need to work extra hard this month so that our 1/Nth shares wind up worth something, rather than nothing." Rather than, "I need some recharge time, I'll let others earn a little more this month, and re-engage for my increments if and when it gets less crazy."

Work to keep him as a friend. Channeling Steven Covey, it would be helpful to first understand what he would like to get out of the business arrangement and what he's committed to invest on his end. Beyond a mutual agreement, find a win-win scenario.

You told us what you've done until now, but are those "many areas" ?

  http://paulgraham.com/equity.html