Ask HN: Co-founder leaving amicably. Convertible debt an option?

[mistakes]

Three of of us started this startup a while back. For more than a year we didn't get very far and finally cofounder A decided to stop working on it full time, at which point his stock stopped vesting. However, based on our vesting, A still owns X% which is a non-trivial percentage. Since A left, and we refocused the company onto a different product line and gained much more traction, becoming close to cash flow positive.

Based on the fact that A's contribution to our current efforts is zero, he volunteered to bow out of the company. We are still too early to put a valuation on his share and buy him out. Is there a fair way to compensate A for his early efforts but 'cap' his share in growth to which he did not contribute?

One option we are considering is converting his share into a convertible note for an amount equal to the salary he gave up by working full time on the startup, with little or no interest and a twenty percent discount at first round. Is this a good idea?

Are there any other options?

[pwim]

However you decide to work out things financially, I'd be careful not to undervalue his effort. You say he contributed nothing to your current product, but I find it unlikely that was the case. Even if you are working on a new product, surely you learned something from the previous one. Also, if it wasn't for his efforts, perhaps you wouldn't have got so far with your previous product, and would still be working on it. A business is a fluid beast, and what you set out to create usually isn't what actually makes you succeed.

[mistakes]

You say he contributed nothing to your current product

Actually, I said

A's contribution to our current efforts is zero

It's an important difference and I chose the word carefully. Our early efforts with him did not succeed, but based on my experience it is almost impossible to succeed without making mistakes first and learning from them. We value his contribution, which is why I am trying to determine a fair way to compensate him for this efforts.

Edit: Let me expand on what I said. It is hard to talk about separation while sounding entirely positive, because separation is not a positive event. I wouldn't even have met my other cofounder if it were not for A. So, rest assured, however this separation is structured, in my mind he will have earned his keep.

[JangoSteve]

I agree with this to an extent. However, I think it's equally important not to over-value his effort.

[Edit: This is coming from someone who's gone through this and later had many people tell me I was far too generous with the buy-out]

If only the world were fair enough that we could all be compensated every time we exert effort. Unfortunately, the world often does not reward us for effort, but rather for outcome.

I'll illustrate my point with a slightly exaggerated example: You could say that if it weren't for my tenth-grade English teacher, I would never have gained the insight to question things widely believed to be true. Then I would have never grown to question my own unhappiness in a white-collar job. Then I never would have never quit and started my own companies. In a very real way, if it weren't for the things I learned from my tenth-grade English teacher, I would have never seen the success I have. Should I track my teacher down and give here X% of every one of my companies?

Of course, in this example, I've almost convinced myself that I should. But my point is that every person in your life contributes in some way. If you go out trying to compensate every person who helped get you to where you are, there will be nothing left for yourself.

Now, this co-founder may deserve to be well-compensated. But don't do it based purely on the idea that they helped contribute in some intangible way to your product's current success. Do it if it was tangible and significant.

[jrockway]

Personally, if I was "A", I would just keep the shares. My time is already gone, so I might as well have a chance at a payoff at a later date.

If I needed money, then I would go for "an amount equal to the salary I gave up by working full time on the startup", which you seem to be offering.

[mistakes]

Actually, I said "a convertible note for an amount equal to"..which gives him a chance for a payoff at a later date and (as I understand it), provides a floor for this payoff while limiting the ceiling to a certain extent.

However I am not sure if this understanding is correct.

[maxniederhofer]

An option for you guys could be to wait until you do your first round of funding and have the incoming investors buy him out. I've seen that done before and it worked well.

Lesson: always include an option to redeem the shares of a founder who leaves. Redemption can specify whether that takes place at nominal or market value of the shares. There should be a good leaver/bad leaver clause that outlines what happens if a founder is fired or leaves voluntarily.

[sajid]

If you're on friendly terms with your cofounder then it's just a question of reaching an agreement both sides are happy with. The best option would be along the lines of what davidu has suggested.

If you're not on friendly terms then it's basically irrelevant that he didn't contribute anything to your current success. There's nothing you can do without his consent.

A 1 year cliff is standard, and he stayed with the company for longer than a year. And since you had a vesting schedule in place, the cofounder is clearly entitled to the stock he's accrued.

It seems to me that the mistake you've made is having an overly generous vesting schedule. 4 years is standard, in which case he would have only accrued about 8%.

[davidu]

Go get any reasonable SV lawyer to have him sign back his stock to the company and then cancel the shares. You can make him an advisor and give him a grant to recognize him for his early efforts.

You will need all the equity you can as you build your company and being nice now giving a big chunk to a non-participating founder will make you bitter later.

If you don't think it will, then let him keep his ~25% vested. He'll be diluted, just like you and everyone else as you raise more.

[mistakes]

This may be a stupid question, but by 'grant', do you mean a stock grant? Why would he agree to a grant of less than X% (which he currently owns)?

The last option is the default, and we are o.k. with it if it comes to that.

[davidu]

Hey may agree to less than what he has today because by giving back a huge chunk of equity to the company it can allocate it to future hires. That way he is hopefully increasing the chances of his somewhat smaller stake being worth more later.

In other words, he'd be better off owning less of something huge than more of something small. :-)

This is not unheard of. It might not be common, but I've only been in silicon valley six years and I've seen it at least a handful of times.

[mistakes]

Thank you for the perspective. It makes sense.

[fleitz]

What is the outcome you want to optimize around? Friendship? Current cash on hand? Maximizing equity for the remaining founders?

I suspect the best thing is to focus on the biz, it's much more important to have a big pie to argue about dividing than to have a fair division of nothing

[cyanbane]

"I suspect the best thing is to focus on the biz"

Agree with this, whats done is done. Keep pushing forward and keep an open mind about his opinions, you never know when a piece of advice from an 'outside' mind might help. Just because he may not have been there during the formative part of the biz doesn't mean his thoughts about it can't make everyone money and see things that other people wrapped up in growth don't see. Hell he/she might even turn out to be an asset as they don't see the day to day and also know you and your other partners faults via the slow time.

[mistakes]

Maximizing equity for the remaining founders (and current and future employees) is the primary objective. Doing so fairly is important also, but to quite a degree, fair is subjective.

Agree that the best thing is to focus on the business and maximize the pie.

[zaidf]

Next time have a cliff so if a founder leaves within the first yr, he gets nothing.

[mistakes]

We had a one year cliff. He left some time after it.

[zaidf]

Ah my bad for assuming you didn't have one.

[jonpaul]

I'm curious, do you have an LLC or a C-Corp? Does anyone know, is this kind of situation easier to handle if you have a C-Corp?

[davidu]

It doesn't have any impact on it. You can deal with this in either case just fine.

OpenDNS was an LLC for it's first 3.5 years of existence and then we converted to a C corp when Sequoia Capital invested.

[cgherb911]

Do the math on what x% is in dollars based on your premoney evaluation. Give him the note for that amount and treat him as if he were a friends and family investor.

[mistakes]

Good idea but this would require us to wait till we raise funding, and therefore have a valuation. We are wondering if there is a way to resolve this right now so that it doesn't complicate an already complicated fundraising process.

[cgherb911]

Have you pitched any VC's or angels? What premoney are you giving them?

If you don't have a premoney, then cut him a fair salary for the time he worked in a convertible note. The convertible note will be the optimal way to have a nice looking cap table.

I just suggest that you deal with this matter quickly while everyone is in a good mood. Success in a business after someone leaves can be dangerous...

[mistakes]

Agreed that we need to deal with this matter quickly. Thank you for your advice.