I’ve been involved with 4 startups over the last 10 years or so, 3 as a co-founder. I’m a follower of Paul Graham and the YC camp of startup wisdom. There’s now a great deal of literature laying out the unbreakable rules for startups. Despite studying this literature, I’ve managed to break each of these rules, in some cases more than once. In every case, I have come to regret it.
1. Choose your cofounders carefully
If your startup is successful, you’ll spend the majority of your waking time with these people for the next 5 years. Invest the right amount of time getting to know each other. Ideally, you’ll have worked with these people for a few years at another company before you do your own thing.
Your relationship will be like a marriage, but even more intense.
Three co-founders feels like the right number. Try to find the most driven, effective people you know and convince them to join you. Unless there’s a really good reason, equity splits should be equal. If you don’t think your cofounders as effective or valuable as you, why are you starting a company with them?
2. Written agreements from the start
An agreement doesn’t have to be complex, or necessarily involve lawyers. There are plenty of open-source co-founder agreements published by law firms. But you need to agree:
a) Any money invested, either as equity or debt
b) Equity split
c) Salaries, included any deferred compensation
In the simplest case, the agreement will be “no money invested, equal equity splits, zero salary”. But as soon as bills need paying, things get trickier. An investor friend recently told me that he makes a rule of telling founders, “I won’t ask you to trust me”. All deals go into writing immediately.
3. All stock must be on a vesting schedule
Vesting means that stock is earned over the lifetime of a person’s involvement at a company. A standard vesting schedule is “4 year vesting with a 1 year cliff”. This means, if I have 48 shares in a company, 12 of those become irrevocably mine (i.e. “vest”) on the first anniversary of my joining the company. The remaining 36 shares vest monthly over the remaining 3 years - 1 share per month.
If I leave (or I’m fired) after 3 years, I walk away with 36 shares. The remaining 12 shares are taken back by the company.
Vesting is a good thing for everyone. It ties people’s incentives to the long-term success of the company. I’ve heard founders even talking about 6 or 8 year vesting sometimes.
If your co-founder says “just trust me”, see above.
4. Keep company money separate
When your company needs to pay bills and you’ve not raised outside investment yet, be very clear who’s paying and under what terms. Is the money going to be repaid? When?
As soon as you can, establish a separate company bank account. All cofounders ideally put the same amount of cash in, and bills get paid out from that account. Simple.
If you’re putting in money as a stop-gap before an investment round and expect the money to be repaid, put this in writing. It should appear in your company’s balance sheet as a liability - “Director Loan”. You’ll also need to let investors know if you expect to use their investment to pay back loans.
5. When you go out to raise investment, don’t over-optimise for valuation.
PG stood up one Tuesday evening at Y Combinator with a memorable lesson. YC companies are competitive about everything. In each new batch, founders are told not to compete over who can raise at the highest valuation. And every batch, some founders ignore this advice. Airbnb, we were told, raised their seed round of $600k on a valuation of something like $3.5m - certainly nothing like the uncapped convertible notes we sometimes see at the moment. And the Airbnb founders are just fine with how they’re doing.
You should spend a little time figuring out what price the market will offer. Choose the investors you think you could work with for next 5-10 years. Don’t spend time shopping the deal around to increase your valuation. Also, don’t pick crappy investors just because they offer a higher valuation.