Equity contract as a co-founder. Is this clause strange?
Long story short is that exited as a co-founder of a start-up at the end of last year.
I had 1 year of vested equity, 7.5% that came from around 1000 hours of working as a CTO. I exited amicably, as my other co-founder (and majority shareholder) felt me living in Europe as CTO would hinder any fundraising that was attempted in the US.
Not the greatest situation from my side, but I can live with it.
Last week a more official contract was drafted as the company moved from an LLC into a Corp. Everything looked good, but one clause raised an alarm:
At any point, my equity can be bought back by the company, at a rate decided by market valuation/3rd party.
This struck me as unfair, as the company could buy my equity back at a very low valuation. I have a good relationship with my co-founder, so I don't think that would happen, but I flagged it anyway as, well, you need to take personal opinion out of the equation when dealing with contracts.
The response was, the fact I own 7.5% may spook VC & Institutional investors at a later date given I have a lot of equity, and am no longer involved in the company.
Is this a usual approach? Apparently it was drafted by startup lawyers. I think this severely limits my upside in a risky undertaking. Frankly, if the company does well, I would like to be in control of the equity unless it exits completely.
7.5% doesn't seem like a huge chunk, especially since it will be diluted down by the time any VCs get involved. Seems comparable to an angel investor owning <= 10% and I don't see VCs batting an eyelid at that scenario.
Am I right to push back?
I have one more question. If I was to agree to the clause I would a minimum payoff clause added to protect any early-stage buyback.
I hinted i would accept a 10x payoff, calculated by 1000 hours x my contracting rate x10. This was met with resistance, as 10x is a unicorn expectation and 3.5x is more like it. Not sure on that one either, I was involved in building the product from the ground up, so I would expect the payoff to reflect the high chance that the startup doesn't make it in the long run.
I would be grateful for any comments.
If you had a previous thing in writing you shouldn't feel forced to accept these new terms, I wouldn't, it's the right move to push back in my unprofessional subjective opinion.
They can still try to dilut you out by manipulation if they want to and such...
Personally, I'd push back, but then live with whatever the result is and move on.
In my experience, lawyers are obsessed with guarding against worst-case scenarios. That's reasonable considering their position—they don't want to be known as the lawyer who let their client get screwed—but their typical terms can often be onerous and require pushback. I experienced this during my Stripe acquisition dealing with lawyers on both sides.
FWIW, your co-founder seems far too focused on "what looks good to investors." I find it hard to believe that many investors who are truly excited about the business will walk away because of a small equity stake owned by an early CTO who contributed significantly and left on amicable terms. Forcing you out of the company because of investor optics was also pretty extreme.
All that said, I've fought legal issues like this before and seen many others who have as well, and 99% of the time your time would be better spent elsewhere, starting new projects, and keeping the lessons you learned here in mind.
BTW. Don't take current relationships as a good predictor what may/will happen in future.
I think you should try to push back, but not loose too much sleep over it. Dialog is always a good first approach. You can ask what they expect with that clause. If you understand what they want to achieve, perhaps you can offer them something in between both expectations.
Something that I find reasonable, is a clause stating that if you want to sell your shares, the company (or other co-founders) have right of first refusal, i.e. if you get an offer for your shares, the company should have the right to buy them from you at the same price, in this way you protect the company from external parties, take overs, etc.
Right now, you are struggling over nothing (i.e. the company has no price yet, etc). Can you read Spanish? This interview with Evan Henshaw-Plath is always a good anchor to go back to.
Usual disclaimers (IANAL, internet advice is worth what you paid for it, etc)...
This seems unusual to me.
I understand why the company would want this clause, but it seems like a material change from your original agreement. It's definitely not something I would agree to.
What's unclear to me is whether you can avoid this happening. Do you already have a written agreement? What are the conditions for changing that agreement?
This isn't really a valid concern IMO. It's what drag along/tag along clauses are for. Unless you have some kind of weird dilution/liquidity preferences that would be unacceptable for serious investors? (in which case you renegotiate those instead).
This is a typical leaver clause for vesting agreements. This is even the good case because it signals that you are a ”good leaver”. (In bad leaver case, many times the price is predetermined fixed forever) you can push back of course, but lawyers will be reluctant to change this if they take into account the company interest seriously so expect long negotiation in that case.