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We’ve said something similar in a previous article, but it bears repeating: equity is wealth. When building your own company or joining a venture as a co-founder, it is essential to ensure that founder equity is properly documented and formalized. Doing so not only ensures that your hard work translates into meaningful ownership, but also helps prevent costly disputes down the road. This article explores the potential pitfalls that can arise when founder equity is not formalized early.
What Does It Mean to Formalize Founder Equity?
Let’s start with the basics: what does it mean to formalize founder equity? At a high level, it means clearly documenting who owns what in the company and ensuring that those records align with the company’s corporate documents. Founders typically formalize equity through stock purchase agreements, vesting schedules, board or director resolutions, and related documentation.
While verbal agreements may feel sufficient in the early days, it is critical to put everything in writing. Clear documentation creates a reliable paper trail and provides certainty if questions arise in the future.
What Can Go Wrong If Founder Equity Isn’t Formalized?
Although the list of potential issues is long, the following are among the most common.
Founder Disputes
If the equity breakdown is not clearly documented, disputes regarding ownership percentages, vesting schedules, and departure terms can easily arise. For example, one founder may believe they are fully vested and free to leave with their entire ownership stake, while another may believe that only 50% has vested. This type of misalignment can quickly escalate into a costly and time-consuming dispute. Time spent resolving internal conflicts is time not spent building the business.
Departing Founders
When a founder leaves without clear documentation in place, disagreements often follow. A departing founder may believe they are entitled to a larger stake than the company recognizes. If someone feels they are “leaving money on the table,” they may be willing to challenge the company’s position. Properly structured vesting schedules and written agreements help manage expectations and reduce the risk of conflict.
Cap Table Confusion
A messy cap table is never a good sign. Even if you do not plan to approach investors immediately, clarity around ownership promotes alignment and accountability. People are more motivated when they understand exactly what they own.
Consider this analogy: would you put the same level of effort into a school project worth 15% of your grade as one worth 80%? Clear, written terms ensure that everyone understands their stake and remains fully committed.
Fundraising Delays or Red Flags
Some startups have the luxury of time when raising capital; others are racing to secure funding before their runway runs out. In either scenario, properly documented equity is essential.
Investors expect clear ownership structures, aligned incentives, and accurate documentation. If they are investing in your company, they need certainty about what they are receiving in return. A lack of formalized equity can delay closing, complicate negotiations, reduce investor confidence, and even impact your pre-money valuation. Put simply, unclear equity structures can jeopardize venture financing altogether.
Needless to say, formalizing founder equity early is critical. It saves time, reduces risk, and allows future transactions to proceed more efficiently. If you need assistance with structuring or documenting founder equity, consider reaching out to a qualified legal advisor to ensure your company is set up for long-term success.
