Co-founders often plan to put in sweat equity into their start-up for 6 months or so, after which they foresee being able to compensate themselves out of revenues or outside funding.  Everyone loves the plan, quits their jobs with Big Corp, and gets to work on the big idea. Equity is divided equally, and unconditionally, because this is going to work.

Then reality hits.  The 6 month mark passes … then 7 … then 8 … and the revenues and/or outside funding have not yet materialized.  Bank accounts dwindle, spouses get nervous, and eventually one of the co-founders is forced to significantly cut their time commitment to the start-up in order to pursue a more regular paycheck.  The departing co-founder is apologetic, wishes the others well, and says “well, I’ll see you at the next shareholder meeting.”

Understandably, the co-founders who are still grinding away trying to make the start-up work are not pleased when they realize that their equity stakes are no greater than that of the party who is no longer eating ramen noodles with them. How could this have been avoided?

In many cases the departing co-founder does the “right thing,” and voluntarily gives up some of their equity.  However, this does not always occur and when it does not there are a lot of hard feelings and disillusioned entrepreneurs.

I am believer that there should be some sort of vesting mechanism on sweat-equity based founder shares, for example vesting over three years, to ensure that those who continue to man the ship have the largest stakes in the venture.  While planning for less than unconditional success isn’t fun, addressing this issue at inception is much easier than the emotional and destructive debates that often occur when co-founders part ways.