Structuring Stock Vesting for Non-Operating Co-Founders: Best Practices for Startup Equity Allocation

Traditional startup structures do not accommodate non-operating co-founders as a standalone role. If someone is contributing anything significant, they should either be seen as an investor, advisor, or consultant. However, in today's entrepreneurial landscape, it's becoming more common to have co-founders who are not directly involved in day-to-day operations. This article explores how to structure stock vesting for such individuals, ensuring both fairness and alignment of incentives.

Understanding Co-Founders' Roles

First, it's essential to clearly define the role of each co-founder. If a co-founder is actively involved in the day-to-day operations, they should be on the same vesting schedule as any other founder. This typically includes a four-year straight-line vesting structure with a one-year cliff. The vesting schedule is designed to reward loyalty and discourage early exits, aligning the interests of the founders with the long-term success of the company.

If a co-founder is not operating but contributing something valuable, such as cash investment, connections, ideas, or domain expertise, the vesting terms must be tailored accordingly to acknowledge their contributions while maintaining fairness among all founders.

Investor Co-Founders and Their Vesting

If a co-founder is investing cash, the investment can be treated as seed funding. The percentage received should be proportional to the amount invested relative to the post-money valuation. This ensures that the investor is rewarded for their financial commitment to the startup.

Connections Co-Founders and Their Vesting

Connections co-founders, who provide introductions rather than active labor, are generally less valuable. They should be seen as mentors rather than co-founders. The vesting terms for such co-founders should be minimal, often no more than 0.15 to 1 percent of the total equity. These terms should vest over a longer period to reflect the ongoing nature of their contributions. However, if the connections co-founder is actively involved in day-to-day operations, they should be treated as a full co-founder and placed on the same vesting schedule as others.

Idea Co-Founders and Their Vesting

Idea co-founders contribute valuable intangible assets in the form of initial concepts or prototypes. However, ideas alone are not enough to sustain a startup. The value of the idea at the initial stage is estimated at around 150,000 dollars. If an idea co-founder invests 10 hours of work at a rate of 150 dollars per hour, their initial investment is approximately 1,500. This input should be rewarded, but the reward should be minimal, around 1 percent of the equity. This equity should vest over four years with a cliff, requiring a minimum of 10 hours of work per year to vest fully.

Setup Co-Founders and Their Vesting

The value of having a setup co-founder who helps establish the company's infrastructure cannot be underestimated. These individuals might help with HR, legal, team building, and customer outreach. If the setup co-founder is only needed temporarily, such as for a one-year period, the vesting terms should reflect this temporary nature. A one-year vesting period with a six-month cliff is appropriate in such cases. They should be rewarded with 25 percent of the equity that would be given to a full-time co-founder who plans to work for four years.

Domain Knowledge Co-Founders and Their Vesting

Domain knowledge can be a powerful asset, but it must be applied in a collaborative and ongoing manner. While domain knowledge can provide a leg up in the initial stages of fundraising, it should not be overvalued. Vesting terms for domain knowledge co-founders should include a one-year cliff and a four-year vesting period to ensure their continued involvement and commitment.

Conclusion

Properly structuring stock vesting for non-operating co-founders requires a clear understanding of their contributions and the overall startup valuation. By implementing tailored vesting schedules, startups can ensure that all co-founders are aligned with the company's long-term goals and that rewards are fairly distributed. This approach not only enhances the alignment of interests but also contributes to the overall success of the startup.