I got burned by a partner once. He flaked out after just a few months, keeping a big chunk of equity while I did all the work.
So when Jenn and I created our partnership agreement for UpStart, we incorporated a partner pre nup. There are a lot of ways partnerships can go sour, and it’s tough to protect against all of them. Also, it’s a bit awkward to be talking divorce during your honeymoon. But better safe than sorry.
The core of our pre nup is a partner vesting mechanism. It works like this… Both partners start with slices of the equity pie. Let’s say we each get 50 shares out of 100 total, to keep things simple. Over the coming years, we’ll work hard to turn our respective equity stakes into something valuable. But we’ll have to earn our rights to that equity.
We’ll earn a bit more every quarter (three months), over a four year period. With four quarters per year over four years, there are a total of 16 vesting periods. So, we’ll each earn about three shares every quarter. At the end of the first quarter, we’ll each earn three shares. At the end of the second quarter, each of us will have earned a total of six shares. And so on, until we reach 50 each.
If one partner leaves to do something else, or otherwise stops contributing in a positive way (e.g. gross negligence) they’ll only walk away with the equity they’ve earned up until the day they leave.
Suppose we’ve been working on the startup for 13 months, and we’re struggling. At that point, one partner wants to stick it out, and another decides to pursue other opportunities. The partner who leaves keeps four quarters of equity, or 12 shares. The other partner gets the remaining 38 shares. So now the partner who leaves owns 12 over 100 shares, or 12%. The partner who sticks around gets the remainder, or 88%.
Flake factor be-gone.
Simple and smart. We’ve used overcomplicated operating agreements prepped by overpaid lawyers to protect against this scenario – but the method described here is much easier and accomplishes the same thing.
Hey David,
I’ve been in similar situations a couple of times. And this totally makes sense. But how do you protect against a “partial-flake”. The partner who isn’t really pulling their weight but doesn’t see it that way. How do you quantify someone pulling their weight? Any thoughts?
–matty j
Matt-
You can put language in your partnership or operating agreement about what constitutes acceptable performance, ideally with the help of a good labor lawyer. It can be tricky to enforce in practice, however. If a partner isn’t pulling their weight, even after you’ve called them out on it, it can be helpful to get your advisory board involved. They can assess the situation, provide objective feedback, and apply peer pressure, which tends to be more constructive than the threat of taking legal action.
This is great advice, and I wish I’d had it before I entered into a partnership. If you’re doing something that could be at all substantial, I think the up-front hassle is worth it.
I could not agree with this post any more! Just last year, I was, for lack of a better word, abandoned by a business partner after I had invested a year and several thousands of dollars into a new business that we had started together. Despite my ongoing practice of transparency and accountability, she disappeared after meeting a guy. She stopped responding to my e-mail updates and I only learned what happened to her from a former, mutual classmate. Needless to say, I shuttered the business and moved on. Definitely get something in writing and be very clear about what you plan to deliver and what is expected from your business partner(s).