Considerations When Allocating Stock to Founders

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Foley & Lardner LLPThere are countless things to consider when getting your startup off the ground, and one that many don't consider early on is the allocation of stock to founders.  This is a critical step that is important to handle very early in launching your company.

When a company incorporates, there will be a specific number of common stock shares that are authorized. Founders must decide how many of those shares they will allocate to themselves and how they will divide up those shares equitably.

Founders typically receive a large portion of stock because of the significant role in launching and operating the company.  That number usually comes in somewhere around 80-90% of the total outstanding stock. 

When there are multiple founders, they must decide on the division of that stock among the founders.  Stock can be divided equally among the founders; however, that can sometimes lead to issues down the road and reallocation later on as roles and contribution level changes.

To better divide the stock from the outset, a variety of considerations should be made.

  1. What is the level of risk the founder is taking? The level of risk is one of the most significant points to consider. If a founder is leaving the security of a full-time job to work on the startup exclusively, that would be a higher level of risk than someone simply doing this on the side.
  2. What is the level of contribution of the founder? What is their role within the firm? Along with determining allocation, founders must clarify their roles and the level of expectation of each person. Someone taking on a CEO role would likely have a greater level of contribution daily than a founder who serves in a more advisory or consulting role. Those with a higher level of contribution or a more active role would receive a greater stock allocation.
  3. Who developed the idea or concept? Who developed the intellectual property? This is another crucial issue. Founders who were directly involved in the concept development and development of the IP should be rewarded with a larger percentage of the stock.
  4. Who put together the business plan? A company's business plan is a crucial component to its long-term success and in attracting investors. Therefore, looking at those founders who put together and fine-tune the business plan will be a large part of the allocation process.
  5. Who secured investors? Securing investors is of the utmost importance to the success of a startup. The role founders play in providing connections to investors or actively working to secure investment should also be a factor when allocating stock.
  6. Development stage. Founders that joined a company in its earlier stages of development, such as before a priced round, typically receive a larger portion of the company equity for the time they invested and the risk they assumed working at a young company.

These are some of the points that should be considered to allocate the stock fairly and to help to avoid disputes in the future.  Of course, no one can predict the future, and roles will change as time goes on, as will the level of contribution by founders.  But attempting to work out allocation from the beginning based on the information available is an important part of starting any business.  The end goal is to balance allocating equity among co-founders, leaving enough available to sustain hiring and growth. Be strategic.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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