Abstract

Michael Reich is having severe doubts about how he split the equity with his co-founders two months
ago, when they completed a one-page "November Agreement." Since then, Michael has found an angel
investor and has worked non-stop on the business, while one co-founder was off enjoying the winter
break with his family and the other worked on lucrative consulting contracts for other companies.
Michael has just sent his co-founders a proposal that would re-allocate the equity within their founding
team, and all three founders are getting ready to reopen a negotiation they thought had been finalized.

UpDown: Confidential Instructions for GEORG

 On February 5, Michael emailed his proposal for re-splitting the equity between the founders.
 you felt that Michael was over-weighting the contributions he had made in recent weeks.
 you are a bit uncertain as to the time and energy you will be able to devote to this venture in
the months and years ahead.
 As you see it, there are four key issues to negotiate.

Issue I. Founders’ Equity—Split Between Michael, Georg, and Phuc

 the amount of Founders’ Equity that each of you will receive

 Your proposed stake is much lower than it was in the November agreement
o up to an additional 2% in Founders’ Equity for yourself
 you receive slightly more Founders’ Equity than does Phuc.
o (1) Phuc is receiving a salary in addition to Founders’ Equity
o ) You have been with the company from the very beginning

Each additional 1% in Founders’ Equity to you is an additional 25 points to you. Each 1% reduction in
your Founders’ Equity would be a loss of 25 points

Issue II. Salary for Phuc

 you and Georg “would only be giving up a social life at the Harvard Business School,
 Phuc revealed that his current annual salary was close to $200,000 from his contract-consulting
work
 his annual salary will likely drop to $40,000
 But how much should he get paid, and shouldn’t the fact that he receives a salary reduce his
share of equity?
 Phuc will be paid $70,000 (bringing his annual compensation including consulting work to
$110,000).
 Any additional UpDown salary he wishes to receive should come in exchange for less equity.

Specifically, for every $10,000 in additional salary that Phuc makes, you consider it a loss of 5 points to
you. Note that your scoring system makes you indifferent between Phuc making $70,000 vs. Phuc
making $110,000 in exchange for giving up 1.60% of his Founders’ Equity. 1

Issue III. Seed Equity for Initial Investment

 Michael’s proposal divides the total equity in UpDown into two categories: Founders’ Equity
(96% of total equity) and Seed Equity (4% of total equity).
  First, if Phuc had been present at the time of the founding, he too would have willingly put in
this seed money
o You do not disagree with that.
 two of you split the Seed Equity equally
 Phuc, on the other hand, wants the current pool of Seed Equity to be split equally by all three of
you

Issue IV. Founders’ Equity—Warren’s Share

 Michael’s proposal gives Warren 1% Founders’ Equity, which you think is too low
 Both Michael and Phuc are likely to resist giving Warren any more than 1%.

Each 0.25% reduction in Warren’s share below 1.5% is equivalent to a loss of 10 points to you.

The Option to Walk Away

But if your point total is less than -115 points, you cannot agree to the deal.