The only mistake I regret; important advice for startup founders

I’ve talked a lot in this blog about the mistakes I’ve made over the past couple of years, what I’ve learnt, and the ways I apply all this to how I run the company now.  I don’t regret any of the mistakes I’ve mentioned so far; each one helped me grow as a person and as a business leader; each contributed to Posse’s evolution into the awesome platform of tomorrow.  But there’s one mistake I haven’t discussed yet, and it’s the only one I regret.  I fell into it at the beginning when, surrounded by a group of friends, I formed the company.

Posse was my idea.  I drove it right from the start.  But in the early days, I didn’t know anything at all about running a technology company.  I wasn’t confident that the idea would work and that I wouldn’t end up with egg on my face.  In the interests of spreading the financial and reputational risk, I asked a few friends to help.  After I’d written the plan, fleshed out the idea and who’d be involved, I sat in a cafe and wrote on a napkin how I’d divide up the company.  Different people would have different responsibilities, and for that they’d receive a percentage of the shareholding.

I appreciate that this blog will touch a raw nerve in some people but I think it’s an important story to tell.  I’ve decided to write it because, since I don’t have any plans to start another company, this isn’t a lesson that I can learn from.  But I hope that my telling it may prevent others from making the same mistake.

I meet lots of enthusiastic young entrepreneurs at various events who tell me of some great idea, and they’re starting a company with a bunch of people.  When I ask how they’re dividing up the company they say something like, ‘I own 50% and the other 50% is split between a guy who’s doing the technology and another who’s going to run the operations and raise the money.’  Sound familiar?  Although I didn’t screw myself that badly, the setup is similar for many young companies.  At the very start, no one wants to haggle about shareholding because it just seems silly.  At this stage, the company isn’t even worth anything, so why argue over 30% of nothing.  Right?

Wrong.  The company does have value at the start.  It’s worth the energy and intellect the founding team is prepared to invest.  When I think back to 2009, the year I started Posse, I too felt that this newborn idea didn’t have inherent value.  Now I look back at the colossal amount of work and perseverance I’ve put into it.  I dropped a successful music company and gave up virtually all of my free time for three years.  That level of commitment was the company’s only asset at the start.

The problem is, there’s no way of measuring future contributions so you just guess and split the company.  What usually happens is that one or some people will work incredibly hard to get things off the ground and others will drift, either because they can’t handle the pace or aren’t focused on the project.  This irks the hardworking founders, who try to negotiate the others out of their shareholding.  The slackers say no and everyone falls out. Then, either the company falls over or moves on with a bitter founder (like in The Social Network).

I suggest an alternative.  Say you have three founding partners.  A has the idea, will raise the money and lead the business, B is the engineer who’ll build the product and lead the engineering team in the future, and C understands the industry, will run the marketing and be the face of the company.  You agree that, if everyone commits equally and does a good job in their field, a fair split of the equity would be 50/25/25.

If you want to know the viability of a startup, you can’t just commit to a six-month trial.  It’s highly likely that your first idea won’t be bang on.  You’ll iterate, learn, and try a few models before you know if the company will succeed.  If you look at most successful tech companies like Twitter, AirB&B, Groupon, or TurntableFM, they each took around two years to strike on the right model, so the founding team must be committed for 3 years.

You start with 100,000 shares in the company all valued at $1 each.  The company then loans the founders money to buy shares in their own company (Founder A gets $50,000 and founders B and C $25,000 each).  The loan just sits on the company’s books so no actual money need change hands.  The company would then have the right to cancel a founder’s loan and buy back the shares at any time if voted for by the other two founders (or a majority).  Further, the company has an agreement with each founder that an equal proportion of shares become ‘safe’ each month over three years.

If, after twelve months, the marketing founder wasn’t working out and had started his own side project that consumed most of his time, the other two founders would have the right to cancel 2/3 of his shares.  If everyone commits equally and works to the same level of ability and integrity over three years, then all founders retain the equity that was planned at the start.  The same rule should apply to anyone you want to give shares to – directors, commercial partners, suppliers and team members.

Many people have been involved in making Posse a success.  Some have contributed far more than their shareholding would suggest.  As a founder, you must value people who contribute to the company generously – especially as they’re backing a project where success is not guaranteed.  There’s nothing more frustrating than wanting to reward hard-working superstars with shares and being restricted on account of a few who did very little but happened to be around at a time when you were naive or forced by circumstance to hand over equity.

It’s the one mistake I regret.  I hope that by sharing it I’ll help prevent others from making it too.