Five Secrets for How to Avoid the Biggest Sweat Equity Mistake Startups Make
It happens all too often. In the excitement of the early days of a startup, the founder offers equity to a key hire or contractor. Often it’s a key player that is promised the coveted status of “co-founder”, such as the developer that is believed to be able to build out the company’s tech vision as the CTO. There’s a promise of x% of the company. The amount is usually too much. There’s no money for attorneys and there’s little time to document the arrangement, but the excitement and expectations are high: the founder/CEO is confident that funding is imminent and the co-founder CTO is confident that the tech will be built in only a few months. Meanwhile, what gets lodged in the indelible memory of the co-founder is the x% of ownership that was promised and little thought is given to the eventual dilution from with other employee equity grants, advisor warrants, seed funding, venture capital funding, etc.
Then come the unmet expectations: the funding doesn’t come through as hoped, patience is strained, tempers flare and the tech platform stretches on interminably without the necessary funding for a tech team or it simply doesn’t deliver. In a huff, the founder/CEO fires the CTO after only x number of months. But what about the promised equity? The company still lacks a formal options plan (which was going to be put in place after funding), so nothing ever got documented. The CTO "lawyers up" and demands to see the evidence of his stock grant. The company hires counsel and is asked if the CTO was on a vesting schedule or if there was a documented specification for the tech platform and if the promised equity was contingent upon the successful delivery of the platform. The CTO claims ownership of the software he developed, which dooms any hope of ever raising capital for the startup.
Regret and frustration and legal bills mount. The distractions build, morale plummets, and another tech startup bites the dust.
So what’s the answer to avoid this tech startup doom loop?
Establish very clear goals and deliverables: instead of "boiling the ocean" and expecting or promising to create an entire app, stick to smaller chunks of work one phase at a time such as creating a wireframe or writing a requirements document
Develop one, overall agreement that establishes how you will work together, who owns the deliverables, how disputes will be handled, etc.
Create a separate, specific Statement of Work (SOW) for each of those chunks of work with very clear deliverables, payment terms, and acceptance criteria in various forms and combinations of Cash and Sweat Equity
Grant Sweat Equity along the way in exchange for successful deliverables
Use iron-clad "battle-tested" thorough legal documents to protect both sides
It may sound complicated, but our downloadable Sweat Equity Kit reduces this time-consuming and expensive legal process from weeks and tens of thousands of dollars to only minutes and peanuts.