“How can I negotiate more equity in a start-up venture?”

Question: My current employer has offered me a 10% ownership interest of a new business. The new business has just the two of us: the owner and myself. I had the idea for the original product, and I am working on building the product and business, including legal, administrative and operations matters.

My employer said that, if I did not like the deal, I would be fired. How’s that for leverage! 

The new venture has $0 capital currently but he has assigned the company a value of $10 million. I feel as though I am building the ship he will sail away in.

Any suggestions regarding how I might negotiate a larger interest in the company would be greatly appreciated.

Bob C.
Boston, Massachusetts

                                           
Answer: Dear Bob:

It’s not an easy situation you’re in, but there are things you can do:     

1. The key to getting what you want from your boss is always “What is most important to your boss.” That is the number one “secret” to workplace negotiating, and the negotiating “secret” that most people fail to keep in mind. What “motivates” others is not what you want but, rather, what they want. If you can offer to help them get it, or on the other side of the coin, create some “risk” to their getting it, that will give you leverage. Keep that foremost in your mind, although you should, of course, not forget what it is you are seeking, too.  

2. It seems to me that your boss very much wants commercial development of the new product you conceived of. From what you have described, your boss thinks the new product is potentially very valuable, and he has high hopes of making it into the centerpiece of the new company – with your help. There are two things he needs to do that: (1) you, and (2) your help. From your perspective, you can stay, you can go, you can help him get what he wants, you might even hinder his getting what he wants. It will be his perception of your ability to help, or hurt, his commercial development of the new product that’s key to your request for further equity. Even the suggestion that, “You know, I do want to stay, but I would be far more motivated to stay, and work on the weekends, if I was at least a 34% partner” might be persuasive.

3. Understand that in most states owning less than 1/3 of a small company gives you essentially no rights of ownership. It’s a little complicated to explain, but the law in most states says that, in a “closely held” company, which is what you and your boss envision, ownership of less than 34% gives you essentially no legal rights, unless you have a very well-considered and carefully negotiated agreement. So, for example, if the new company decides to sell the new product to your boss’s wife for $10.00, you really have no say to block that. I often tell my clients that, in closely held companies, I would rather you be an employee than a 10% owner. You actually have more rights and say as an employee than as a 10% partner. This may be the basis for a request for additional equity: you’ve been advised that 10% means little, if anything, and may even constitute a step backward from being an employee.

4. My experience and intuition tells me he wants you to sign a document that gives him (or his company) full rights to the product. I think you may have legally enforceable rights in the idea, or the product, or you can bring the idea or product to someone else who might give you a better deal. My very first concern is that your boss will offer you 10% of the company, and have you sign a document that includes this concept: “I, Bob, acknowledge that the Product belongs exclusively to the company, and not me.” To my mind, that would be a kind of neat trick by which he gives you nothing, and takes everything from you. That said, this too might be a basis for a request for more equity: you have been told  that you may have certain rights in the product, and to give them up would necessitate more equity. 

We offer Two Model Letters you can use to obtain Rights to Your Creation at Work. For more info, just [click here].

5. My experience and intuition also tells me he wants you – and needs you – to develop the product, and after that he will find a way of “firing” you. Many people think that an employee can be fired, but you can’t “fire” a partner. Actually, it’s easier to “fire” a partner than it is to fire an employee. If that happens, after you’ve devoted years to the company, what you fear will, in fact, happen: you will “build the ship, and he will sail away in it.” You might suggest an agreement that gives you “sweat equity,” that is either (a) 5% more of the company every year, until you hit 49%, or (b) 2% more of the company each time revenues go up $50,000 (or some other number.)

You might also ask for a provision that says, “If the Company ever wants to sell the Product, or an interest in the Product, I have a right to buy the Product or the interest in the Product, for the same price offered by someone else.”

6. You might also present what we call a “trigger of value” to your boss. In this context, that would mean something like this: “If the company achieves an agreed  significant goal, say, sales of $500,000 in one year, I would like my goal of 25% ownership to be achieved, too. ”

7. I am also concerned that his “old” company is retaining rights to the product, and the “new” company you will own 10% of will not own the product. This kind of fraud happens a lot to unsuspecting employees in your situation. If you do proceed with the new company – no matter what percentage of ownership you have – make sure the product is part of it.     

8. Though you have the threat of being fired if you don’t accept the “deal,” I suggest you consider telling your boss that you would prefer either a 34% interest, or to be named a “co-owner” of the product, itself. Though this might cause your firing, in some ways I’d rather you lost your job now than have you build a product and a company, and then lose it all later. I acknowledge that it is easy for me to suggest that, because it is not me who might lose my job: this is your life, and your risk.  But I do suggest the “10%-or-be-fired” ultimatum you face calls for this kind of gutsy response.

9. If you’re not ready for this kind of risk, that is, being fired and having a bit of a battle on your hands, perhaps you are not really ready to be in business. Please don’t take this as any kind of criticism, but to be in business does require a certain level of assertiveness, risk-taking and self-confidence that is not required to be an employee. I urge you to consider both (a) do you really want the risks of being a business person, and (b) even more so, do you really want to be a partner with this person? In my experience, no one can disappoint, distract and damage you more than a partner can. You must try to choose carefully.

I’m glad to hear you are considering being a partner, and it is a very exciting step to take. Listen carefully to your intuition, don’t be afraid to be assertive, and consider, too, retaining an experience legal counselor to help guide you along the way.

If you’d like to obtain a list of experienced employment attorneys in Massachusetts, where you live [click here].

My Very Best, 
Al Sklover

© 2011 Alan L. Sklover, All Rights Reserved.