What to do when an equity-holding team member leaves a startup
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Today’s question comes from Phillip. Would it affect a startup’s ability to fundraise or sell the company if a co-founder with substantial equity leaves?
This can be a frustrating situation, but it happens quite often. Whether it’s an internal relationship issue, personal issue, or other work situation, there are many reasons why this happens. It most often happens in startups that are pre-revenue, because if you are unable to pay someone it’s easier for them to walk away.
An equity-holding member leaving can hurt you
Even though this does happen, it can hurt your company if you don’t put some things in place in the beginning. In this case, when someone leaves, they should not be able to keep a large portion of the business. That’s why it’s important to have a cliff setup so that if they leave after a year or whatever the time period is they only keep a small portion of equity.
You won’t be able to raise money if someone owns 40 percent of the company and they aren’t involved anymore and they aren’t willing to give it up. It’s fine for them to keep some of their equity, but you need to negotiate it down to single-digit equity when they leave.
One way to negotiate with them is to bring their equity down as the company’s valuation goes up. If they leave the company with no current investment or revenue, then they have a large percentage of nothing, so it should be feasible to bring them down.
Planning ahead is best
If you haven’t yet given equity to anyone, then it’s critical that you sit down and think through worst-case scenarios so that you protect yourself in advance if someone leaves. This is best for pre-Series A startups. It’s an important conversation to have because it is a business and it’s not personal.
“It’s important to have hard conversations about worst-case scenarios before you start giving out equity because at the end of the day it’s a business.”
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