Treating people fairly in a start-up company means giving them a reward that is proportionate to the contributions made relative to others participating in the business. In other words, if you make 75% of the necessary contributions to a company you should enjoy 75% of the benefits when that company someday starts generating excess cash either from operations or the sale of all or part of the equity. However, because people generally lack a method for valuing and monitoring the various inputs made by an individual (more on this later), fairness tends to be highly subjective and difficult to achieve.
When a group of people work together towards a common goal they are a team, but when it comes time to negotiate their slice of the equity it’s every man for himself. It pits start-up brother against start-up brother (or sister, of course). Individuals naturally act in their self-interest and when the split isn’t clear greed creeps in. Even when individuals have good intentions mistakes will be made. For instance, when two founders go “50/50” on a business one inevitably makes a disproportionate contribution and they will both know it.
There are two directions of unfairness. The first is someone having less than they deserve and the second is someone having more than they deserve. Both can cause irreparable damage to an otherwise healthy relationship, especially as the stakes get higher. In a good start-up, the stakes start out low, but get high (hopefully). When the stakes are high the negative feelings caused by unfairness manifest themselves in arguments, resentment and sometimes legal battles which can take their toll, if not destroy, a young company.
More Than They Deserve
When someone gets more than they deserve they are taking advantage of the other members of the team. Perhaps they are a better negotiator, perhaps they are a better salesperson, perhaps they lied when they made their case or perhaps they intimidate others. Whatever the reason, they have treated others unfairly and damage will be done.
Professional investors routinely take more than they deserve offering term sheets that are oppressive and serve the interests of the investor much more than the interests of the start-up team. Young entrepreneurs often fall prey to these tactics. It is so common, in fact, that people take it for granted that venture capital or other outside investment will come at great expense. It is important for entrepreneurs to appreciate the extent to which they are being exploited and know their own tolerance for the behavior.
In some cases an individual will actually be allowed or even encouraged to take more than they deserve. This can be a form of manipulation that could be costly down the road when that person will owe favors to others that may not be in their best interest.
Less Than They Deserve
When someone gets less than they deserve they will immediately feel resentment toward those who got more. Feelings of distrust and/or inadequacy will hurt productivity and motivation will dip. Those most likely to get taken advantage of are those who don’t have the willingness to walk away from the negotiation and will feel stuck in a bad situation. Even those who ultimately reap the rewards of a liquidation event will still feel resentment toward others.
If the individually willfully accepts less than they deserve problems will arise when they see what they could have achieved if they had been more diligent during negotiation. Amateur investors, like friends & family, may allow an entrepreneur to get more favorable terms than they actually deserve because they want to “help them out.” Here, too, problems can arise as the stakes get higher.
Repairing the Damage
When unfairness exists, it is often difficult (if not impossible) to remedy the situation without stirring up additional problem. For instance, the remedy may tip the scales in the opposite direction as the one with more gives up more than they should. Partners will find themselves back at the negotiating table before too long.
Changing ownership structures often requires legal and accounting work to amend agreements, calculate tax implications and other expensive tasks that would have been unnecessary. Too many rounds of changes can leave a shareholder agreement looking like the back seat of the family car creating a major deterrent for potential investors.
Avoiding the Problem
The best way to manage the problems caused by unfairness is to avoid them altogether. A Grunt Fund is a tool for tracking the tangible and intangible contributions to a start-up company. Time, equipment, supplies, relationships and intellectual property are just a few of the inputs that help a company succeed. Each one can be valued relative to other inputs. When the time comes, the Grunt Fund allows entrepreneurs to then allocate equity in a manner that is fair to everyone involved.
In a start-up company fairness is fun. When everyone feels like they are getting what they deserve they feel respected and valued as a member of the team. Under these circumstances a team can do their best work.