What are vesting and a cliff in co-founder equity agreements?

Vesting, typically over four years, means equity is earned over time. A one-year cliff means if a co-founder leaves or is fired within the first year, they receive no equity, acting as a safeguard for the company.

How should a CEO approach co-founder equity negotiations?

A great CEO's first thought should be how to structure the equity split to maximize co-founder motivation and long-term commitment, rather than focusing solely on negotiation. Vesting and cliffs provide a safety net for this approach.

Why is it beneficial to be generous with co-founder equity?

Because vesting and cliffs act as a hedge and provide a 'get out of jail free card,' it often benefits the company to be more generous with equity. This generosity fosters the long-term motivation needed for co-founders to stay through challenging times.

What is the goal of equity for co-founders?

The goal is for a co-founder's equity stake to be the primary motivator driving them to dedicate significant effort, such as working late, on weekends, and recruiting others. It aims to make them feel like true owners.

Should co-founder equity splits always be equal?

While equal equity splits can be a nice rule of thumb ('all things being equal'), they cannot always be applied. CEOs should always consider the future motivation of their co-founders and be considerate of that when deciding on splits.

Key Moments

How Much Equity to Give Your Cofounder - Michael Seibel

Y Combinator

Science & Technology4 min read5 min video

Jun 6, 2019|349,625 views|7,169|137

YC Y Combinator Michael Seibel How Much Equity to Give Your Cofounder Startup Advice Startup Equity Cofoudner Equity Founder Equity Twitch Socialcam Justintv Equity

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Key Moments

TL;DR

Startup co-founder equity splits should maximize motivation, not be based on negotiation; vesting and cliffs are essential safeguards.

Key Insights

Equity splits are primarily a tool to motivate co-founders to commit to the long haul, often requiring CEOs to consider co-founders' future interests.

Four-year vesting with a one-year cliff is the standard "safety mechanism" for equity grants, allowing CEOs to correct co-founder decisions within the first year with no long-term harm.

Generosity with equity is encouraged because vesting acts as a hedge, and motivated co-founders are crucial for a startup's long-term viability and impact.

The ultimate goal is for a co-founder's equity stake to intrinsically motivate them to work late, on weekends, and recruit others, fostering a sense of true ownership.

Equity splits must prioritize co-founder motivation above all else

Deciding how to split equity among co-founders is a critical decision that most startup leaders get wrong by focusing on negotiation rather than motivation. Michael Seibel of Y Combinator argues that the primary purpose of equity is to ensure co-founders remain motivated to stick with the company through the many years it takes to build a successful, impactful business. Often, co-founders don't fully grasp the immense time commitment required if the startup succeeds. Therefore, the CEO must consider what equity split will best incentivize their co-founders, even if the co-founders themselves aren't thinking about their long-term interests at that moment. The CEO's first thought should not be about achieving a fair negotiated split, but about creating an equity structure that maximizes team motivation.

Vesting and cliffs are essential safeguards for equity distribution

While the idea of giving away equity can be concerning due to the high rate of startup failure and co-founder disputes, the primary mechanism for safety is vesting with a cliff. Typically, equity is granted with four-year vesting, meaning the co-founder must remain with the company for four years to fully earn their stake. Accompanying this is usually a one-year cliff: if a co-founder leaves or is terminated within the first year, they receive no equity. This structure acts as a crucial hedge for the CEO. It allows for correction of poor co-founder choices within the first year without causing long-term damage to the company.

Generosity with equity benefits the company long-term

Because vesting and cliffs provide a safety net, CEOs are actually encouraged to be more generous when granting equity to co-founders. This generosity fosters long-term motivation, which is especially vital during the inevitable difficult periods that almost every startup experiences. Seibel emphasizes that the goal is not to have to motivate co-founders daily. Instead, their equity stake should be the driving force that compels them to go above and beyond—working late nights, dedicating weekends, and actively recruiting talented individuals. This intrinsic motivation transforms co-founders into true owners, deeply invested in the company's success, rather than mere employees.

The impact of intrinsically motivated co-founders

When co-founders are truly motivated by their equity, the company becomes significantly more viable and has a far greater chance of success. This motivation leads to a higher level of commitment and problem-solving during challenging times. It influences their willingness to put in extra effort, think creatively, and operate with a mindset of ownership. This is the ultimate objective of equity allocation: to align incentives so completely that the success of the company is inherently tied to the co-founders' own long-term financial and professional well-being.

Equal splits as a rule of thumb, but not always applicable

While Seibel has previously suggested that equal equity splits are often a good starting point for most companies, he clarifies that this is a rule of thumb and cannot be universally applied. The specific circumstances and contributions of each co-founder must be considered. The CEO needs to be considerate of the future motivation of their co-founders. If there's a doubt or lack of confidence in a co-founder's long-term value and commitment, it's more prudent to reconsider their role as a co-founder rather than granting a generous equity stake they may not fully earn or deserve through their contributions.

Reconsidering co-founders if equity isn't warranted

Ultimately, the decision on equity distribution should reflect a deep belief in the co-founders' future contributions and commitment. If a CEO finds themselves hesitant to offer a significant equity grant, it may indicate a deeper issue with the co-founder selection itself. Seibel suggests that if you don't believe your co-founders are worth a generous equity stake, you should seriously reconsider who is on your team. The purpose of co-founders is to build a company together, and their equity is a testament to that shared endeavor and future potential.

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Co-founder Equity Best Practices

Practical takeaways from this episode

Do This

Prioritize equity splits that maximize co-founder motivation.

Implement four-year vesting with a one-year cliff as a safety mechanism.

Consider being generous with equity to foster long-term commitment.

Ensure co-founders feel like true owners, not just employees.

Reconsider co-founder choices if you don't believe they warrant generous equity.

Avoid This

Don't base equity splits solely on negotiation.

Don't underestimate the long-term time commitment required for a startup.

Don't fail to implement vesting and cliffs.

Don't hesitate to be generous if it ensures long-term motivation.

Common Questions

Equity splits are designed to motivate co-founders to remain committed to the company through the many years it takes to build a large, impactful business. It ensures they have a long-term stake in the company's success.