Founder Departure
Founder departure is inevitable. And the more founders a startup has, the more likely one will depart early in the life of the company. But the effect of a founder’s departure on the remaining founder’s equity varies greatly based on whether the initial investment was a priced round vs a SAFE or other convertible instruments.
Imagine our initial cap table with 2 founders and a seed investor who owns 20%
| Starting Ownership (shares) | Starting Ownership (%) | |
|---|---|---|
| Founder A | 1,000,000 | 40% |
| Founder B | 1,000,000 | 40% |
| Seed Investor | 500,000 | 20% |
| 2,500,000 | 100% |
Now imagine that Founder B has decided to part ways with the company after a few months. Although technically the founder hasn’t vested any shares (most early grants have a one year cliff), the founders agree that the departing founder will get to keep 200,000 shares in return for signing a clean separation agreement. The remaining shares will revert to the company’s ownership, essentially “disappearing” from the denominator and boosting each shareholder’s equity. The new total outstanding shares in the company is reduced by the forfeited 800,000 shares resulting in 1.6M fully diluted shares.
| Starting Ownership (shares) | Starting Ownership (%) | Founder departure (shares buyback) | Ownership after departure (shares) | Ownership after departure (%) | |
|---|---|---|---|---|---|
| Founder A | 1,000,000 | 40% | 1,000,000 | 58.82% | |
| Founder B | 1,000,000 | 40% | (800,000) | 200,000 | 11.76% |
| Seed Investor | 500,000 | 20% | 500,000 | 29.41% | |
| 2,500,000 | 100% | 1,700,000 | 100% |
Note that, in the example above, both Founder A and the Seed Investor’s ownership was boosted by roughly 47% (800,000/1,700,000)
Now, imagine that the initial round was done via a SAFE as opposed to a via a priced round. In this instance the investors actually get the right to own 20% of the company at the future financing. But they don’t actually get issues any shares. So the cap table really looks like
| Starting Ownership (shares) | Starting Ownership (%) | |
|---|---|---|
| Founder A | 1,000,000 | 50% (40% after the SAFE converts) |
| Founder B | 1,000,000 | 50% (40% after the SAFE converts) |
| Seed Investor | The right to buy 20% at the next financing round | |
| 2,500,000 | 100% |
Now, just as in the example above, the founder remaining shares will revert to the company’s ownership, essentially “disappearing” from the denominator and boosting each shareholder’s equity. But, the seed investor is not actually a shareholder. They still have the right to buy 20% at the future round, but the SAFE does not provide a mechanism for boosting that ownership in the event of a founder departure. As a result, all of that ownership accrues to Founder A
| Starting Ownership (shares) | Starting Ownership (%) | Founder departure (shares buyback) | Ownership after departure (shares) | Starting Ownership (%) | |
|---|---|---|---|---|---|
| Founder A | 1,000,000 | 50% (40% after the SAFE converts) | 1,000,000 | 83.3% (66.6% after the SAFE converts) | |
| Founder B | 1,000,000 | 50% (40% after the SAFE converts) | (800,000) | 200,000 | 16.6% (13.3% after the SAFE converts) |
| Seed Investor | SAFE: The right to buy 20% at the next financing round | SAFE: The right to buy 20% at the next financing round | |||
| 2,500,000 | 100% | 1,200,000 | 100% |
By choosing to use a convertible instrument as opposed to a priced round, the existing shareholders are able to boost their ownership in the event of a founder or advisor separation.