US Corporate Law 20 Episodes (1)
Is the equal share of equity among the founding team partners a taboo? Equity allocation of Apple, Google, Haidilao, and Aiduo.
Equity allocation | Is the equal share of equity between the founding team partners a taboo? Equity allocation of Apple, Google, Haidilao, and Aiduo | How is your company's equity divided? Those pits in equity allocation, one step is wrong, from the angel round seed round A round B round C round has been delayed until the merger and listing
Nowadays, more and more elites in the technology field choose to start their own businesses. Entrepreneurship is inseparable from the company, but after most entrepreneurs register the company, how to allocate the company's equity, how to negotiate with investors, what pitfalls when signing contracts, and even mergers and acquisitions and listings after the company grows and grows. There is a lot of confusion. So I decided to launch 20 lectures on American corporate law, focusing on the necessary legal knowledge for startups. In the first lecture today, I will talk to you about the equity allocation of startups.
Basic Theory
When many people contact me, they often ask, "Lawyer Liu, I and a few friends are going to start a business. We are going to start a company. How do you think this equity should be allocated?"
In fact, the shareholding itself is not a fixed number, and it is not even a legal issue. It mainly depends on the contribution ratio between your partners and the value to the company. In theory, 50/50 or 99/1 is possible. At the same time, the shareholding ratio is indeed crucial for the company's subsequent stable and sustainable development. The development of many startups will go through such a mental journey, from working together, sharing different dreams, fighting in the same room, and perishing together. The reason why this phenomenon occurs is often that there is a problem with the distribution of equity at the beginning. Before a few founders blindly decide on an equity allocation ratio that will send the company to the point of no return, it is necessary to understand a major taboo in equity allocation, that is, equity sharing.
Equity splitting is a common and most serious mistake in the company's equity allocation. Some people even assert that equity splitting is the worst shareholding structure in the world. Two people are 50% each, three people are 33% each, and four people are 25% each. These are the cases of equal shares.
Every time I talk about this place in a live lecture, someone will always say, "Oh, our company is divided equally. If you ask them why, they will say, "Oh, I was embarrassed at the time." In fact, I just want to say, if you are embarrassed about this, then don't start a company.
Why do you say this, because if the equity is divided equally, then you don't do anything else, and there will be quarrels between the founders. Some people will tell me that my partner is my alumni, college classmate, Bunk and bunk, there will certainly be no differences. Upfront Venture, the largest investment institution in Los Angeles, their managing partner Mark Suster once said, "Even if you *think* you know them, people change. Even if you think you know others, people change. Two people No matter how hard the relationship is, no matter how hard the relationship is, there will always be disagreements when it comes to implementing specific issues. This kind of entanglement in decision-making is very costly for the company, and a startup company is already facing difficulties. Add internal difficulties and create obstacles for your company for the so-called superficial fairness at the beginning.
Case Analysis
Let's use the examples of four companies to analyze in detail, Apple and Google in the United States, and Haidilao and Aiduo in China.
Apple
Every time I talk about this, someone will refute me, how did Apple fail, and people are still alive and well. But the failure mentioned here refers to the fact that the company has suffered losses due to the structure of equity sharing. If it is not for the equity sharing, they can take a lot less detours.
You must have heard of Steve Jobs being kicked out of Apple and then being brought back. Among them, the scene where he was kicked out was because of the hidden danger caused by the equal share of the company's equity.
In April 1976, when Apple was in its infancy, Jobs and Woz each owned 45%, while Wayne owned 10%. But this Wayne quit soon because he was not very adventurous, so in fact, Apple's original structure was that Jobs and Woznia split 50% of the time.
In August 1976, Apple was very short of money after it first opened. In order to get Markkula's investment, Apple sold 26% of the shares to Markkula, and Jobs and Woz each 26%, and the other 22% as reserved shares. . You must know that because the reserved shares did not fall to specific people, it is equivalent to not having the 22% in the specific voting. That is to say, Apple's shares after the introduction of Markkula are still an even structure, with 26% each of Jobs, Woz, and Markkula.
By January 1977, when the new Apple was formed, they still opted for a split structure, with Jobs 30%, Woz 30%, Markkula 30%, and an engineer Holt 10%. Because the three main partners are split equally, this is still an equity split structure.
In 1980, when Apple went public, Jobs, the largest shareholder, accounted for 15%, Markkula, the second largest shareholder, accounted for 11.4%, and Woz, the third largest shareholder, accounted for 6.5%.
In 1985, with Markkula's backing, Apple fired Jobs from all positions at Apple, and Jobs was kicked out of Apple. Jobs recalled that he always thought Markkula would be on his side. The reason why Apple has such a result is that the difference between Jobs' 15% and Markkula's 11.4% is too small, and Jobs blindly trusts Markkula. And as we said before, people can change. Once Markkula is no longer with Steve Jobs, then Markkula will randomly pull a 4% minority shareholder, and Jobs will have nothing to say.
Apple was lucky. In 1996, Markkula came to his senses, appointed people on their merits, and invited Jobs back again, creating the Jobs myth and today's Apple empire. And Aiduo VCD, which shares the same equity equally, is not so lucky.
Aido VCD
Now everyone has never seen this company anymore. This company was very popular in the early 1990s. They invited Jackie Chan to advertise for them, and marked the CCTV weather forecast in 5 seconds. The sky-high golden advertising period is known as the king of the standard. The two founders, Hu Zhibiao and Chen Tiannan, were playmates who grew up together in a small village. They also started repairing electrical appliances together and slept in the same bed when it was difficult. In the early days of the business, the two share equity equally, but after the business started, Hu Zhibiao took the lead and Chen Tiannan was the shopkeeper. Later, another 10% minority shareholder of the village government was added, Hu Zhibiao and Chen Tiannan each with 45%. Such a structure is actually worse than a 50% split, because it creates a situation in which two 45% major shareholders compete for 10% of the minority shareholders, and the 10% of the minority shareholders instead become the company's decision makers. After the company became bigger, Hu Zhibiao and Chen Tiannan also had more disagreements. Later, the village government chose to stand on Chen Tiannan's side. In this way, Hu Zhibiao, who had loved a lot of shit and urine, was kicked out of the company. As everyone can imagine, the logo's love ended in failure soon.
Haidilao
Let's look at an example of success even after overcoming the equity split situation. The founders of Haidilao were Zhang Yong and his wife and Shi Yonghong and his wife. At the beginning, there were four people, 25% of each person. At the beginning of the business, everyone's contributions were similar, but as the company gradually expanded, the management ability of Shi Yonghong and his wife had obviously not kept up with the company's progress. At this time, Zhang Yong and his wife proposed to acquire 18% of the company in the hands of Shi Yonghong and his wife. Equity, that is, after the acquisition, Zhang Yong and his wife have a total of 68%, and Shi Yonghong and his wife have a total of 32%. The reason for such a numerical ratio is that there are some major matters in the Chinese company law that require 2/3 of the shareholders to vote, that is to say, after the acquisition of equity, Zhang Yong has the right to vote and absolute control over all matters of the company. Control, note that in the United States there is no 2/3 limit, only a majority vote. And this equity acquisition is based on the price of the original stock when the company was founded, which is basically equivalent to giving it for nothing (note that this is impossible in the United States, and the equity acquisition in the United States must be based on the current value of the company's stock at that time). Shi Yonghong and his wife agreed to what appears to be a "Nanjing Treaty" deal. However, this also created the myth that Haidilao was listed on the Hong Kong stock market with a total market value of HK$94.446 billion, and Shi Yonghong and his wife also made a lot of money. Just imagine that if Shi Yonghong and his wife failed to complete Zhang Yong and his wife, then the company's development may be limited and it may not be able to succeed. So it should be said that looking back, the loss-making business of Shi Yonghong and his wife was actually a good deal.
Haidilao's equity was divided equally at the beginning, and Shi Yonghong, the founder of the Buddhist system, gave up the equity generously, overcoming the hidden danger of equity sharing.
There is also a magical company that has been split equally since its inception, and is still one of the top companies in the world. That is Google, which we are familiar with, and its parent company, Alpha, to be precise.
At the beginning of the establishment, the two shared 50% of the equity equally. Until today, they each hold 6% of the equity of Alpha. This is also where I often get questioned by the audience every time I talk about the equal share of equity. Such a famous company has an equal share of equity. How can it be said that the equal share of equity is not good? It should be said that Google has too many strange places in the law, from the equal share of shares, to restarting the abandoned WVR for more than half a century, to the ingenious use of Dutch auction pricing when IPO, they have too much. There are many things worth mentioning, but they don't really have universal practicability. Especially in the aspect of equity sharing, Google is basically the only company among the successful large companies that everyone is familiar with now. Other companies either suffered big losses in equity scoring, or corrected the structure of equity sharing in time to avoid it. problem occurred. Let’s lay the groundwork here. We will talk about the WVR and Dutch auction just mentioned.
Summarize
Not every company with equal shareholding is a failed company, but it should be said that shareholding is the most difficult structure to manage. Some companies even adopt the Co-CEO model, with co-CEOs. Of course, such a structure even exists in relatively large companies. There are such examples among the clients I represent. But it is true that if you want to build a company based on this shareholding structure, you need more documents and terms to constrain it. If you can save yourself the hassle of all this in the first place with a reasonable number, why not take the easy route?
The average life expectancy of a startup company is 2.5 years, so there is a saying that if you don’t die for three years, it is a successful startup. Entrepreneurship is a life-and-death experience. Eight of the "nine deaths" are due to infighting within the team. The root cause of infighting is often the issue of equity allocation.
We often chat with some friends who are investing. Investors actually see if the entrepreneurial team has any hope. They just say the three words People, People, People, which is actually the word "team". Important things are said three times. There are so many good ideas and ideas now. But not everyone can produce results. What is a good team? It's not that a CTO with a Ph.D. in computer science from MIT and a CEO with an MBA from Stanford can make a company well. A good team must have a foundation for cooperation, mutual trust, and a reasonable restraint mechanism.
The most important and fundamental restriction is the restriction from the shareholding structure.
Here are 20 lectures on American company law, the necessary legal knowledge to focus on startup companies, I'm Liu Xiaoxiao, see you in the next issue~
