How to join as a cofounder: Creating a founders agreement, splitting equity, dividing partnership income, vesting schedules, and more

I recently considered joining an existing business as a cofounder, and I quickly realized that I had no idea how to do it. I've started my own businesses, but joining one is a whole different ball game — particularly when you're meeting the person online for the first time. How do you split ownership? How do you structure distributions? How do you make sure you're both protected?

In the end, I decided against joining the business. But I wanted to get a better understanding, so I did do some digging into what other indie hackers have done, as well as what the internet in general had to say. I hope it's a resource for anyone looking to partner up — whether you're joining a business or bringing on a cofounder.

Cofounder

Let's get some of the basics out of the way. A well-matched cofounder can be a godsend. They share the workload and, if you choose the right one, they have expertise in the areas that you don't. They bring their network and audience to the table. They support you and keep you motivated. They commiserate and celebrate with you. And so much more.

A cofounder who isn't a good match, on the other hand… I've been there and it can be rough.

A few things that make a cofounder a good match are complementary temperament, different operational skills, similar work habits, similar vision, self-sufficiency, resilience, and of course, it's helpful if you get along.

If you're the one with the business, it's important to keep in mind that you don't usually need a cofounder right off the bat. And unless you already have someone you trust who is eager to join forces, you probably shouldn't go looking for one until you've made some headway. If you're non-technical and wondering how you could possibly make any headway without a tech co-founder, check out my article on how and when to find a technical cofounder. My article on no code might help too.

If you don't have a business, or you do but you don't have any cofounder propects, check out this article on where to find cofounders.

How to form a partnership

If you're joining an existing company, they'll probably have a business entity set up already. But in case you're joining at the very beginning or they just don't have that particular duck in a row yet, I'll briefly discuss how to do it. I should preface this by saying that I'm not a lawyer. But here's what I've learned.

First off, Stripe Atlas makes the whole thing easy, so if you don't mind dropping a few bucks, start there. But personally, I've always registered companies through the secretary of state. If you're in the US and you're going the LLC route, LLC University is a free, step-by-step resource on how to do this in each state. I've found it to be hugely helpful.

Speaking of the US, here's a list of the best and worst states to incorporate in. Interestingly, Delaware isn't listed as one of the best states to incorporate in, so I'll just mention that it's a popular choice for indie hackers thanks to its privacy protection, tax benefits, business-friendly laws, cheaper filing fees, and so on. I believe that's where Stripe Atlas sets new businesses up.

I personally am a big proponent of local commerce, so I prefer to give my money to the state where I live. That means I pay a bit more, but not much, and I think it's worth it.

As for what type of legal structure is right for you, here's a good place to start.

Now, if you're the one with the business and you're bringing someone on, here's how you add them legally to an LLC (in the US). First, check your operating agreement for any requirements about how to handle bringing on a new member. Then settle on terms (I'll get into this next). Update your operating agreement, if you have one, to include the new member and the terms. Then update your articles of organization and file them with the secretary of state. State laws do vary, so make sure to take a look at yours. If you were a single-member LLC, then bringing on a cofounder will make you a multi-member LLC, and you'll be taxed as a partnership. You'll need to file form8832 to inform the IRS of this. And you'll now need to apply for an employer identification number (EIN).

Ok, now let's move on to the heart of this article.

Founders agreement

Personally, I've had a number of businesses, but I've only ever had a founder's agreement drawn up once. And that was way back when I was in high school (my dad insisted — wisely). I've gotten by without one since then. The reason for that, in my opinion, is that I've already had strong relationships with most of the cofounders I've had. But then again, I've heard that this isn't actually that helpful in practice, so maybe I've just been getting lucky.

Regardless, founder's agreements are important. Like, really important. If I had joined that company, I would definitely have put one together. So here's what I've learned. Again, not a lawyer.

A founder's agreement is a contract outlining the rights and responsibilities of each founder. It is legally binding. Among its many benefits is that it provides clarity on the following:

• Roles
• Conflict/dispute resolution — this is particularly important when equity is split equally.
• Exit clauses
• Equity percentages
• Financial contributions
• How a cofounder can default and what happens
• And a whole lot more (see next section)

This kind of structure is important from a legal perspective, but the clarity that it provides can also be hugely helpful in avoiding conflict between founders — everything is in writing, so you have something to lean on when tensions are high.

Draw it up before you officially join the company or, at a minimum, before you invest much time and/or money. If you're joining a business with multiple cofounders, they may already have one in place, in which case you would only need to make adjustments to that (assuming they did a good job on it originally).

And remember, businesses should change over time, and your agreement probably should too. It's a good idea to re-examine it every once in a while. Many people suggest doing that yearly.

Founders agreement template

When you're ready to draw up an agreement, you've got a few options. You can find a business lawyer to write it up, but that can be expensive.

You can just grab a free template and hope that it covers you. Honestly, I think that's a decent option for bootstrapped founders.

You can do a mix of the two — find a template, fill in all the blanks and customize it to the best of your ability, then ask a lawyer to review it and suggest edits. This will take far less time for the lawyer, which means you can save a few bucks. Some lawyers may even have their own template which you can fill out, so check in about that if you go this route. I've done this before (albeit with other types of contracts) and it has worked well for me.

There are lots of free templates out there for you to choose from. I'm not in a position to say which one is best, but I'll list a few below to get you started

• Template by the University of Pennsylvania's law department, including instructions and a guide to the tough conversations that need to be had.
• Template by PandaDoc
• Template by Wonder Legal
• Template by Cocosign

Finally, there are services like LegalZoom, ZenBusiness, and so forth. They tend to be cheaper than a standard lawyer.

Whichever route you take, make sure your agreement includes names, length of validity, company goals, roles/responsibilities, equity percentages, financial contributions, IP, compensation, vesting schedule, events of default, and exit clauses.

How to split equity in a startup

Advice on splitting equity is all over the board. And while online calculators and weighted formulas abound to help you figure out who should get what, they're really just starting points. Nothing can replace frank conversations between cofounders to figure out what feels really fair to all parties involved.

To help you find your way around those conversations, here’s a look at some common reasons people choose to split it equally and some common reasons they choose not to.

Folks like Michael Seibel of YCombinator think it’s best to split as close to equal as possible. Here's why.

Unequal splits can create resentment and apathy. Splitting equally means that all owners should feel an equal sense of ownership, which means they'll be more motivated and invested. And it's (arguably) easier to stay in right-relationship with cofounders when there's an equal split.

If any one partner owns more than 50 percent equity, that person’s opinion weighs significantly more than anyone else’s. Most people look at this as a good thing because it means no stalemates. But there are other ways to avoid those, and one person getting the final say on everything regardless of their current contribution or expertise can lead to dangerous territory.

Some would argue that the person who did most of the initial work (or maybe the "visionary") should get more, but that may be shortsighted. Seibel says it can take 7 to 10 years to build a really successful company, and there are going to be times when one person plays a greater role than the other and vice versa.

Others like Mike Moyer of Slicing Pie are sure that dynamic splitting is the way to go. Here are a few reasons for a more dynamic approach, instead of going 50/50.

As I mentioned above, an equal split can hinder the decision-making process because it requires a majority (or in the case of two cofounders, unanimous) vote. For the really tough decisions, this can actually lead to mediation, which no one wants. Equal splits can also act as a red flag to investors, as they might mean that the founders are avoiding the tough conversations.

With enough frankness, you should be able to get a sense of how much each person truly plans to invest. If one of you has already quit their job and invested a bunch of their own money while the other maintains their day job and edits a document from time to time, that’s a good reason for an unequal split.

My two cents? Every situation is different, but in general, I personally side with Seibel on this one — equal splits. It may not always make sense for established startups, but I think it's the right choice for indie hackers, more often than not. Because, if you're the new guy, of course you'll want that. And if you're not, well then you'll have a partner who is eager to prove themselves, rather than a glorified employee.

And while I think it's really important to get this sorted before investing too much time or money, lots of companies wait a month or more to get a feel for the partnership before deciding. It gives them time to get a feel for what each cofounder will bring to the business before having the conversation. If you do that, just make sure that it's noted in the founder's agreement that you'll be getting equity, and on what date that negotiation will take place.

In case it's helpful, I grabbed a couple of quotes from other discussions between indie hackers on the forum. @shawn_maplegum said:

“Co-founders should have equal equity unless one person is funding the business since you're all taking equal risk.”

And @tobins said:

“Equal split keeps it fair and equal split doesn’t mean you all have the same say in decisions. If it’s decision-making power someone is concerned about, then figure out how to make that work without debating about ownership. Here are some things to consider:

• All founders must have the same vesting schedule.
• Anyone not full-time is not a founder.
• Execution > Idea
• Commitments > Connections

There are always exceptions to the rule. For example if the other two are already operating the business (+ generating revenue) and need technology to help them scale, then there's a valid reason to offer less equity to someone coming in. They've effectively lowered the risk for someone to jump on board.”

Vesting Schedules

It's also important to consider a vesting schedule. Vesting schedules are preset schedules by which equity is distributed a little bit at a time.

Whether you decide to split right down the middle or take a more nuanced approach, I think including a vesting schedule is almost always the way to go when joining an established company — particularly if the cofounders don't already know each other. It quells fears about cofounder breakups, and it helps to prevent someone from walking away with a bigger piece of the pie than they deserve.

Here’s how it works. Typically, new cofounders enter into an agreement that includes four years of vesting with a one-year cliff. Meaning that even if you own half the company, if you leave (or you get the boot) within the first year, you walk away with nothing. If after a year, you leave, you’d walk away with 25 percent of what you would have gotten. After two years, you’d walk away with 50 percent of it, and so on until you have your agreed-upon equity after four years. You can also do it by milestones instead of time.

Four years with a one-year cliff might be a little long for indie hackers — particularly if the company is young. The nice thing about cofounding a business is that you make the rules. So, if you can imagine a vesting schedule that would suit your business better, go with that.

If you go this route, make sure to include it in your founder's agreement.

How to split profits fairly

There are lots of partnership profit sharing models out there. If you're wondering how to divide profit in partnerships, there's no one way to do it, but here are some tips.

First off, you need to decide whether profit-sharing is something you want to do. Plenty of early-stage companies just put all the revenue back into the business to expedite growth. Honestly, that's a pretty good option, at least until you're making enough to make a meaningful income. But once all partners are in agreement that you'll split the profits, here are a few ways you can deal with it:

• Divvy up the profits according to equity. This one is pretty common.
• If one person has invested money (or time), you could give them all (or most) of the profits until they have been reimbursed (less the time or money that you're putting in).
• Split the profits equally
• Pay everyone a different base salary, then distribute profits equally on top of that.
• Pay everyone specified rates, similar to freelancers.
• Pay based on merit or output or contribution.
• Don't pay out profits at all — reinvest it back into the business.

I've tried a couple of these approaches, but these days I always opt for splitting profits equally.

As for how to distribute it, I personally found the following approach to work really well: My cofounders and I decide on a certain amount that we want accessible for expenses (this will increase over time) at all times. Then, at regular intervals (once a week for me), I take the revenue and top up our checking account to that number. Then, if there's anything that I want to set aside some additional money for (e.g. new designs, ad campaign, etc.), I do that. Everything left over that is then distributed according to the percentage equity. In my case, it's always an even split. That works well for me. Don't forget to put 20-30% of this income into a tax fund before touching it, to be paid to the IRS quarterly. The amount you'll get will vary according to revenue and expenses, but you'll know first and foremost that your expenses will be covered.

Once you know how you'll split the profits, make sure it's noted explicitly in your agreement.

Of course, you'll need to set up business savings and checking accounts where both cofounders have access. Until trust is formed, you can ask your bank to require signoff from both parties for transactions. Obviously, the tradeoff is that this can significantly slow things down. I've never personally done that.

Whether it's the bank account, the codebase, or something else, make sure all cofounders have access. One person should not hold all the keys.

Wrapping up

One thing I saw over and over again while researching this was the importance of having candid conversations about these hard topics right away. Don't be afraid to bring it up when considering joining a company. There's nothing awkward or greedy or presumptuous about it. If they're not willing to have the conversation, they're probably not a very safe bet for a cofounder.

So what about you? Anyone out there joined a business as a cofounder? Or brought a cofounder into your business? I'd love to learn from your experiences.