Help! Friend asking me to help start a Large Scale Business

[jamie2377356]

Hi there,

I was recently contacted by an old colleague whom i have not spoken to in a while about being part of a new company. It is a great idea and he is basically a genius, capable of almost anything he wants to accomplish.

He says he has already added an IT guy, a legal guy, and sales guy, (whom i have not met) and just needs me to join on the research side to round out the digital team who are located on opposite sides of the world. He says he is offering everyone 5% of the company which will be scaled down as the company attracts new investors. He says that he considers us all founders, but can foudner only have 5%, while he has the rest at 75%?

He is asking to contribute 2 hours a day, and hopes the launch will be within one year.

He says no one is signing any contracts yet as we are all friends and we will figure it out later.

I know very little about this kind of agreement, what are the questions should i be asking? He is trying to rush me in saying just say yes and then we will figure everything out after, because the first mover advantage is huge in this market..

Is profit sharing different from the 5% equity he is offering. Is it possible my 5% might be scaled down to 0.1%??

Yes so any thoughts on what type of questions i should be asking him would be greatly appreciated if anyone has a moment, he is hounding me!!

Also what are the questions should i be asking myself?

[mthomas]

A 5% ownership is always 5% ownership. So your ownership can't be scaled down unless you sell it. Is your friend suggesting that YOUR ownership % would be scaled down as the firm attracts new investors? Or that other investors will be offered a lower percentage as more and more investors are attracted?

If you are interested in this, GET EVERYTHING IN WRITING. It doesn't matter how close the two of you are, you need to be protected to ensure you are getting compensated based on what was originally agreed to you. You don't want to be given a 5% stake in a company, than that amount somehow taken away from you when the firm grows. So again, get an agreement in writing, detailing what is expected out of you and what you will get in return. DO NOT proceed if you do not get something in writing.

The fact that you are being "rushed" into this, coupled with the fact that your friend doesn't want to sign any contracts makes me a bit suspicious. I can appreciate his desire to move forward quickly, but he should also appreciate your desire to protect yourself and your interests.

[jamie2377356]

Thanks very much mthomas,

Everyone's % will be scaled down as we get new investors, iI thought that was typical for a startup. I think there is a 500K investment pending from a potential investor, this is a big project. I am just concerned if there should be a cap on how low my % can go..?

I am still not sure if I am entitled to profit sharing automatically if I have a 5% stake in the company, or does that need to be specified separately..?

Thank you so much

[mthomas]

Wait, everyone's ownership percentage will be scaled down as more investors are attracted? How does your friend expect to accomplish this? Make you sell your shares? Your percent ownership is YOURS. I don't see how you can legally lose your % stake in the company without selling it willingly. Your % cap shouldn't change at all. Your concern shouldn't be how low the percentage can go, but the fact that your friend is even suggesting it be reduced.

I suppose if he worded it "you will be getting X number of shares, which roughly equals 5% of the company NOW, but that could change as more shares are issued to more investors", this would probably indicate that your % ownership would decrease since he is specifying a number of shares, but if he is telling you: "I will give you 5% of the company", then I can't see how this can change without you selling any of your stake.

If this company is set up as a corporation, then you are definitely 100% entitled to your percentage of the profits by default. This does not have to be agreed upon (although again, you should get everything in writing and have your lawyer present).

I'm not positive as to the legalities of how profits are distributed if a business is set up as something other than the corporation, but I believe that if a business is not a corporation, you MIGHT not be entitled to the same % profit distributions as your ownership by DEFAULT, this may have to be explicitly agreed upon.

However, I urge you, don't take my word for it. If you really want to be part of this deal (and to be honest it sounds a little suspicious), absolutely consult with a lawyer.

[justy540]

Contracts will keep you guys friends, as nothing becomes personal, it's in the contract. Lack of contracts on the other hand....

[chrispalko]

Please handle everything by contract. Seek a business lawyer, asap.

[jamie2377356]

thanks guys,

maybe that is why he doesnt want to sign the contract. because he plans on selling 25% to investors down the road., and he won't be able to do that if we sign the contract now ...hmm

anyway the situation sounds most close to this one you mentioned,

"I suppose if he worded it "you will be getting X number of shares, which roughly equals 5% of the company NOW, but that could change as more shares are issued to more investors", this would probably indicate that your % ownership would decrease since he is specifying a number of shares, but if he is telling you:"

although he has not specified "shares", after 25% is sold everyone's % will be scaled back equally. (5 people each at 5%, and him at 75%)

does anyone know where i can find any sample contracts?

does anyone know where i can get free/cheap legal advice from toronto or online?

[mthomas]

You might want to check out entrepreneur.com, I believe they have a section called "formnet" that might have contract templates.

Do you remember how your friend worded how the ownership would be divided up?

Also, I wouldn't just download a template, fill in the blanks and sign it. You should absolutely consult with a lawyer.

[jamie2377356]

Yes thank you, I think i am going to be pretty firm about having him create an operational document and then finding a layer to interpret it. Although this could lead to him just choosing someone else for the position, and shows that I don't trust him... I think it is worth it.

His wording was
"IT: 5% equity
Legal: 5% equity
Sales: 5% equity
Accountant (to be filled): 5% equity
Research (to be filled): upto 5% equity (depending on the time you can put in...)
Founder (author of this quotation): the remainder - 75%

Now - the plan has always been to sell 20-25% of the company to a family office at the outset in exchange for 500k of seed financing. When this happen, it will not come entirely out of my stake but will be pro rata scaled from everyone... therefore the final balance will look something like everyone else having 4% and me having about 60%..."


How much do cheap business lawyers charge anyway. Maybe I can find one from craigslist..

[mthomas]

So allow me to clarify something...you would fall under holding PART OF the 75% remaining for the founders? Did his wording go into detail as to HOW the ownership will be divied up among founders?

[Sepiraph]

Also what are the questions should i be asking myself?

- Ask yourself if it is actually of net benefit to you?
- How much of 5% will this be actually worth? How much risk is involved? 5% of $0 is still $0. Usually this type of situation occurs when the start-up has really limited cash flow.
- How trustworthy is this person & how likely is that he'd pull a stunt on you?
- How devoted to this would you be if it was only 5% (assuming net)
- 2 hr/day for 1 year is 730 hr ~ almost 20 weeks of solid work
- If things don't work out, what will you get out of this?

After you answered all these questions (and the other one you had originally), get everything in writing.