Co-Founder Equity Mistakes to Avoid with Michael Seibel | Startup School

Core Philosophy: Be Generous with Co-Founder Equity

The biggest mistake founders make is being stingy with equity during the most delicate time in a startup's life. This creates resentment and causes talented co-founders to leave just when breakthrough moments might happen.

The Three Types of Founders:

1. The Jedi Founder - Generous with co-founder equity
2. The Dumb Founder - Also generous with co-founder equity
3. The Midwit Founder - Overthinks skill sets, contributions, time commitments, and networks

Key Principles:

• Motivation Over Calculation: Focus on keeping co-founders motivated for 4+ years, not just today
• Forward-Looking: Most of your company's work hasn't been completed yet
• Generous = Smart: The more generous you are, the more you can expect strong founders to stay motivated

Important Context:

This advice specifically applies to:

• Tech software startups expecting VC funding
• Pre-product market fit companies in their beginning stages
• Founding team conversations happening early in the company

Timestamp: [0:01-2:03]

The Psychology of Long-Term Motivation

The critical mistake founders make is not thinking about how to motivate their team today AND tomorrow. You're typically giving people equity they'll earn over four years, so you need to prevent future resentment.

The Resentment Scenario:

The Solution - Close to Equal Splits:

• Go for close to equal equity splits (doesn't have to be exactly equal)
• Think beyond today: What will keep them motivated over all four years?
• Prevent the "grinding founder" syndrome: When co-founders feel undervalued despite equal effort

The CEO's Real Job:

Not just convincing co-founders to work on your company today, but ensuring they stay motivated for the entire journey and hopefully much longer.

Timestamp: [2:04-3:11]

Essential Protection Mechanisms

Even if everyone likes each other and believes nothing will go wrong, vesting and cliffs are non-negotiable best practices that protect the entire founding team.

How Vesting Works:

• Equity is earned over time (not given all at once)
• If you leave early, you don't get all the equity
• Standard timeline: Four-year vesting period

How Cliffs Work:

• One-year cliff is most common
• No equity earned until you hit the one-year mark
• Protects against early departures that could destroy the cap table

Why Life Happens:

• Family circumstances change
• People get sick
• Performance issues arise
• Sometimes people have to leave even when they don't want to

The Protection Factor:

Vesting and cliffs give founders the ability to let other founders go or for founders to leave without destroying the company's equity structure.

Timestamp: [3:15-4:44]

The Essential Team Test

The co-founder title shouldn't be given out casually. Your founding team should be the smallest number of people who can build an MVP, get it to customers, and start learning.

The Essential Founder Framework:

1. Can help build an MVP
2. Can get product in customers' hands
3. Can contribute to learning and iteration

Red Flags to Watch For:

• Teams with 5-7 co-founders: Something weird is happening
• Conversations haven't happened: People avoiding difficult decisions
• Seven people are NOT essential for getting a product to customers

The Generous Equity Strategy:

Being generous with equity actually helps you remove "co-founders" who:

• Aren't truly essential to the founding team
• Should be employees instead of founders
• Don't deserve the co-founder title

Timestamp: [4:44-5:34]

Future Work, Not Past Contributions

The fundamental misunderstanding most founders have is thinking equity rewards past work. In reality, equity is about motivating people for work they haven't done yet.

The Reality Check:

The Mindset Shift:

• Equity = Future Motivation (not past rewards)
• Most work lies ahead of the founding team
• Motivation matters more than historical contributions

CEO Responsibilities:

The Captain of the Ship:

1. Must have ability to fire non-performing founders
2. Should reserve this right regardless of equity split
3. Needs ultimate accountability for company success

The Accountability Factor:

If You Can't Accept This:

Timestamp: [5:37-6:38]

Essential Insights:

1. Be generous with co-founder equity - The biggest mistake is being stingy during the delicate early stages, which causes talented people to leave when success might be just around the corner
2. Equity motivates future work, not past contributions - Most of your company's work hasn't been completed yet, so focus on keeping people motivated for the 4+ year journey ahead
3. Use vesting and cliffs for ALL founders - Even if everyone gets along, life happens and these mechanisms protect the entire team and cap table

Actionable Insights:

• Aim for close to equal equity splits to prevent resentment and maintain long-term motivation
• Implement standard 4-year vesting with 1-year cliffs for all founders without exception
• Ensure the CEO has authority to remove non-performing founders regardless of equity arrangements
• Limit co-founder titles to truly essential team members who can build MVP and get it to customers
• Don't overthink complex calculations about contributions, skills, and networks - generosity trumps complexity

Timestamp: [0:01-6:38]

People Mentioned:

• Michael Seibel - YC Group Partner providing the core advice on co-founder equity splits and startup best practices

Companies & Organizations:

• Y Combinator (YC) - Startup accelerator providing the framework and best practices discussed in this content

Concepts & Frameworks:

• Four-Year Vesting Schedule - Standard timeline for earning equity over time in startups
• One-Year Cliff - Common protection mechanism preventing equity distribution until one year of service
• Co-Founder vs Employee Distinction - Framework for determining who deserves founder-level equity and title
• MVP Development Strategy - Minimum viable product approach to defining essential founding team members

Timestamp: [0:01-6:38]

Pre-Product Market Fit Breakup Guidelines

The most responsible thing co-founders can do is have honest conversations about what will happen if things don't work out. Here are YC's proven guidelines for handling co-founder breakups in pre-product market fit companies.

Before the One-Year Cliff:

Token Equity Only (0.5% - 2%):

• Extremely typical for departing founders to receive minimal equity
• Remember: No evidence the company will work yet
• Reality check: Vast majority of work still needs to be done

After One-Year Cliff, Pre-Product Market Fit:

Maximum 5% Retention:

• Departing founders should retain no more than 5% of the company
• Often requires giving back equity that was originally granted
• Rationale: So much work remains to be done

Standard Severance Practices:

• If fired: 1-3 months severance is reasonable
• If they leave voluntarily: Severance not typical (but possible)

Timestamp: [6:40-8:23]

Required Legal and Governance Changes

Every founder who leaves or is fired should complete these essential steps to ensure clean separation and protect the remaining team.

Required Actions for ALL Departing Founders:

1. Resign from the board - Clean governance structure
2. Sign a release - Legal protection for both parties
3. Grant proxy voting rights - Allow remaining founders to vote their shares

The Logic Behind Proxy Rights:

CEO Departures - Special Considerations:

While it's typically non-CEO founders who leave or get fired, sometimes life happens to CEOs too.

CEO Expectations:

• Previous CEOs should understand these same expectations
• Sometimes CEOs screw up and need to be replaced
• Sometimes CEOs choose to leave voluntarily
• New CEO must arrange the breakup according to these guidelines

Timestamp: [8:24-9:33]

The Most Common Bad Reason for Massive Inequality

The classic mistake: "I own 90% of the company, I asked my co-founder if they're willing to own 10%, they said yes, so everything's good, right?" This is a perfect example of optimizing for today instead of tomorrow.

The CEO's Fatal Flaw:

The Real Questions to Ask:

• Not: What is your co-founder happy with today?
• Instead: What will keep them excited in year three when everything sucks?
• Critical: What's going to keep them motivated to stay and work extremely hard?

The Tomorrow Mindset:

The Motivation Challenge:

When the company hits rough patches (which it will), that 10% equity holder will question their commitment while watching the 90% holder reap the rewards of their equal effort.

Timestamp: [9:42-10:31]

Why Ideas Are Worthless and Execution Is Everything

One of the most common justifications for unequal splits: "It was my idea, they're just building it." This reveals a fundamental misunderstanding of what creates value in startups.

The Brutal Reality About Ideas:

The Execution Truth:

Why Your Co-Founder Deserves More:

• That co-founder will be essential in executing the company
• If they're not essential, they shouldn't be a co-founder at all
• Execution differentiates successful companies from failed ones

The Value Creation Reality:

Ideas don't create value - turning ideas into working products that customers love creates value. Your "idea person" vs "execution person" distinction misses the point entirely.

Timestamp: [10:32-10:59]

Why Head Starts Don't Matter in the Long Game

Another common justification: "I started working 6 months before my co-founders, so I deserve a lot more equity. They weren't there at the beginning."

The Long Game Perspective:

The Journey Reality:

Time Scale That Actually Matters:

• 10-20-30 year journey if really successful
• 99% of work still remains to be done
• 6-month head start becomes insignificant in this context

The Math That Matters:

When you're looking at decades of building, iterating, scaling, and growing, does 6 months of early work really justify owning 3-4x more equity than someone who will grind alongside you for the next 10+ years?

Timestamp: [11:02-11:26]

Why Mixing Salary and Equity Creates Dangerous Precedents

The final common mistake: "My co-founder needs a salary and I don't, so they should get less equity." This fundamentally misunderstands the different purposes of salary versus equity.

The Clear Distinction:

Salary vs. Equity Purposes:

Salary Function:

• Money needed to live - rent, food, basic survival
• Enables ability to work in your company
• Practical necessity for participation

Equity Function:

• Motivates extremely hard work and exceptional performance
• Compensates for below-market salary sacrifice
• Drives long-term commitment and dedication

The Dangerous Precedent:

Why This Matters:

Creating equity inequality based on salary needs sets up resentment and demotivation exactly when you need maximum commitment from your founding team.

Timestamp: [11:27-12:00]

Essential Insights:

1. Plan for breakups before they happen - The most responsible thing co-founders can do is discuss breakup scenarios upfront using proven YC guidelines
2. Pre-PMF departures should retain minimal equity - Before one-year cliff: 0.5-2%, after cliff but pre-PMF: maximum 5% to motivate remaining team
3. "My co-founder agreed" optimizes for today, not tomorrow - Think about what will motivate them in year three when everything sucks, not what they accept today

Actionable Insights:

• Reject the "idea person" justification - Ideas are worthless; execution is everything, and YC sees 30,000+ identical ideas every six months
• Don't penalize salary needs with reduced equity - Salary covers survival needs, equity drives motivation and exceptional performance
• 6-month head starts don't justify massive inequality - In 10-30 year journeys, early timing advantages become statistically insignificant
• Require standard breakup procedures - All departing founders must resign from board, sign releases, and grant proxy voting rights
• Always think long-term motivation - CEOs must optimize for keeping co-founders excited through the inevitable rough patches

Timestamp: [6:40-12:00]

People Mentioned:

• Michael Seibel - YC Group Partner providing guidelines on co-founder breakups and debunking bad equity split justifications

Companies & Organizations:

• Y Combinator (YC) - Startup accelerator that receives 30,000+ applications every six months and has developed proven breakup guidelines

Concepts & Frameworks:

• Pre-Product Market Fit Breakup Guidelines - YC's proven framework for handling equity when co-founders leave early-stage companies
• One-Year Cliff Protection - Standard vesting mechanism that determines equity retention upon departure
• Proxy Voting Rights - Legal mechanism allowing remaining founders to vote shares of departed co-founders
• Salary vs. Equity Distinction - Framework separating survival needs (salary) from motivation mechanisms (equity)
• Long-term Motivation Strategy - CEO responsibility to think beyond immediate agreement to sustained co-founder engagement

Timestamp: [6:40-12:00]

The Experience vs. Motivation Balance

"I'm older and much more experienced than my co-founder" - This is arguably the trickiest justification for unequal splits because experience does create real value, but it can't override fundamental motivation principles.

What Experience Actually Brings:

• Can contribute significantly to company success
• Helps with fundraising and investor relationships
• Provides capabilities younger co-founders often lack
• Opens doors that would otherwise stay closed

The Co-Founder Reality Check:

The Motivation Imperative:

The Experience Trap:

If someone is truly essential (co-founder level), their long-term motivation matters more than acknowledging past achievements. A demotivated "experienced" co-founder becomes a liability, not an asset.

Timestamp: [12:09-12:41]

The Fundraising Illusion

"I hired my co-founder after raising some money" - People are shocked to learn that fundraising doesn't dramatically improve your odds of success.

The Brutal Fundraising Reality:

The Math That Matters:

Even With Significant Funding:

• $100,000 raised: 99% of work still remains
• $500,000 raised: 99% of work still remains
• Post-fundraising hiring: Doesn't change the fundamental equation

The Launch Fallacy:

Why Launch Changes Nothing:

Getting your MVP out is literally just step one. The real work of building a sustainable, scalable business that customers love happens after launch.

Timestamp: [12:42-13:19]

The Short-Term Thinking Trap

All these justifications for unequal equity splits reveal the same fundamental flaw: short-term thinking when you need long-term strategy.

The Common Thread:

What Separates Great Founders:

The Long-Term Mindset:

• Best founders are long-term thinkers
• Not only thinking about today but about tomorrow
• Thinking about co-founders' needs even when co-founders aren't

The Team Success Formula:

Equity as a Tool, Not a Reward:

Timestamp: [13:20-14:05]

The Innovation Trap in Equity Distribution

Why This Doesn't Work:

The Goal-Setting Problem:

• Unclear how to set goals at the beginning of a tech startup journey
• Goals constantly change as companies pivot and evolve
• Measuring things precisely at the start is a big fallacy

The Innovation Fallacy:

Why Stick to Best Practices:

Performance-based equity sounds smart but creates complexity where simplicity works better. Your energy should go into building products customers love, not creating complicated equity formulas.

Timestamp: [14:06-15:11]

The Full-Time Commitment Reality

The uncomfortable truth about part-time founders that most people don't want to hear.

The Blunt Assessment:

The Successful Company Pattern:

The Commitment Standard:

Edge Cases Don't Change the Rule:

While there might be some edge cases with part-time arrangements or people who "swap in and swap out," these are exceptions that prove the rule rather than viable strategies for building great companies.

The Viability Test:

Look at the companies that have built massive value over decades - the pattern is clear. Full-time commitment from the founding team isn't negotiable if you want to compete at the highest levels.

Timestamp: [15:12-15:40]

The Clarity vs. Complexity Problem

"What about dynamic equity agreements where the equity isn't really set and depends on future company accomplishments?" These sound sophisticated but create motivation problems.

The Motivation Psychology:

Why People Create Complex Systems:

Your Real Protection:

The Wherewithal Test:

The Respect Factor:

Timestamp: [15:41-17:13]

The Long-Term Success Paradox

Even in massively successful companies, one founder often sticks around longer and becomes more valuable over 10-15 years. Shouldn't they deserve vastly more equity?

The Success Pattern:

Famous Examples:

• Amazon and Jeff Bezos
• Facebook and Mark Zuckerberg
• Other long-term founder success stories

The Counter-Intuitive Truth:

The Early Years Reality:

The Activation Energy Principle:

The Foundation Matters:

The Ultimate Goal:

Timestamp: [17:14-19:19]

Essential Insights:

1. All bad equity justifications stem from short-term thinking - Whether it's experience, fundraising, or timing advantages, the pattern is always optimizing for today instead of long-term motivation
2. The first 4-6 years are where most value gets created and most companies die - Even future "Jeff Bezos" types need generous co-founder equity because those early co-founders provide the activation energy to even stay in the game
3. Equity is a motivation tool, not a reward system - Best founders don't hoard equity; they use it strategically to produce maximum motivation from their small team

Actionable Insights:

• Avoid performance-based equity schemes - Focus innovation on products and customers, not complicated equity formulas that create uncertainty
• Reject part-time founder arrangements - Successful companies require full-time commitment from all founders
• Skip dynamic equity agreements - Clear, known equity stakes motivate better than complex, changing formulas
• Use vesting and cliffs as your protection - These proven mechanisms eliminate the need for fancy schemes
• Think like a long-term founder - Consider co-founders' needs even when they don't, because small teams must accomplish massive goals together
• Remember the activation energy principle - Early co-founders get you into the game; without them, you might never reach the success where equity splits matter

Timestamp: [12:01-19:19]

People Mentioned:

• Michael Seibel - YC Group Partner providing final thoughts on equity distribution philosophy and debunking common bad advice
• Jeff Bezos - Amazon founder used as example of long-term founder success and why early generosity still matters
• Mark Zuckerberg - Facebook founder cited as another example of founders who stay longer but shouldn't penalize early co-founders

Companies & Organizations:

• Amazon - Example of successful company where one founder stayed much longer but early team was still crucial
• Facebook - Another example of long-term founder success built on early team collaboration
• Y Combinator (YC) - Startup accelerator providing best practices for equity distribution

Concepts & Frameworks:

• Performance-Based Equity - Flawed approach that creates uncertainty instead of motivation in early-stage startups
• Dynamic Equity Agreements - Complex systems that sound sophisticated but reduce founder motivation through uncertainty
• Part-Time Founder Model - Arrangement that doesn't work for building viable, successful companies
• Activation Energy Principle - Concept that early co-founders provide essential energy to get companies into the success game
• Long-Term vs. Short-Term Thinking - Fundamental mindset difference that separates successful founders from those who fail
• Four to Six Year Value Creation Window - Critical period where most startup value gets created and most companies either succeed or die

Timestamp: [12:01-19:19]