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The Exiting Founder Equity Dilemma
If you are a startup founder and decide to part ways with your cofounder — whether because of a dispute or simply a change in direction — you need to think carefully about your equity. What’s best for the company? And what will bring the most value for your vested stock?
Why Large Equity Stakes Are a Problem
If you leave with a substantial amount of equity (anything over 8%), you face a challenge.
Investors do not like to see “dead weight” on the cap table — meaning equity held by a departing founder who no longer contributes to the company.
From an investor’s perspective, an exiting founder should usually hold less than 8%, and in most cases less than 5%, in order for the company to remain investable.
If you leave with 50% of the company, the company is essentially uninvestable. Your cofounder may lose motivation to continue working, and your 50% could soon be worth nothing.
At the same time, you don’t want to simply hand your equity back.
You worked hard, you earned your vested shares, and you deserve to be compensated for your efforts. The challenge is finding a structure that respects your contribution without crippling the company’s finances.
Why Cash Repurchase Rarely Works
In theory, the cleanest option is for the company to repurchase your shares at fair market value (FMV). In practice, that almost never happens. If the company has enough cash to buy back your shares, using that money could deplete resources so severely that it jeopardizes growth and long-term survival.
Practical Solutions
There are a few tools founders and companies use to resolve this dilemma:
1. Repurchase with a Promissory Note
The company repurchases your equity at FMV but pays you over time.
- Payments are made in installments, or in a lump sum once a milestone is hit (e.g., raising $10M+ in financing).
- Payments accelerate upon an acquisition or exit.
- A pledge agreement may secure the note, meaning your shares serve as collateral until you’re fully paid.
2. Call Option Structure
Instead of an immediate repurchase, you can grant the company a call option to buy back your shares later at today’s FMV.
- Example: You exit when FMV is $10 per share. The company can’t pay now, but it holds the right to repurchase later at $10.
- At the next financing round, new investors often exercise the option as part of the deal.
- This allows you to eventually cash out while keeping the company’s cap table clean for fundraising.
3. Investor or Secondary Purchase
If the company has raised significant preferred financing, you may be able to sell some of your shares on the secondary market or directly to existing investors.
- Keep in mind: Most financing documents grant investors a Right of First Refusal (ROFR), meaning they get the first chance to buy your shares before an outside buyer.
- While secondary sales are more common in later stages, they can provide liquidity and solve the dead-weight issue.
The Takeaway
If you’re leaving your startup with more than 8% equity, you need a plan. Walking away with too much equity can kill future investment opportunities, de-motivate remaining founders, and ultimately destroy the value of your hard-earned shares.
Solutions like promissory notes, call options, or structured investor purchases can allow you to realize value for your work while ensuring the company remains fundable. The key is to strike a balance — protecting your interests while keeping the company healthy enough to grow.
If you’re facing this dilemma, reach out to an attorney experienced in startup governance and financing. At Sutter Law, we help founders structure exits that protect both the individual and the company.
