Meaning
Informal commitments made by founders to early employees, advisors, or investors guarantee a fixed proportion of the company’s future equity. These percentage promises create considerable ambiguity because the total share count changes as the company grows and raises capital. The commitment often conflicts with the formal terms of later investment agreements.
Contractual Risk
Early-stage communications via email or text messages often contain these informal agreements. In many cases, percentage promises are made before the company is officially incorporated or before a cap table is established. This practice leads to confusion when formal option grants are issued.
Dispute Resolution
Resolving these informal agreements often requires complex negotiations or legal settlements before a funding round can close. Corporate attorneys must spend thirty hours reconciling these past statements with the actual cap table to prevent lawsuits from disgruntled early contributors. The cost of failing to resolve these issues can be a delayed or canceled investment round.
Clear, written agreements specifying share numbers are the only way to avoid these problems.
Equity Allocation
Fulfilling these commitments requires the company to allocate a portion of the equity pool to the recipient. This allocation reduces the amount of equity available for future hires and investors. The final allocation must be approved by the board.
