Equity, Shareholders, Investment - How Much Should Brand Founders Give Away? | Phil Hails-Smith, Managing Partner, Joelson

0:00You can ask AI to create me a co-founder agreement. It'll probably generate a very good draft of something, but it's not going to ask you the questions that you don't know.

0:12So many founders of early stage scaling CPG brands are thinking about things like shareholders agreements, co-founder agreements, raising investment, valuing their company. And often you don't know where to turn to find out the real stats, the real deets in terms of who's giving equity to who at what rate, how are people valuing their companies, how are people thinking about raising investments, how are people structuring their shareholder agreements and particularly their co-founder agreements. Well, I decided it was time that we got the lowdown. So I invited Phil Hales-Smith, one of the managing partners of Jolson, onto the show today to give us all of the lowdown to try and lay it out for any of you out there who want to know not just the principles behind it, but the actual details of what best practice are, including the numbers.

1:00Let's dive in.

1:05Phil Hales-Smith from Jolson, welcome back to Brand Growth Heroes. How are you doing? Hey Fiona, yeah, it's great to be back again and very much looking forward to this chat. Yeah, look, I asked you to come on because so many times I get asked, how do I structure so many different deals when it comes to co-founder agreements, shareholder agreements, bringing on an advisor, raising investment? There's just so many different points where you have to think about having a contract with somebody that gives them security, gives you security, gives them equity potentially, and nobody really knows what the benchmarks are.

1:44And I thought we could deconstruct that together? Sure. Yeah, listen, I mean, delighted to. That's what I spend a lot of my life doing. So yeah, I'd be very happy to come dive in and sort of talk that through. Amazing. Why don't we just spend two minutes telling everybody who may not have met you on the previous episode we did together, just tell everyone quickly, what kind of things are you working on day to day? It's Jolson here. I'm the managing partner. So I kind of run the corporate team here. And we're really, really privileged that we kind of work with a whole range of different companies in the consumer space.

2:13And that covers, you know, food and drink, health and wellness, beauty, a broad range of different sort of product categories.

2:27Welcome to Brand Growth Heroes, the leading podcast for the founders of Challenger grocery brands. I'm your host, Fiona Fitz. My 25 years at global giants such as Nestle and Challenger brands such as Goo Chocolate Puds, Chobani and Strong Roots, as well as coached to over 400 scaling brands, means I have the experience to ask the questions that truly matter and get you the insight that will inspire you to think differently and drive serious growth for your brand.

2:59Throw some brands at us so everyone can drool. In the last couple of years, you know, we've worked with trip we've worked with biotiful and dairy we've worked with two chicks um we've kind of been supporting a lot of your brand growth heroes cohorts so all the aunties and people like that it's kind of a huge cross-section and and you know we're really lucky that we work with some of the greatest sort of founders and entrepreneurs in the consumer space but from a really early stage so you know what i love is kind of meeting founders who are thinking about an idea and then how to actually kind of bring that idea into, well, what does a company look like?

3:36What does the, you know, what does the founding team look like? How do I raise investment? What are the advisors that I need? And what are the commercial deals that sort of sit around all of that? The value that we bring is that we, you know, we're really happy to start really early working with those founders, you know, before they've even set up a company and then sort of taking it through as they raise investment, as they bring on their first employees, and then as they kind of bring investors on board, and then hopefully in a few years' time getting to a successful exit. That's part of the thesis and part of what we've been doing for the last 27 years here at Jolson.

4:11And it's something that I'm really happy to share and talk about in terms of those kind of key principles and how we kind of work through that. I think that's brilliant because so many people have, well, so there are founders out there who are really good at networking, are really good at asking the right questions, meeting the right people. And they've got some benchmarks around, you know, how much equity to give at which stages and, you know, what a co-founder agreement should have. But then there are probably, you know, 80 % of people who don't have that network and who don't know that you can be cheeky and ask the right questions and kind of build up this matrix in your head of what you need to consider at each stage and what that means in terms of conditions, in terms of conditions and, you know, what you're signing up to and what equity you're getting.

4:52And I'm sure there, it's just feels like the Wild West for them. I have to say it because I love this, you know, just for anyone listening, Phil and Paul, Managing Partners of Jolson, did the deal between Innocent and Coca-Cola, right? One of the first deals as a very baby lawyer in 1999, Paul and I met the Innocent founders when they were doing their first fundraise. And so we did that transaction where they raised a grand total of£250 ,000 and they never raised any additional investment until they sold to Coca-Cola. That was probably the starting point for us focusing on working with founders and how you start, grow and scale a business.

5:26It was almost like us doing an MBA in terms of understanding how you create a business that kind of takes on the big players in the industry. And, you know, we were learning, I mean, you know, some of the marketing stuff they did was a bit on the edge in terms of legal. For us, it was a learning experience from, you know, a high growth company that was super successful, but also they were learning from us. It's an amazing kind of experience that we've had. And then we've been able to bring that to a whole load of other consumer brands, you know, since then. Like say you're somebody who has started your consumer packaged goods, whether that's in food or beverage or in health and nutrition or wellness or household products or whatever it is, you know, you could be a Purdy and Fig a few years ago, or you could be an ancient and brave, or you could be a Huel even, or you could just be, you know, jam.

6:14Will we start with either you've had the idea and you've worked it up and you've got the product and the prototype and you've maybe got your first listings and you want to bring on a co-founder. Is that the right place to start? You could start earlier. So, I mean, you could start with, let's assume that it's two co-founders who are coming up with this idea, working out what their skill sets are how they actually go to market and then before you even start thinking about engaging with how to create the brand what the trademark looks like or the the brand assets look like or anything along those lines it's like well you need to kind of set up a company so you know making sure that you've set up the right legal structure and then sort of what is the deal between the co-founders right and what are the norms for that how does that work what's the the fair thing in terms of the equity split, who's getting what percentage between the co-founders, depending on the different contributions.

7:08How do you actually decide that? Because I thought, you know, it's 50-50 or 60-40 or 70-30, like what makes that split fair? Well, so you're considering who's initially the driving force behind this business, right? Whose principal idea was it? What is the commitment going to be in the early phase of the business? You know, there could be somebody who's quitting their job and starting full time whilst the other co-founder sort of does it part time, that will dictate the proportion of equity that you get. Yeah. Later on, you can kind of look at sort of fixing that if you think there's an imbalance, if you're both working full time and you're both, you know, sort of founding the business.

7:41But we'll come to that a bit later in terms of other things. Then the key thing is sort of kind of agreeing, well, actually, what happens if one of us leaves? Do you hold on to your equity? Do you have to give some of it back? Does some of it just, you know, kind of automatically go back to the other co-founder? They're hard conversations to have. So let's talk about this because I think we always talk about the principles, but we don't talk about how you actually make the decisions. So say, let's take an example. I'm the driving force behind the idea. I bring someone on quite early on and we're both going to do the same amount of work on paper.

8:14That's what it looks like. Where do I start? 60-40? I mean, do you start with something that feels right? Does it come down to a feeling that where both people are happy? It has to be something that you both feel is fair and equitable. So how do you actually make that decision? I mean, is there a magic equation or is it just about what feels right? So there's no magic equation. I mean, it very much is it's intuition, what feels fair and equitable between the co-founders and also what they're comfortable with. Very rare that you get a pure 50-50 split, i.e. both people are kind of, you know, we're fully in this to day one.

8:4860-40, 70-30 is a very common split in terms of how that works through. That's the first metric for us to realise actually, that it's very rare that you get a 50-50 split. There's usually somebody who is coming to the table looking for more because they were the one who was the driving force early doors. Or they had the original idea. They had the original idea. Or they're the ones who started making the product at their kitchen table, you know, and then they were like, oh, this is good. There isn't a magic formula, but I think, you know, there's obviously key factors that you will build into it, right?

9:23Hey, just a quick word about Brand Growth Heroes partner, Jolson. So look, as a founder, you've got loads on your plate. Fundraising, shareholders, co-founders, co-manufacturing, product, NPD, you name it. Scaling is really complex and the legal side of scaling can be really complex too. Who your legal partner is really matters because it's not something we can afford to get wrong. That's why I work with Jolson. Jolson have worked with brands like Little Moons, Trip, Two Chicks, Graze, Costa Malika, and they've even advised the innocent founders on their sale to Coca-Cola and they still work with them today at Jam Jar.

9:57And for me, it's not just that they're brilliant at what they do, but they're also really good people. They care about founders, they care about doing things properly and that really matters. And they're also one of the few law firms that's both B Corp certified and a member of 1 % for the planet. Recently, I asked managing partner Paul Chappie, why does a scaling brand need a corporate lawyer? So you definitely need someone that's going to have your back, that is going to be looking at those pitfalls that may be coming in the future, preferably someone that knows the industry, because having that context is really important when negotiating, be that commercial agreements or funding arrangements.

10:38And at the end of the day, you really need to have someone that you can trust and obviously can negotiate hard when they need to. you're not going to believe this but Jolson is actually offering a free legal consultation to any founders who listen to brand growth heroes podcast and I would definitely take them up on it you'll find a link to book now directly here in the show notes below or just drop a comment underneath the episode and I will connect you with them directly and now let's get back to the show

11:11so we often talk about this though you know that there's like conceptually all the things that we need to consider at different stages. But how do you make decision whether someone gets 50-50, 60-40, 70-30? Is it just that you're feeling what's fair? There's definitely not a magic equation. What I would say is it's very rare for it to be 50-50 because everybody comes with, you know, different contributions. It's usually based on, you know, what people think is fair, what people commercially are comfortable with. And that's based on a number of factors. Whose idea was it in the first place? Who started making the product?

11:40Kind of kitchen table story. whose kitchen table was it, who was actually the person that actually came up with that idea. You know, those are the kind of key contributing factors. And then things like, oh, you know, if somebody's quitting their job first and starting full time, you know, and how long they're going to go unpaid for, you know, all of those sorts of things, those leaps of faith, you compensate them for a bit more equity in certain circumstances. I get that. OK. And then you said something really interesting, which was I was deciding at that point when you're writing the agreement, the co-founder agreement, what will happen when somebody leaves.

12:12So talk about that. What should happen when somebody leaves? Like, what are the options and why might you decide one option versus another? So this is where lawyers spend their entire lives, right, thinking about what might go wrong and then trying to document what happens in those circumstances. This is a co-founder relationship is obviously a long term kind of relationship to found a business together. So you've got to think about, well, OK, that's great. but, you know, life happens in the interim, you know, so things like parental leave, what happens if you have, you know, an illness that means you can't, you know, continue to work in the business.

12:47There is a lot of different sort of variables within that. And what you'd normally do is sort of try and work out, well, you know, if somebody just decides I'm quitting, I'm out, and for no real reason, then in those circumstances, you probably wouldn't want them to keep their equity. At all, none of it. Right, at all. What about the years they've put into it? So say if they leave after three or four years and they were instrumental in building that business, why wouldn't it be fair that they keep some equity? So in those circumstances, what you would then do is you'd kind of negotiate and agree what's called a vesting schedule.

13:17It compensates you over a period of time, you know, that you'd sort of say in the first year, nobody vests anything. After that, you then start vesting your shares in a kind of, you know, whether it's 25 % a year. So you're kind of saying, well, over a three or four year period, you will vest you know a certain proportion of those shares you would get to keep a certain proportion right if you left in in you know voluntarily now if you did something wrong so you know you did something that was really naughty like i don't know um you had your hand in the till or you kind of you know you you were fired for gross misconduct because you were saying terrible things about the business in those circumstances you should lose all of your shares right because you've done something that's potentially damaging to the business and so therefore you shouldn't keep them.

14:03But what you've got to be very careful of is investors at a later stage take a really poor view of what's called dead equity. So people who aren't contributing to the business but have shares in the business. And a significant share, you mean? Yeah, you've got to factor that in, right? And I think that it's a tough discussion, but you've got to try and have those. And if you can't have those difficult discussions at the outset, then is it a partnership that's based on sort of the right values and the principles to start with. And sorry if this is a stupid question, but say you're the principal co-founder, you know, you're the person with the 60%, right?

14:38And is it the other person whose shares are vesting? Do you already have that 60 %? Well, again, that's the conversation. If it's two co-founders, I would always, and they both have different skill sets, and they're both going to contribute differently, you know, you can't really have a one-way vesting or a one-way sort of exit provision, because it needs to be fair, and it needs to be balanced. And that is then a disincentive for people to leave if you think about it. Yeah, okay, that's true. Okay, so then, so imagine we get our co-founder agreement right up front. Now, why haven't we done this using AI at this point?

15:10Well, I mean, you can definitely use AI. AI, you know, in terms of the way that, you know, we currently are sort of experimenting with AI quite a lot, it's only as good as the prompts and the information you're feeding it. Yeah. You can ask AI to create me a co-founder agreement, it'll probably generate a very good draft of something, but it's not going to ask you the questions that you don't know it's not going to come up with the solution for a commercial debate between you about who should get the right percentages what does the lever provisions look like what's vesting you can say well this is what we think having trawled you know all of the the model and whatever the inputs are to those models and the other thing about ai you've got to be very careful of is a lot of it is based on you know if you think about the two largest you know kind of you know, Anthropic or OpenAI, they're both US-based, right?

15:59So a lot of what's going into the model to train it is US law, which is completely irrelevant for an English business, right? There will be norms in America, which won't be the same here. You can download stuff from the internet as much as you like, right, in terms of legal documents, but you're not going to get the advice. You're not going to get the sort of... Tailored approach. The quality of the inputs or even challenging you in terms of commercially, is that the right thing to be doing, right that you kind of need that kind of bespoke personalized advice that you kind of get when you actually go and see a professional ultimately ai is going to be a sort of support to a lot of founders in lots of different you know kind of quick win questions simplifying things thinking about supply chain thinking about how you kind of do things in a faster more effective way creating agents that will kind of review things as you go through but ultimately that you're still going to need to interrogate that and you can only interrogate it with knowledge and understanding.

16:56I know, I think that's people, what people miss is they don't realise that unless you know the subject inside out, you can't do the prompt in a way that's going to deliver something that covers all the basis and actually creates value. Okay, so then imagine these co-founders then have, this is all working, etc, etc. At some point in time, they want to bring on an advisor, right? or they want to bring on a board, an advisory board or advisors, what kind of equity should they be looking to share? Quite a small amount. Again, it goes back to the principles of what value is the advisor bringing? Are they, you know, kind of going to facilitate and enable the business to grow and scale, you know, or deliver some of the plans?

17:36Is there expertise that you're buying in that ultimately you're compensating them through equity? I've seen some advisors ask for, you know, a substantial amount, you know five seven and a half that's too much in my view you know if it's in the the one to two and a half range in terms of overall percentage that's possibly you know acceptable depending on what they're actually going to contribute and and you know there may be certain advisors out there who will also want to be part of your round so actually if you bring in a you know a significant player in terms of um you know coming onto your board or whether it's an advisory board or formally onto the board and they're saying well i'd like to be remunerated with a bit of cash plus some equity but i'll also participate in the round they may be able to unlock other investors who come in as well so so there's a big balancing act keeping as much equity in the founding team in those early days is really important because if you then sort of play forward and you are going to raise capital from whether it's venture capital or elsewhere you get diluted and and the problem is that you've got to just you've got to think about you know what that dilution looks like it's tricky let's call that out then what kind of percentages do the do you want to keep in the founding team along the way at the different stages of investment i mean that's a really hard one what i always try and say to them is listen in the early days when you're doing your kind of initial kind of angel round you want to keep control of the business and that means that you want to have more effectively more than 75%.

19:08And so what you want to try and end up with is a position in an ideal world where, you know, you're never really less than sort of 30%. And that's kind of throughout the whole kind of journey. And if you can keep it above 50%, that's even better. Right. Okay. And what's why 75 % a magic number? 75 % ultimately means you've got super control of the company. So again, it's like, what are the government's governance frameworks? You know, if you control 75 % of the business, you are in control of the business and you can't change anything without your consent. The usual rule of thumb is 50 % plus is, you know, you've got majority controlled and majority wins in most circumstances.

19:48As soon as you then go below 50%, then, you know, you're not technically in control. Although, you know, there's lots of legal documentation in terms of the shareholders agreement where you can give you additional rights to sort of negotiate that. If you're getting value and insight out of the conversations we have with the founders and business leaders on Brand Growth Heroes podcast, then please like, follow, subscribe wherever you're watching or listening to the podcast, whether that's iTunes or Spotify or YouTube, or whether you're connecting with us on LinkedIn or Instagram. It really matters.

20:18It matters that you click that button. It matters that you comment. It matters that you engage. We love hearing from you. So write a comment, write a review on iTunes. Tell us if it's making a difference to you. Tell us if you like it. Thank you so much. So let's imagine you're at the kind of the one to three million and you're bringing on a team and you want to put 10 % or 12 % aside for employee options and shares. Is that usually the amount they would put by for? It sort of depends on the type of business and who you're thinking of bringing into the option pool. Normally, the range is probably at very early stage.

20:56So the one to three million, I would say 15 to 20 % is a pool size that you would want. If you've got investors who already invested, they will probably want to make it slightly smaller. And then the other sensitivity is who gets diluted by those options, right? So if you're doing it at the same time as around, quite often, and again, this gets quite technical, but investors will say, well, the valuation is X on a fully diluted basis. That means that the founding team is basically taking the dilution of the option pool. So you've got to be really careful about some of this stuff, you know, and ultimately, you've got to work out what's fair for you and your investors and also for the option holders in the future.

21:36Okay, can you spell that out a bit more clearly with numbers for people? Let's give it some numbers. You're raising a million off a 5 million valuation, right? And they say well that's on a fully diluted basis if 20 of your equity is in in options okay then essentially you're getting a proportion of the amount that you're raising is effectively diluting you as the as the shareholders the current founding shareholders so if we look at the numbers on that you're you're saying well of that round 20 so that's that's 200 grand is effectively being diluted out of the founding team rather than out of the investors.

22:16Okay, so the investors are saying we don't want our equity to be... Diluted by the options. So even if you haven't issued options, and again, this is a negotiation, because sometimes you say, well, you know, I know that I've got 10 % of that pool that's already been issued, but the other 10 % is for future employees. The negotiation there is, well, if we've already issued these options, then obviously that will be diluted because they are going to turn into shares. But the 10 % that hasn't been issued, well, ultimately that's benefiting all shareholders after the round. So we should all be diluted by that.

22:51You need the help and guidance and support to actually understand some of that complexity. Because if you didn't know that and then you tried to do it with AI, you wouldn't have prompted for that. Correct. You see. See, there's a live example, everybody, of why you need to know in order to be able to use it properly. OK, that's really interesting. What are the other stages? So you've got your employees are coming in and they are getting options that vest. Let's talk about milestones and cliffs and all of those things. Yeah. So what's great about UK investments is there's a great scheme for options, which is really tax efficient, called EMI, stands for Enterprise Management Incentive Scheme.

23:29It's approved by HMRC. You know, it's not totally straightforward. So there's a complexity around having to agree valuations and time periods. But essentially, it's super flexible. It's very tax efficient. It kind of means that when you grant those options, there's no tax implication on the employee or on the company. They are very flexible in terms of the scheme itself. So you can tailor vesting. So when they actually sort of technically are entitled to have those options, you can tailor when they actually exercise or when they actually can implement those options and become shareholders. and you can also build in performance milestones individually for certain employees in terms of their options so they're very flexible the great thing about them is that that they and because they're a government approved scheme hmrc authorized when people get to exercise their options so they have to pay for the pay for their shares usually you're able to agree a very low valuation for those options compared to the valuation of the company and also when you then come to pay for them usually you do that when there is a liquidity event so a significant funding round or a sale of the business and so therefore the employee basically doesn't need to pay for them they get paid for through what they would have received as a shareholder and then the balance they keep and and if they've held the shares for effectively over two or the options for over two years they get the benefit of what's called business asset disposal relief so their capital gains beneficial, business asset disposal relief brings it down to an 18 % capital gains tax rate, whereas the standard rate is 24.

25:06So, if you think about that compared to a bonus, a bonus, if you were a higher rate taxpayer, taxed at 45%, these options, which, you know, obviously there's a risk because the company may not get to an exit, but ultimately they're taxed at 18 % currently. Brilliant. That is a great explanation. Thank you so much. So, imagine then you're thinking about your senior management team, right? You're two co-founders, but then you've brought in someone quite early who is your commercial director or has made their way up to be commercial director and head of marketing. What are you giving them in terms of options and program to vest those options?