Further reading: http://www.businessinsider.com/the-startup-cooperative-2011-12
If you’ve been on more than one startup team, you may have experienced difficulties with the “ownership talk” — the founders of a startup decide who is entitled to what equity share. Although the talk sometimes goes smoothly, issues can arise when some founders solely contribute capital while others solely contribute sweat equity, or when founders come from different walks of life — for example, the mid-aged business pro teaming up with the fresh-out-of-college computer science major, or when one or some of the founders in a team are simultaneously working on another startup project or in a part-time job when other founders are devoting all their time. In these situations founders often agree to equally split equity, only later coming to view the situation as unfair, at which time redistributing the equity is a highly difficult and expensive, if not impossible, proposition. It isn’t until later into the start-up process when everyone’s actual contribution and the fair equity distribution structure becomes clear, but that point can come after the start-up is legally organized and equity has been distributed among the founders.
Sean Blanchfield, an entrepreneur living in Dublin, has proposed a new business organization based on the co-op model, which he calls the “startup cooperative”. Based on Blanchfield’s description, the idea appears to be largely based on an incubator/accelerator model, with one important distinction — when an entrepreneurial team comes to the startup co-op, they transfer total ownership (equity) to the co-op in exchange for membership in the co-op, and only once the team decides on the equity split does the co-op transfer ownership back to the team/company.
The major advantage to this model is that it allows entrepreneurial teams to put off the equity split discussion until the team has had a chance to work together and figure out whether they can work well together and see what kind of a contribution each team member is making so the team can have a more informed equity split discussion. In addition, the co-op can provide services already found in incubator/accelerator companies, such as seed capital, co-working space, free or discounted access to professional services (IT, accounting, legal services, etc.), mentorship, and introductions to angel investors and venture capital firms, not to mention the obvious networking opportunities among the startups in the program. And like an incubator or accelerator, in exchange for its services the co-op can retain a stake in the company, which it can ultimately cash in to help fund the co-op.
In addition to allowing entrepreneurial teams to have a trial run with each other, the start-up co-op can also be used by entrepreneurs in other useful ways:
– Someone with entrepreneurial spirit and in-demand skills, but without a business idea, can join the co-op and find a startup looking for team members
– Someone with multiple business ideas can bring them all to the co-op and assemble teams around each idea, having the option to leave with a team and idea once one takes off while being able to take a smaller stake in the other ideas if they take off as well
– A already-successful entrepreneur who simply doesn’t have the time to work on an idea can “lend” it to the co-op, allowing a team to form around the idea and accepting a small equity share in return
– If someone falls out with one team but still feels the entrepreneurial itch, they can more easily find another startup team to join
The idea, while exciting, poses a number of legal issues. The major issue is what form of business organization a startup co-op should take. The nature of the co-op can also limit the form of business organization a startup can take while under the co-op — for example, a startup will be unable to form as a partnership, since the co-op is the only initial owner — potentially forcing the founding team who is unhappy with the business form to effect a change once they leave the co-op. Moreover, organizing the co-op as a cooperative (where applicable), corporation, partnership, or LLC having ownership of a myriad of different forms of business organization can be unwieldy. However, it is clear that each startup has to be legally differentiated from the other so as to separate the assets and liabilities of each startup from the others. It is possible that a whole new form of business organization may be needed to efficiently operate a startup co-op, but getting all the states to adopt a new form of business organization is a process that may take years, if not decades.
There are a myriad of other issues relating to operations, governance, and taxation. For example, how much governing powers will co-op members (who are team members in the various startups) have? What is the most effective procedure for a startup when they want to leave the co-op? What happens if the co-op refuses to let a startup leave for one reason or another, or wishes to expel a disruptive startup team? Conflicts among team members, and between startups and the co-op will likely have to be settled by some established mediation/arbitration structure in order to avoid the possibility of the time, expense, and stress of litigation.
Furthermore, what are the tax consequences for a startup team transferring the business idea to the co-op, and then the co-op eventually transferring equity back to the team, or even the tax consequences for team members coming and going from the co-op itself? These issues will have to be settled with very careful tax planning, which may be made difficult in the coming years with proposed tax code changes affecting businesses.
Then there are issues that startups in the co-op may face within themselves and which may have to be accounted for by the co-op, such as the team simply being unable to come to consensus on the equity split, or startups preparing for angel or VC funding finding confusion and/or resistance from angels or VCs who may be unfamiliar with the co-op model. This may be a particular problem for the early adopters should a startup co-op ever come to fruition; however, angels and VCs are often quick to learn about developments in entrepreneurship, although it may not settle the complexities in equity structures and financials being part of the co-op may cause.
It is clear that if a startup co-op is ever to be formed, it must be created with extreme care and diligence and attention to the numerous legal and operational issues; moreover, the first startups who join must take a leap of faith that the model will actually work — if it fails, the first adopters may end up leaving their companies in legal limbo. However, the concept is an intriguing, exciting one, and I truly hope that eventually a group of entrepreneurs will attempt to make it work and be successful, or at the very least that a discussion starts among entrepreneurs and legal professionals as to the viability of a startup cooperative.
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All credit for this idea goes to Sean Blanchfield (@seanblanchfield), whose original blog post on this topic is republished at the link above.