Startups often begin with an idea, a few founders, and the hope of attracting investment. From the start, equity agreements play a crucial role in determining how ownership will be divided, how control will be managed, and how future conflicts might be handled.
At Boodell & Domanskis, LLC in Chicago, Illinois, we understand this process and how to help you.
An equity agreement isn’t just a contract—it’s a statement of each party’s contributions, rights, and expectations. Without clear terms in place, founders may face disputes that hinder growth or stall funding. Investors, in turn, may hesitate to contribute capital if ownership terms are ambiguous.
Setting Expectations Between Founders
Before engaging with investors, founders need to align among themselves. This alignment means more than just dividing shares. It involves agreeing on roles, responsibilities, and how those will be reflected in ownership.
Founders should discuss several points early:
How much equity each founder receives and why
Vesting schedules and what happens if a founder leaves
Intellectual property contributions
Decision-making authority and voting rights
These issues should be resolved in writing. Oral understandings can create confusion later, especially when external capital comes into play.
Vesting and Founder Commitments
Vesting schedules are a tool to encourage long-term commitment. Instead of receiving all their equity upfront, founders earn their shares over time or after meeting specific milestones. A standard vesting period is four years with a one-year cliff, meaning no equity is earned until after the first year.
This structure protects the company from the sudden departure of a founder who hasn't yet made a lasting contribution. It also gives remaining founders and investors greater confidence in the continuity of leadership.
Vesting terms should be explicitly stated in the equity agreement. This allows all parties to understand the terms under which equity is earned and retained.
Equity Splits With Early Employees
Founders may want to allocate a portion of the company’s equity to early hires. An employee stock option pool is typically created for this purpose.
Determining who qualifies for options, how much each employee receives, and how options vest are all decisions that need careful planning. These details should be aligned with company goals and reviewed before seeking external investment. A poorly structured option pool can dilute founder ownership or delay critical hires.
Equity agreements should clarify how the option pool impacts ownership percentages and voting power, particularly in advance of investment rounds.
Bringing Investors Into the Structure
When founders begin raising capital, investor equity must be defined in ways that are both fair and attractive. This process usually begins with a term sheet, which outlines basic investment terms. However, the equity agreement spells out the binding terms of ownership.
Investors often receive preferred stock, which carries rights not available to common stockholders. These rights might include liquidation preferences, anti-dilution protections, and special voting rights.
Each of these terms should be carefully drafted and negotiated. For example:
Liquidation preferences: Define how proceeds are distributed if the company is sold
Anti-dilution provisions: Adjust investor ownership if new shares are issued at a lower price
Board representation: Allow investors to appoint directors
Such provisions can significantly impact control and future fundraising efforts, so it’s important to tailor each equity agreement to the company’s needs and investor expectations.
Prioritizing Simplicity and Scalability
Early-stage companies benefit from equity agreements that are both thorough and scalable. Overly complicated structures can deter future investors or make later changes costly.
A clear cap table, consistent equity terms, and flexible provisions help companies adapt as they grow. While it might be tempting to customize every aspect, standard terms—when reasonable—can simplify negotiations and support long-term development.
Founders should also review how each agreement affects potential exits, such as acquisitions or public offerings. Equity structures that are too rigid may create roadblocks later on.
Addressing Tax and Regulatory Considerations
Equity agreements carry tax consequences for founders, employees, and investors. For example, issuing restricted stock to founders often triggers the need for a Section 83(b) election with the IRS.
This election, made within 30 days of the stock grant, allows founders to pay taxes upfront, based on the current value, rather than vesting when the value might be much higher.
Failing to file an 83(b) election can result in a significant tax burden. Similarly, options granted to employees must be priced correctly under IRS rules to avoid penalties.
Illinois startups also need to be aware of state-specific filing and reporting requirements. Corporate formalities, including keeping proper records of stock issuance, are necessary to maintain compliance.
All these elements—tax treatment, securities law, and corporate governance—must be integrated into equity agreements. Early legal guidance can prevent mistakes that are hard to correct down the line.
Planning for Future Funding Rounds
Founders should structure initial equity agreements with later financing in mind. As new rounds are raised, earlier agreements need to accommodate incoming investors without starting from scratch.
Pro-rata rights, for instance, give existing investors the ability to maintain their ownership percentage in future rounds. Drag-along rights compel minority shareholders to agree to a sale under defined conditions, helping founders pursue exit opportunities with fewer obstacles.
These clauses are useful when included from the beginning. Retroactive negotiation is rarely effective and may lead to disputes or lost deals.
Avoiding Common Pitfalls
Even well-meaning founders can make mistakes when structuring equity. Some of the most common include:
Allocating too much equity too early
Ignoring vesting schedules
Overlooking tax consequences
Failing to document contributions clearly
Using informal agreements or templates without legal review
Each misstep can affect a company’s ability to raise funds or retain ownership. Equity agreements should be seen as living documents, reviewed regularly as the company evolves.
Maintaining Clarity With Documentation
Thorough documentation is critical. Every equity issuance, whether to founders, employees, or investors, should be tracked in the company’s capitalization table. Supporting documents—including stock purchase agreements, board resolutions, and IRS filings—should be kept up to date and stored securely.
For Illinois-based startups, compliance with local corporate law is especially important. Whether formed as a C corporation or an LLC, each entity type has distinct rules for ownership and control. Equity agreements should reflect the company’s structure and conform to both state and federal laws.
Failure to document ownership properly can lead to costly litigation or loss of investor confidence. It's not enough to reach an agreement—proof and process matter just as much.
Revisiting Agreements Over Time
As companies scale, equity terms should be reviewed and revised when necessary. New hires, changing market conditions, and updated business models often call for adjustments. A flexible but well-organized approach allows startups to grow without becoming overburdened by outdated agreements.
Founders and investors benefit from periodic reviews of equity terms, especially when preparing for significant changes like acquisitions or fundraising events.
Clear communication and documented updates help maintain trust and alignment among stakeholders.
Structuring equity agreements is one of the most important steps in building a startup. Whether working with co-founders, bringing in key hires, or raising capital, these agreements define the economic and control relationships that will carry the company forward.
While there’s no single formula, companies that take the time to plan, document, and periodically revisit their equity agreements tend to avoid avoidable disputes and attract better investment opportunities. For Illinois founders, working with legal counsel who understands the state’s corporate rules adds another layer of clarity and protection.
Call Boodell & Domanskis, LLC Today
Equity agreements aren't just paperwork—they’re the foundation of the company’s ownership structure and long-term strategy. When treated with care, they support growth, protect contributors, and build trust from day one. For more information, contact our attorneys in Chicago, Illinois, today.
