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We split the company on a handshake and never issued stock. What now?

Co-foundersEquityFormationCompliance

Three people agree before incorporating to split the company 40, 40 and 20, write it in a one-page founders' agreement or an email, form the corporation, and never issue any shares. The agreement may be enforceable as to the percentages, and it still leaves the company with no stockholders, no vesting, no intellectual property assignments and no answer to what happens when one of the three leaves. The fix is to do now what should have been done at formation: a board consent approving the issuance, a restricted stock purchase agreement for each founder with a vesting schedule, payment for the shares, an invention assignment from each founder, and an 83(b) election within 30 days of the issuance. The only question is the price.

Why the delay costs money

At formation the stock is worth its par value and the founders buy it for a few hundred dollars. A year later, with a product, customers or a SAFE round, the common stock has a value, and a founder who receives it for less pays income tax on the difference. If the company is still worth very little, the board can find the fair market value is still nominal and issue at that. If it has raised money, a 409A appraisal sets the value and the founders either pay it or take the tax hit, and both are worse than the $400 it would have cost on day one. Every month of waiting also moves back the start of the one-year holding period for long-term capital gains and the five-year period for QSBS.

The founder who left in the meantime

This is the case that becomes a dispute. If one of the three has drifted off, they hold a claim to their 20 percent under the handshake and nothing obliges them to accept vesting now. The others' options are to negotiate: a smaller, fully vested stake in exchange for a signed agreement and an IP assignment, or a payment for a release. What they cannot do is issue the shares to the remaining two and pretend the third never existed, because the third will surface during diligence with the email. Settle it before an investor finds it, when the company is worth less and the settlement is cheaper.

The intellectual property

A handshake split says nothing about who owns the code, the designs or the name, so each founder still personally owns whatever they made before the company existed and whatever they made since without an assignment. The invention assignment signed with the stock is what moves it to the company. A founder who has left and never signed one owns their contribution, and that is the second thing an investor's lawyer will find.

Investors will not close on a company whose founders own it by agreement rather than by shares, whose stock is unvested, or whose IP sits with individuals. The cleanup is the same set of documents as a formation, done late.

Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.