Knowledge Base: Safely issuing shares to co-founder

Before allocating equity, it's crucial to define who is receiving the equity.

We will deep dive into allocating equity to co-founders

1. Adding co-founders to the platform
2. Issuing shares to co-founders
   • Issue Options
   • Issue Shares
3. Timing of share issuance
   • Scenario 1: Before a funding round
   • Scenario 2: Part of a funding round
4. Further considerations

Adding co-founders to the platform

In startups, ‘founders’ are typically statutory directors and on the FounderCatalyst platform, a “Founder” is required to be a statutory director (more on platform roles here). This means that while you might have three founders in title, only two may officially be directors on Companies House. The third founder should be listed as a “Shareholder” on the platform.

To ensure proper legal protections for all involved, the non-director founder should:

• Sign an IP assignment (the same IP assignment directors sign)
• Sign an employment or advisor contract (both can be found in our Free Stuff). The Founder Service Agreement is not appropriate as it reflects the 'Director' consideration, and includes clauses related to directorial responsibilities, board authority, and resignation from office.

Issuing shares to co-founders

Startups often incorporate with multiple founders who receive subscriber shares; for example, two co-founders each owning 50% of the business. As the business grows, the founder(s) may wish to bring on another co-founder, such as a CTO. However, allocating shares to a new co-founder without legal safeguards presents a risk to existing shareholders.

Imagine this scenario: the founders collaborate with a CTO on a contractor basis for six months, build trust, agree to bring them on full-time, and decide on a 10% shareholding. The shares are issued, but two months later, the CTO leaves after a disagreement. In such a case, the business has no mechanism to reclaim the shares.

To mitigate this risk, founders have a number of methods to allocate equity.

Methods of Allocating Equity

1. Issue Options

A share option gives the recipient the right, but not the obligation, to purchase company shares at a pre-set price (known as the "exercise" or "strike” price) after a certain period and/or when specific conditions are met. The options only convert to equity (shares) when these milestones or conditions have been fulfilled, as agreed in the option agreement.

For a co-founder, an EMI option scheme may be suitable, as your co-founder should qualify as a director or PAYE employee (see more information on EMI options here).

However, it is unusual to grant options to co-founders since they generally expect to be treated as equal peers to the other co-founders. Additionally, option schemes come with extra costs, making them an expensive method of awarding equity. You can find more details about option schemes here: FounderCatalyst Share Options.

2. Issue Shares

A key decision is whether the co-founder will purchase their shares or receive them for free. If they buy the shares, it can inject some working capital into the business. Alternatively, they could purchase the shares at nominal value which wouldn’t necessarily inject much capital for the business but could make the co-founders shares eligible for SEIS meaning they could pay no capital gains tax on an exit. This would require the co-founder to own less than 30% of the company. More on SEIS below.

You should avoid issuing shares after a funding round, as this will dilute existing investors and shareholders. So, if you want your co-founder to receive X% after year 1, X% after year 2, and so on, you need to be very careful. The three options below (2.1, 2.2, 2.3) address this issue in different ways.

2.1. Standard reverse vesting

This is the most straightforward method. The co-founder gets all the shares upfront and if they leave they are subject to the ‘standard’ leavers provisions in the FounderCatalyst Articles of Association.

Reverse vesting is an obligation on founders and employee shareholders to either resell a part or all of their shares to the other shareholders in the event of them leaving the company, and/or to convert them into worthless ‘deferred’ shares (which addresses any tax issues). More on reverse vesting and leavers provisions here.

2.2. Customised reverse vesting

If the standard vesting provisions do not suit your needs, you can create a specific, customised vesting schedule for the co-founder.

A lawyer will be required to draft the customised vesting schedule, which will be included in the Shareholders’ Agreement and override the vesting provisions in the Articles of Association.

You will need to raise a support ticket for us to be able to make these changes.

2.3. Create an unallocated option pool

Another approach is to create an unallocated option pool to account for the future shareholding percentage. For example, if you agree that the co-founder will receive 2% now and 2% annually for the next four years, you can create an unallocated option pool for the full 10% to reflect their future shareholding.

When they reach a milestone (such as a year-end), you can reduce the option pool and allocate the shares. Note that this does not mean issuing options from the pool—it simply ensures that the cap table calculations (dilution) work pre-funding round. You will also need to disclose this arrangement to investors (who otherwise won’t know what the option pool is allocated for). More on disclosures can be found here.

One significant challenge with this approach is tax implications. If future shares (e.g. those issued in year four) are not issued at their unrestricted market value, your co-founder will need to pay income tax and the company NICs on the difference between what was paid and the UMV. For instance, if the company is valued at £4m now and £40m in four years, the co-founder will need to pay a substantial amount for those shares; otherwise, they will face a heavy tax charge. Ultimately, they should seek independent tax advice.

Timing of share issuance

The timing of issuing shares to a co-founder is extremely important. Below we’ve split out two scenarios:

Scenario 1: Co-founder before a funding round

Firstly, you’ll need a board meeting and the Board Minutes to document that the board approves the issuing of new shares. You also need a Shareholders Resolution where existing shareholders authorise the company to issue new shares. It will generally need to be signed by at least 75% (by number of shares held) of voting shareholders. These are required any time you want to issue shares.

The next step is to download the IP Assignment, Founder Service Agreement, and Articles from the platform and get the founder to sign these. These become accessible as soon as the funding round service is paid for, even if the funding round hasn’t yet closed.

If the founder was to leave, the business is protected by the leavers provisions in the articles. You can see more on reverse vesting provisions here.

The IP Assignment and Founder Service Agreement are important because the articles do not provide full protection such as restrictive covenants which are detailed in the Shareholder Agreement that the co-founder has not signed.

Note: If you want your co-founder to have SEIS shares they need to pay something. You could apply a 99.9% or whatever discount that means they are paying at least nominal value.

See the process to follow below;

Scenario 2: Co-founder as part of funding round

As above, you will need a board meeting (minutes) and shareholder resolution.

In this scenario, timing is extremely important. You don’t want to issue shares after a funding round as it will dilute your new investors – not a good start! This means you will need to issue the shares before the funding round, but as we’ve highlighted, there are risks in doing that…so how do you do it?

You add the co-founder to the platform in the People section and add them to the cap table - this ensures they will be diluted and the cap table maths will be correct. You then add your investors to the funding round and close the round. As part of the process, the platform will require the founders to sign the relevant documentation (IP assignment, Founder Service Agreement, Articles of Association, Subscription & Shareholder Agreement). This means the existing shareholders are protected by the leaver provisions in the articles and provisions in the shareholders agreement.

You then file the SH01, backdated to show that the shares were allotted the day before the funding round closed. This approach ensures that, in the unfortunate event the co-founder does not sign the documents, they do not yet own the shares since the SH01 has not been filed.

Note: If you want your co-founder to have SEIS shares they need to pay something. You could apply a 99.9% or whatever discount that means they are paying at least nominal value.

Further considerations

1. Share classes: You should give your co-founder ordinary shares. Ordinary shares are the only default share class in existence. If you wish to create a new share class in your paperwork, you can do so at the bottom of this page

In most cases different share classes is overcomplicating your structure - see here

2. SEIS shares: If eligible (e.g., with less than 30% shareholding), a co-founder will likely prefer SEIS-compatible shares. These shares are exempt from Capital Gains Tax (CGT) after three years, potentially resulting in significant savings—possibly millions—following a successful business exit. As a result, it is advantageous for the founder to purchase the shares rather than simply being issued them and the purchase can be made at a large discount.