Have you ever diluted someone?

A couple comments.

Entity:

If you're seeking external capital, make them corporations, not LLCs. Any sophisticated investor (I'm talking mindset, not raw wealth) prefers a corporation where you get shares as opposed to an LLC where you're a member.

This is even more imperative if you anticipate changing the ownership structure at all in the future. For instance, right now you're considering diluting a current member based on his lack of involvement, adding a new member based on the value she brings to the table, and other commenters have accurately pointed out the value of adding an option pool.

Any of those items are an absolute mess with an LLC. It can be easy at the state, but it gets complicated the further into the business you get. A corporation lets you set different rights for different share classes (e.g. founders vs. investors, one founder vs. another founder, founders vs. hired employees, etc.), raise external financing painlessly and with good hygiene, and sell the business without any hiccups.

Buying an LLC is always a headache. Always. Note that many, many private investment funds [e.g. VC funds] have clauses in their sub docs or LPAs that state they will only be investing in corporations, not LLCs or trusts or other entity types. You never know who you're meeting, and as you say, when you have someone ready to wire on the spot, you want to put your best foot forward. If you have the option to pick an entity type that doesn't rule out any investor from participating, why wouldn't you?

Dilution:

In one business I started outside my day job (my idea, my initial capital, my labor for the first few months [primarily meetings and document generation], some 1099 hires, and eventually a set of simultaneous W2 hires for both management and employees), I added someone as the second-largest equity position after me with an explicit conversation around what he was supposed to execute on: (i) a defined number of introductions within a specific set of criteria, and (ii) the oversight of those relationships as the business staff executed a process with those relationships. Basically, intros and then account management.

He failed at both. An inconsistent volume of intros (instead of two a week for an average of eight a month, six a month where it would be none for 20 days, four all within one week, and two at the beginning of the following week; a very lumpy and unmanageable method that put a real burden on the employees executing the work), and haphazard management once they were in the door (over-promising, poor internal communication).

We had a candid conversation. It didn't improve the month after the talk. I diluted him by 50% (which was a predetermined amount from our initial conversation before I brought him in). That new lower ownership was supposed to reflect the value of the relationships alone (which I was happy to compensate him for, since the business wouldn't have had them without him).

He continued to under-perform. In that candid conversation where I told him I planned to rectify things if there wasn't any performance improvement within a month, we agreed that if we did pursue that route, we would also reset the expectation on his involvement.

Unfortunately he loved the title and the feeling of people reporting to him, so while he righted the ship in terms of the volume of intros he made (four a month, one regularly each week), he kept up his goofball management shenanigans.

I diluted him an additional 80% from his revised position. This took him to 10% of his original position. He did not take it well. I pointed out that his position was higher than the top-of-market for a very strong, qualified BD executive who sourced business and managed his own accounts. I felt he was more than fairly compensated given that his involved actually had a deleterious effect overall. Yes, we had his intros, but we had a ineffective internal process that affected accounts globally: people couldn't manage process for his intros or non-him intros because of how his nonsense disrupted things.

He swallowed it and retains an ownership stake in a healthy business that has continued to grow almost 100% year-over-year in which he never had to invest capital, only time and some connections. I did create a new share class for him that is equal in all economic elements (liquidation preference, pro rata rights in case of any future investment, etc.) but different on control elements (no board participation or observation, no notification rights, automatic ride-along with dominant share class on any votes, etc.).

Actually, to close the loop, it's worth noting that just about none of what I just shared would have been easily accomplished (maybe not even possible) if that business were an LLC.

Percentage:

There's no set amount to give to a lawyer. You have to figure out the valuation you're ascribing to the business and how much of that value you ascribe to her involvement.

Illustratively, without investment or any revenue but with some promising leads you have already identified, maybe you think the business is worth $1m. So you create a corporation with 1,000,000 shares that have a par value of $1 each.

You think her involvement is worth $50,000 of value. Or maybe $200,000 of value. Whatever value you place on not having to lose time in critical moments by leveraging external counsel (who you have to notify, set time with, discuss, and wait for them to execute) and lose money by paying said counsel. That determines what share count you should grant her.

You can also accomplish this by giving her a slice of the option pool. You do the same math as above, but with 850,000 shares and 150,000 shares permitted for issuance via a board resolution but not yet issued. Thus you have 1,000,000 total shares if issued, so you can then grant her as much of that 15% option pool as you want. Until she exercises them or they vest (however you drew up your documents), she doesn't actually have shares.

I get that it's a touchy topic (as you mentioned). What I recommend is that you give people less than your natural inclination may be, because you can always top them up later much more easily, happily, and painlessly than diluting them down from a current position.

I know a guy that did this. He gave everyone middle-of-the-road equity stakes for a Silicon Valley startup. He went through a seed, Series A, Series B, and was deciding whether to take a Series C.

For those who don't know, if you take a financing round, the implicit expectation from the investors is that you're going to keep running the business until an exit of at least 2x on money is available. So if you're looking at a $400m valuation, that means you're signing up to stick around for a roughly $800m exit.

He felt that would be three more years, and he was tired. He found a $350m exit (3x for his Series B investors, relevant to my point above), and he did two great things for his employees.

• He accelerated everyone's vesting schedules (meaning people who were only 30 months into a 48-month schedule received their full equity allotment as if 48 months had already passed)
• He diluted himself by 10% (of his position) and issued new shares in equal amounts to every single employee (this helped smooth the disparity between early employees and later employees; an early engineer may get options as high as 1.5%, while someone joining two years later may get only 0.25%)

This means every single employee of his got at minimum a high six-figure payout, and his early guys (the ones who took the most risk with the company) all got well into the seven-figure range.

My point is that if you're a good person, the tendency is to want to be nice to people the way you wish people would be nice, courteous, rational, and respectful in the way they treat you. Realize that not everyone is like that. Realize that it's also a lot easier to preserve your optionality where you can make sure someone else gets paid more (because you always intend to do that) for later rather than committing up-front to a thing that may not work.

I have seen a lot of young companies. People change. People get in relationships and have to move or discover a different risk appetite in their life. People decide to go back to school. People find a newer, hotter thing to join. People find an idea of their own to run with. Be conservative with your equity.

Good luck.