Joel Spolsky's Totally Fair Method to Divide Up The Ownership of Any Startup.
answers.onstartups.com
answers.onstartups.com
Let's say a programmer who could make $120,000 a year joins the startup at a $70,000 salary. The next year it gets bumped up to $85,000, and then the year after $95,000.
After three years that programmer has now forgone $110,000 in income. If the company sells the programmer has to earn at least that much back (and we're ignoring lost opportunities from not having the money). So the company has to sell for $5.5 million dollars.
And of course, the programmer may have worked way more hours than she would have at that $120,000 hour job. Let's assume she average 50 hours a week. In any sane world she would earn 25% more for that amount of work. So if we value her time based on her possible $120k salary, the sale needs to deliver $200,000 to her to be worthwhile.
Now we're looking at a $10 million dollar sale.
Oh, and that's assuming that the company doesn't have investors with preferred shares who will take a 3x return. So maybe the sale really needs to be $15 million just to get that $200,000 back. And of course many sales are not all in cash, so maybe she just gets stock in some other company, and that stock may not even be liquid.
All of this assumes that there is an exit as opposed to a bankruptcy.
She's gambling on an amazing exit (not necessarily Google, but something like VMWare buying Zimbra for $100 million. That happens, but it's pretty damn rare.
All of this is compounded by the fact that for the founders, a smallish ($5-20 million exit) is entirely worthwhile. They walk away with a few million dollars each.
Early startup employees get completely and utterly screwed. I'd never consider being one of these employees again unless I was offered a lot more than 2%. I think a fairer number might %10. But really, if you're willing to take that much risk, you might as well just be a founder. That's where the real rewards are.
But it's not about getting "utterly screwed". It's about making a rational decision that some things in life are worth more than financial reward.
Working at a startup has a multitude of non-financial benefits. You'll work with the latest new technologies. You'll play a key role in a small team. You'll be forced to learn all kinds of new skills. You'll meet lots of people. You'll acquire a sense of ownership and confidence that you may never feel when working in a large corp.
If you've got a family to raise and you're worried about your retirement savings, by all means, follow the math and don't expose yourself to the near-certain financial ruin of a startup.
But if you're young, adventurous, or simply value interesting work over a high salary, it can be a lot of fun to get utterly screwed with your measly 2%. I enjoyed my last shot.
Suggesting that startups are inherently interesting misses the fact that a great many of them are rehashes of previous successful startups, which makes one startup feel just like that other startup you just left.
The sense of ownership is also highly variable. It depends on how much of a control freak the technical founder is.
Personally, I choose startups because of the high tolerance most startups have for individuality. I work from home in the mornings, have a standing desk at work and take walks in the middle of the day without anybody freaking out.
Thus, my risk is much lower than a founder's.
Your expected opportunity cost in the case of failure is smaller--like you say, you draw salary as soon as you start (though the salary is often less than market rate). I will point out that employees are usually less well-informed than founders about a company tanking, so will usually have a couple of months lag in looking for another job, and that "I was employee 3 at Vunge Games" doesn't sound nearly as good as "I founded Vunge Games" when you're at interviews.
Your expected payoff in the case of success is probably at least an order of magnitude smaller, and from anecdotal evidence seems to not be much more than it takes to make up the market wage shortfall over the course of your employment.
This isn't intended to be pedantry--I figure that all of them (but especially the expected opportunity cost) are likely to vary based on region and are worth noting as hidden costs. But from my perspective, being an early employee at a start-up is a bit of a mug's game when the alternative is bootstrapped founding from corporate employment.
Except that early Google employees all had stock worth over a million dollars. Same with all early Sun employees, all early eBay employees, all early Amazon employees, all early Yahoo employees (basically anyone with an employee # < 100 was in darn good shape at all of these companies.
The generalization that all employees get screwed, is based on your experience. and I understand that pain, my first startup I was employee #9 and my stock at the time it was acquired [1] was worthless. But it is just that, a generalization. And it is perfectly reasonable to say "My threshold for risk is lower than the risk of working at a startup." And by telling a startup you won't work for less than 10% equity or even going in with that thought is one way of saying that.
I interviewed a guy for the second startup I did, FreeGate, who told me basically he had 'done his homework' and he needed 4 million (about 5% of the outstanding at the time) shares and a competitive salary (which during the boom was insane) and while I loved his skills I wasn't comfortable risking that much equity on this guy who might or might not work out. So we passed. He eventually went to work for Oracle because no startup he talked to would (or perhaps even could) hire him based on his risk tolerance.
In that case I think the market did the right thing, he didn't work at a startup. Now had he come to work for me at the 'standard' offer during that period, he would have done OK, better than 4 years of Oracle salary + their option, but not the multiple millions he was dreaming about. I always recommend that people who absolutely have to be employed for the next 'n' years, avoid start-ups. Too much existence stress.
That being said, I like Joel's approach. The only wrench I see in it is that there often comes a time when you need 'that guy' (or 'that gal') who will take the company to the next level. Could be a VP of sales, or a Manufacturing, or some other part of the company that it needs to do, but nobody in the company is experienced or ready to take the company to the scale it needs. That is a person who comes late but you end up doling out lots of equity to. The return is that everyone's equity value will go way up. Sometimes this person is the difference between continued climb and spiraling death. So in that regard their 'impact' is as much as a founder who got the company to this point.
When that situation comes up, it's always got its own wrinkles to deal with, but generally it comes up because you are doing well, not you're shopping yourself around to try to exit with a positive spin.
The only times I've taken paycuts to do a startup was as a founder, in situations where I've had 20%-25% of the company or more.
If you let people talk you into taking a lower salary to work for a startup without getting a reasonably large chunk of equity, I agree with you, it doesn't make that much sense - at least not unless it's a calculated gamble for a huge exit rather than a startup where the founders are talking about a relatively low priced sale.
But most of the time, if the company has a solid idea and really need you, taking a big paycut isn't necessary. If a startup is going to be sunk by a few tens of k of difference in salary costs, then I wouldn't join it. I might get talked into deferring some of my salary (at a price) until after an A round, but that's it.
You get what you ask for, pretty much. And I always ask. If you take the first offer on the table, then you'll be paid accordingly.
1. If I'm a startup founder, I want to recruit smart employees. Smart employees will do the math you describe above, and they'll know if I'm offering a raw deal. So, in order to attract smart employees, I'll have to offer a fair balance of equity and cash. If I fail to do that, I won't be able to fill my job openings. Or, I'll fill them with people who are irrational or bad at basic math, neither of which would help my company succeed.
2. If I'm an employee, I'll be weighing more job offers than just the startup's. I'll have high-paying jobs at established organizations available to me. If you're offering $70,000 at 80 hours a week, and MegaCorp is offering $120,000 at 40 hours a week, you need to offer something to make up for that enormous difference. If that something is equity, it needs to be a decent amount of it, and you need to convince me of its future value. If you fail to do that, I'll go work for MegaCorp.
Granted, there are plenty of people who won't reason this out. Employees sometimes accept a bad deal without realizing it. But as a business owner, I want employees who are capable of making smart business decisions, even if they're not in an executive position. I'd much rather pay fairly than build a company entirely from the subset of people that I can scam.
Of course money isn't everything, and the real reward in joining a startup early is to have a huge impact on the company, and potentially the world.
Having said that, there are other not-so-visible benefits that can swing both ways:
1) A moderate exit but with lots of buzz in hi-tech community can push your portfolio a little bit.
- "Designed and implemented Path" - "Architected Justin.TV chat component"
Of course if the said company had scaling issues, your name will be associated with it as well. But if your marketing department can twist the words, luck might be on your side.
Once you're done with this company, start reaping the benefit of higher compensation.
2) Skill improvement.
Assuming your bet paid off, using cutting-edge technology can put yourself in the fore-front of consulting game as well.
The early Rails adopters are reaping the benefit of this since a few years ago. Sought after and probably making good money as a consultant if needed.
I have little doubt MongoDB-ers (or the NoSQL-ers) and Node.js-ers are off by much.
After seeing what's going out in the hi-tech community, I believe it is no longer about the "right tools for the right job" for some people. The "changing-tools-and-languages" have become the "game" for some of the developers.
At the end of the day, it depends on how the person handle the situation and flip it to his/her benefits.
I don't mean to sound like a snake oil salesman but it's what you make out of it.
I think there's some after the fact reasoning here: Of course, if you look only at the startups that make it far enough to hire those first employees then risk/reward is much better for founders. But then you have discarded from your sample set all the startups that fail before getting access to the cash needed to hire (revenue or investment). At least where I'm coming from that's the more common case by far, and in that case founders get utterly, royally screwed.
If those tiny differences would make and break the company, it's underfunded and I won't have anything to do with it, or it's too early for them to start hiring and they should offer substantially more equity and involve me as a co-founder.
Except in the insane world of salaried corporate jobs, where overtime doesn't apply.
Another way to look at it. If you get paid $100k per year for 40 hours a week, you might consider taking a job at 32 hours a week for $80k.
And if you see someone who’s doing that and becomes indispensable to the company, I’m a big fan of giving them a lot of stock and treating them like a late co-founder.
Not everything is just a cash value.
False dichotomy. There are plenty of smaller non-startup companies that pay well and offer everything else you mention without asking you to gamble your salary on a big payday.
For example a new employee comes on board. You explain, “We use the Joel method for allocating and vesting equity.” Oh! Great! That’s fair...
(Well, after the acquisition, we did get stock options... Lucent stock options... which, like the Kursk, went underwater and never resurfaced.)
Go ahead and negotiate equity with the goal of maximizing your absolute monetary return. If fighting over $100k in equity costs you $200k of lost opportunities, you are not winning.
It just works, and by it's very nature is fair, everyones happy.
You have your employees bid on either getting paid or taking equity every month?
Also, it's founders, never employees. Employees get cash+bonus, never equity.
We total up the cash available and our runway, say $60k for 2 founders and 12 months. Total equity is of course 100%.
So at one extreme, one founder gets $60K over the year in wages and 0% equity while the other gets 100% equity and no wage packet. At the other end, its $30K each for 50% equity each. Somewhere inbetween is a sweet spot.
The core concept is get the cash now, or potentially more later.
Start with the equal split, then begin negotiating for the value per equity point. Eventually you'll reach a point where you both agree on equity/wage split.
The added bonus is you've also technically valued your startup in the process (value per equity point*100) and have an indication of how much your relative belief in the success of the startup.
Since I tend to keep my expenses down and as an example of the last one I took 55% equity for a $7k drop in monthly cash. Cofounder gets a 7K bonus over the year (he was starting a family at the time) and was happy with his 45%.
Voting rights are equal. Always. Do not fuck with these in the startup phase as they give a sense of ownership and control that founders need to commit.
It's creative and win/win generally for the team. I've yet to have anyone be upset at this. I encourage those considering it to take a closer look.
Because I don't always agree with Joel on this. By the way, the recommended way to use this calculator is that each co-founder tries it separately. Then compare notes.
The calculator gave a multiple percentage point bump to the founder with the idea.
So, grain of salt.
There may be ideas worth an equity bump, but I think Spolsky is dead-on about the common case: the idea doesn't mean anything. Sure, you can take your idea and work it with another team --- but your prospective team can take their ability to execute and work it on another idea.
Moreover, in many many companies, the key idea that enables the business comes long after the team starts on the first idea; maybe it's a pivot, maybe it's a refinement, but either way, the core intellectual kernel that "makes" the business isn't predictable. When it comes, most teams don't suddenly grant the person who generated it another 3% of the company.
It's destructive to suggest that, in the common case, an idea is worth multiple percentage points. Just zero that line out in your calculator. You can't calculate the uncommon cases, so what's useful is a shared understanding of what "usual" is.
Personally --- again, this is just me --- if you all start at the same time, and you all quit your jobs, and you all get the same kind of income (steady salary, quarterly distro, nothing, &c), you split the thing up evenly. Not even worth discussing. 33/33/33 and vest.
So, how do you separate your stripes?
In his example, employee #4 gets 250 shares, while employee #5 gets 50. But in reality, you won't hire the 4 employees at the exact same time, and the next 20 a year later. It will be spread out over time.
I'm sure it's possible to think up a more continuous function for spreading the shares with a similar approach. (but I'm wondering if that's not what already happens somewhat naturally with offer negotiations…)
As usual, Joel proposes you use some common sense, instead of trying to come up with some perfect function. The important thing isn't if employee 4 was hired on Dec 31st and Employee 5 was hired on Jan 1st. If Employee 4 was working in your living room and working off his own laptop, and Employee 5 joins when you have a tiny office, provide him with a computer, have comprehensive health insurance, they're in different bands.
What I'm saying is that it sounds very nice and fair to engineer-type people. But it also sounds like it only works after the fact.
And again, I understand it's not really to be read as a strict formula, but more as something to give you a gross idea of what you're trying to accomplish. But in that case, it's not much different to what's already happening naturally: founders and employees know that the equity offered should reflect how early they arrive in the mix and what they bring to the table. I'm sure you can go in many startups and find the stripes that naturally formed and get something close to that "formula".
(And for those of you who think I am mad, my company is great in that it's fun, the work is extremely challenging yet exciting, and the vision aligns with my own personal vision. It's my dream job.)
1. It's not always about the salary for employees. Some people just don't have the DNA to work at the type of company who gives the 120k salary ( assuming large-co ). They like small companies, being empowered, and all of the other benefits of being part of a team building something. They expect to get 70k and not recoup the difference because they consciously "buy" the lifestyle with the difference in pay. They are driven by the passion of the founder and want to be involved in building "something big". They can't miss the chance to get this experience that would take years in a big company.
This type of employee sees equity in two parts: First as an emotional connection that they're working on something they "own" and second as the dream of a potential payout that gives them the vision / hope of a great future. Both are important emotional motivators that enable the team to gather round a vision and kick-ass nights and weekends to make something valuable.
A startup employee who says, "4%, so you need to sell at 15m or i'm out of here…" is the same person who says they should pay less for electricity because they didn't use as many lights as you. That employee shouldn't be choosing to work at startup A because they offered offered 5k more salary and 1% more equity than startup B. Which one are they passionate about? Where do they want to spend their life for the next few years? The equity is just gambling.
2. Not all founders will share the risk equally even if they all work full-time, quit their jobs, etc.
Scenario A: Founder A is a serial entrepreneur with a few M in the bank while Founder B is an engineer who needs a paycheck. Does Founder A give B 50% or does he just pay him for his work as employee #1?
Scenario B: Founder A doesn't take salary from the company but has a consulting gig that pays 10k/month and takes ~4/hrs a week. Founder B is wealthy and doesn't take salary but doesn't need to spend 4-8 hours a week doing "other obligations" and says Founder A isn't dedicated.
Things get more complex once people become serial entrepreneurs.
I would think that dividing things equally really only makes sense for pretty lean startups.
I'm not sure I really see the point in obsessing over how "fair" the deal you're getting is -- it's not like there's a basket of equivalent startups you're deciding between. Ultimately, your opinion of the EV of the particular business seems likely to trump obsessing over a few hundred basis points of ownership. (At least that's how I justify to myself not being an "equal" partner)
This point, which I fully agree, seems to generate a lot of comments. When he landed on Gibraltar in 71, Tariq ibn Ziyad (http://en.wikipedia.org/wiki/Tariq_ibn_Ziyad) immediately burned his ships and gave a speech to his men starting with: "Oh my warriors, whither would you flee? Behind you is the sea, before you, the enemy. You have left now only the hope of your courage and your constancy." The point is, if you don't have this sort of desperate courage, most probably your startup won't succeed. And you cannot do that while holding on to your day job and salary.
I take issue with these kind of quotes because, to be quite frank, they are completely out of context and make no sense in the myriad of ways people try to make them apply to unrelated contexts. It sounds like nothing more than marketing hype, as opposed to a message of substance.
The point isn't that only full-timers can be founders, but rather that all founders should share a roughly equal level of commitment. If some of the founders are full-time, and some are part-time, then you've got a really severe imbalance in terms of contributions to the company, not to mention risk.
This will cause huge bitterness later on, so it's totally reasonable to say "We're all going in full-time, so if you want to be a founder, you are too. If not, that's fine, and we'll make you hire number one when we can afford to pay you a salary, plus back-pay for hours worked as an IOU."
The quote is, of course, over the top, after all we're not fighting for our lives in a foreign land. But I don't think it's that out of context: I'm 42, have a child, pay a high rent and support my larger family. For me to quit my daily high-paying job to pursue what mat turn out to be a dream does require a huge amount of courage. If the company doesn't succeed, say, after 2-3 years, I may not be able to find another job like this. That's why quotes like that resonate with me.
Please understand that not all would-be founders are 25 year-olds with little to lose.
Personally, I believe that having a day job while working on a startup should not be held against you. If everyone agrees that you're a co-founder, then you deserve co-founder equity.
Do you have less work to do because you have a day job? No, not necessarily. Were you there from the beginning? Yes. Are you involved in founder-like meetings and decisions? If yes, that should be qualification enough.
It was scary, but we did specifically did not burn our bridges. We kept in touch with all the people we could so that if we needed to have some bridge funding via consulting work, it was always on the table for us.
The strongest counter-argument I can make for saying "You need to be doing X,Y,Z to succeed" is that the failure rate for startups is over 90%, so no-one knows what really works or doesn't. There's a combination of execution, luck, and recognizing good timing that comes into play. I've seen companies/individuals hit it big with the most laid back attitude toward the product because they found the right thing at the right time (PlentyOfFish), and people who work insanely hard who just disappear (the list is huge here...).
Yeah, remember those guys who had that computer fruit company. Pear was it? Or Apple? something like that.
They had some good ideas, but because one of the founders kept working at his HP day job while designing the new company's first computer they never amounted to anything.
As someone with two kids and plenty of bills, I'm fine with taking the British at Dunkirk approach - live to fight another day.
You've been hellbanned, for this post bagging Edward Tufte: http://news.ycombinator.com/item?id=2991211
Which doesn't seem worth a hellban, and you seem a reasonable guy, so I thought I'd let you know. Hopefully you'll read this and be able to talk to someone at HN and sort it out.
I think the real issue is not about sharing wealth since it can be shared through other mechanisms for the core team - faster promotions, more cash comp, better work environment...
Its really about whether you want to keep it private. If you want to keep it private, then what is the value of the options if there is no exit?
I presume this is the same thinking that James Goodnight at SAS (http://en.wikipedia.org/wiki/SAS_Institute#Company_and_softw...) & Mike Bloomberg would have gone through to try and keep the company private.
You need to understand that for any organisation for long term success and to be world class, one need to have people who has enthusiasm, hope and imagination to live a prosperous life and can do anything for his/her leader and not those who just stick around because they are forced for survival with shattered dreams. People needs to have immense faith (it was thus far) in its leader for any organisation for long term successes. We live in a capitalistic world and money plays a important role in every way, you understand it and so Mr.vembu. And I am really doubtful, if monkeys can bring all successes which Zoho can but happy people do.
Sadly, because it actually aligns VCs, founders, and employees in the same pool, I don't see this being accepted by very many investors.
"I owe you"
it just says that I'm indebted to you in some way
isn't "vesting" traditionally determined as "in service" with the company, ie: full-time employment?
side projects are a flake factory. everybody is "busy." you split 50-50 w/ some guy and then he disappears for 6 months. you're pretty pissed.
The second group face not only a time value of money problem, but they're also accepting the risk of default (which is fairly likely in startups). They deserve substantial additional compensation for their willingness to leave capital in the company during early growth. One potentially fair way to do this would be to give them convertible notes with the same terms as whatever your first external angels get.
After all, leaving $100,000 in the startup's bank account has the same net effect as drawing the salary, then investing $100,000 in the startup.
The best advice I can give is to make sure you have agreement on the terms up front. If someone seems uneasy, don't move ahead. Find a way to agree. In our case, one of the founders who exited:
* Continually brought up the fact that he had loaned the company money as a leverage point
* After some time (over a year) decided to make an issue over the terms he agreed to
We managed to negotiate an amicable exit, but boy was it tough.
On balance do you think you (all) did the right thing at the time (for the company) or could you have done something different earlier on?
Also, had you worked with this person before?
An uneasy consensus is not a consensus. When founding a company, consensus is critical in matters of finance.
I think we could have done something different, but I'm not sure I'd trade our current circumstances on an unknown. I think that ultimately, losing those two founders was the right thing. They probably shouldn't have been a part of the company to begin with. Maybe I should revise my statement of "find a way to agree" to "find a way to agree completely, or don't move ahead". Finding the line between uneasy and unworkable is something you learn with experience.
I worked with the person before, but only in terms of work. My working contractual relationship was with his employer, with me acting as a third-party contractor. I found myself positioned as a moderate between two extreme fiscal viewpoints, one that placed a high value on the time value of money, and one that placed hardly any value there. I did not recognize at the time that this is a "founder smell" (vis-à-vis, a code smell). I thought that the two fiscally conservative members could bring discipline to the group.
What I later realized is that the behavior of a group is not equivalent to an average of the individual members' personalities. This seems obvious, but you'd be amazed how often people act on this very premise.
The problem with negotiating little details of ownership early is that anyone who believes they did not negotiate well is likely to feel taken advantage of.
I wonder if issuing convertible debt would be a good solution. So then you are giving equity to reward the founder for taking on the high risk of not being repaid, but you let future investment determine how much they should get.
If founders want to fundraise then the question of equity vs salary is likely to be moot.
The point about the risk of default is real but I wouldn't say that 'deserves substantial additional compensation'. If they're putting in substantial funds then yes, that's more like investment but if we're talking about comparatively small sums (as I believe Spolsky was referring to) then I see it as less of an issue. Presumably, all founders have aligned interests. Also, you could argue that founders still have the opportunity cost of not taking those high-paying job in MegaCorp.
The expected value of a $100k IOU from a startup is likely $10-20k.
The expected value of $100k in equity is (if priced reasonably) roughly $100k even though the value in case of default is $0.
If somebody was really adamant with me about IOUs being treated equivalent to cash, I'd ask if we could simplify and just pay all the founders equally, at the same time to get rid of the discussion.
The challenge, however, is not to identify the time value of money and the inherent risks of not taking a salary. The problem is to quantify those risks and costs in a way which all the cofounders will consider fair...all the while recognizing that forty percent of a startup is probably worth just as much as sixty percent, i.e. Nothing.