Here's the thing about each layer after the founders owning 10%. In his example, layer 2 (first employees) consists of 5 people, each of whom own 2%. Those employees probably took a pretty significant pay cut to work at this startup.<p>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.<p>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.<p>And of course, the programmer may have worked <i>way</i> 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.<p>Now we're looking at a $10 million dollar sale.<p>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.<p>All of this assumes that there is an exit as opposed to a bankruptcy.<p>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.<p>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.<p>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.
As he points out, most people feel that being treated fairly is the most important thing (this has more to do with not being demotivated by an unfair split than being motivated by the equity itself). The beauty of this kind of post is that once it achieves a certain level of notoriety, it automatically becomes “fair” in everyone’s mind.<p>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...
Try to avoid getting bogged down in 'fairness'. If your startup makes a nice exit, chances are that someone will get more money than they 'deserve' (hardly ever you), and someone will get less money than they 'deserve' (almost always you). Alternatively you could spend all your time fighting to make it 'fair', and end up with a fair slice of zero because your startup failed. Keep this in mind when choosing co-founders as well. If your college roomate says he doesn't want to share the electric bill equally because his lights are off more often than yours; what will he be like when there is <i>real money</i> on the table?<p>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.
Solution I personally use and has yet to fail: Auction system trading monthly wage packet vs. unit equity.<p>It just works, and by it's very nature is fair, everyones happy.
Mandatory link: the co-founder equity calculator <a href="http://foundrs.com/calculator" rel="nofollow">http://foundrs.com/calculator</a><p>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.
I know it's a back-of-the-envelop affair, but one thing I'm a bit unclear is that hiring is not done in batch in January.<p>So, how do you separate your stripes?<p>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.<p>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…)
Here's my totally fair method of dividing up the ownership. Talk it out with your co-founders. Whichever cut is chosen at that discussion is fair. Why? Because it was discussed and not proposed..... Furthermore, because it was agreed upon.
At my startup, we have talked about this issue several times about how we can fairly compensate employees for their contributions to the company. Our company is a bit different in that we have a lot of young employees who are eager to learn and believe in the vision rather than people who maximizes reward and minimizes risk. Because of our employee makeup, we're adopting a revenue sharing plan. In my eyes, that's as fair as you can get: getting a ton of experience with the latest technologies for a temporary cut in pay. As a lot of commenters have said, it really depends on your situation, but I believe the reward is potentially great if you're a young engineer who's seeking a long-term reputation as a good programmer.<p>(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.)
Two points:<p>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 <i>not</i> 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.<p>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.<p>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.<p>2. Not all founders will share the risk equally even if they all work full-time, quit their jobs, etc.<p>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?<p>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.<p>Things get more complex once people become serial entrepreneurs.
I think it's totally reasonable that, if one founder is putting a significant amount of capital at risk, he should hold a higher share of the company going forward.<p>I would think that dividing things equally really only makes sense for pretty lean startups.<p>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)
"What if one of the founders doesn't work full time on the company? Then they're not a founder. In my book nobody who is not working full time counts as a founder."<p>This point, which I fully agree, seems to generate a lot of comments. When he landed on Gibraltar in 71, Tariq ibn Ziyad (<a href="http://en.wikipedia.org/wiki/Tariq_ibn_Ziyad" rel="nofollow">http://en.wikipedia.org/wiki/Tariq_ibn_Ziyad</a>) 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.
There is a company in India which has not taken any outside funding and doing great business so far. There are many employees who has been toiling there for 10-15 years with expectations that they will become rich sooner as company started doing really well with all hardwork. Recently, one fine day "the founder" in his internal memo says that you can call me the super rich. All shares has been distributed to himself and his family members and now all employees are monkeys with hand full of peanuts. Wake up with shattered dreams.
Guess who is this company?
Yes, you are right, its ZOHO. Period.
I especially like this because it flattens series / preference. There's no "Series FF"-style shenanigans where founders can convert and cash out in later rounds while their VCs hold out for a fanciful exit, leaving employees high and dry, and there's no opportunity for broken preferred/common conversion that lets VCs exit with a much better deal than their founders or employees get - everyone owns the same shares.<p>Sadly, because it actually aligns VCs, founders, and employees in the same pool, I don't see this being accepted by very many investors.
good post, but most cannot afford to pay them out-of-pocket for their time (nor do they expect that), and we're all approaching this as a project we'll do on our nights and weekends, right?<p>isn't "vesting" traditionally determined as "in service" with the company, ie: full-time employment?<p>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.
I disagree with his assessment that it's fair for some founders to take cash now and others to receive only IOUs payable later.<p>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.<p>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.