How To Allocate Founder and Employee Equity
Joel Spolsky, co-founder and CEO of our portfolio company Stack Exchange, posted an excellent answer to the question in the title of this post on the Stack site OnStartups.
I'm not going to reblog the entire answer here. I'd encourage you to go read Joel's answer. However, I am going to highlight some of the most important points from Joel's post:
- Fairness, and the perception of fairness, is much more valuable than owning a large stake.
- Before factoring in dilution from investors, the founders should end up with about 50% of the company, total. Each of the next five layers should end up with about 10% of the company, split equally among everyone in the layer. [go read Joel's answer to understand how he sets up these layers]
- It never makes sense to give anyone equity without vesting.
- Ideas are pretty much worthless.
- Nobody who is not working full time counts as a founder.
The thing I love the most about Joel's post is he throws darts into a lot of conventional wisdom about founder equity allocation. I particularly like his notion that the person with the idea should not command a premium on equity allocation.
What Joel's post makes clear is that founder equity should be for services to be rendered in the tough initial year(s) when the risk is highest and capital (ie cash comp) is nonexistent. It is not for coming up with the idea, writing a patent, or going without a salary.
And I second with emphasis the focus on fairness. Founding teams that allocate the founders equity fairly stay together a lot more than founding teams where one founder has a much better deal than the others. The same is true of venture capital firms. The most stable venture partnerships are those where the partners share in the carry equally or near equally. At the end of the day, this is as much about respect as it is about money. And when people feel disrespected, they are going to leave at some point.
Great post by Joel. I'm looking forward to the disqussion on this one.
“Ideas are pretty much worthless.”I know that’s how they’re often treated, but I think that’s really too bad. It’s as if Joel’s saying that with enough money, hype, and hustle you can build any notion into something a greater fool will buy.
I don’t think he is meaning exactly that. The reality is that there are none or very few really original ideas. Whenever someone comes with a brilliant idea there are a few others with exactly the same idea. They have reacted to the same realities and stimulus and arrived to the same place. From that point, the key to success is gonna be execution. That doesn’t mean that good execution with a bad idea will go well, just that a great idea without execution will go nowhere.
This is what he wrote, in full:No. Ideas are pretty much worthless. It is not worth the arguments it would cause to pay someone in equity for an idea. If one of you had the idea but you both quit your jobs and started working at the same time, you should both get the same amount of equity. Working on the company is what causes value, not thinking up some crazy invention in the shower.
I agree Dave.The whole “ideas are worthless” mantra gets on my tits.Sure, “I’m gonna solve world hunger” is pretty worthless by itself.But if you can back the idea up with thorough domain knowledge, a well-researched and innovative solution, and a credible execution plan then the idea is about a worthless as the one to use links to rank web pages.
Case in point. One google founder had that idea. They shared the equityequally
There are ideas and there are ideas.An idea around which someone develops a business plan — yes, there are still folks who know how to write a real business plan — is hugely different than a moment’s inspiration in front of a white board.Once you have started or otherwise grown a business or two, you realize that it is far more important to determine how you are going to provide nutrition to the idea than just to crack the seed casing.I place great value on ideas which come with a bit of hard work fleshing them out and modeling their viability — not some baloney spreadsheet with a bunch of pie in the sky assumptions — along the lines of a National Intelligence Assessment which provides a factual framework in which to evaluate an obscure or intangible or unprovable thesis.This requires some critical thinking.I have seen some great ideas robbed of life by the failure to think through the next steps and I have seen some truly mediocre ideas blossom because of the follow on thinking.I think a good idea framed with a bit of truly high quality thinking creates a lot of value and should be regarded as such.
That is not what he is saying. I see the same ideas every day. The ones thatare special know how to execute the ideas in a way that leads to massadoption
I think this is often phrased poorly, given that “idea” has a broad range of meaning. All of the details that go into great execution are also ideas, and they _are_ exceedingly valuable. For example, “we’re going to make our homepage purposefully sparse to reduce confusion” is an idea that’s arguably more important than the skills required to do so, though it depends on whether you consider the execution of that idea the actual coding of the HTML and CSS to make it happen or the leadership initiative to convince everyone else that it’s a good idea and shape the rest of the product around that idea. Which is my point – the terms are somewhat fluid.Strong execution isn’t separate from ideas – it’s the process of getting from a general conceptual idea to a lot of little concrete detail-oriented implementation ideas which are doable.
I agree. But I also know what Joel meant when he wrote it
Then don’t perpetuate a blatant false generalization, because many of your readers may not know what you or Joel meant. You would be helping many entrepreneurs by providing clear and thoughtful context as Fields has above. This “shock” phrase has spread too far and wide already.
This is a blog. Its a community. Its a rap session. We discuss stuff here.There are no absolutes
A great “product idea” is not enough. You have to have or know how to find and validate great product ideas, marketing/distribution channel ideas, and also have strong ideas about how to build and motivate a team. Lots of ideas need to come, derived from aptitude and experience, and then you have to mix them together with sustained hard work 🙂
Go forth, ye readers, and execute your idea in a way that leads to mass adoption!
Don’t get hung up on the word ‘idea’…think of it as ‘dreams’ instead, because to me, ideas without execution are really just dreams…and then ask yourself how much is a dream really worth?Also, ideas don’t equal strategy…strategy to execute on an idea *is* worth something…but still actually executing on that strategy is *everything*
The market decides the value of dreams, ideas, and execution with every investment and purchase. Pretty wicked to see it in action, but there’s little customer concern about all the workings behind the veil, for them it comes down to product quality. It’s only from working on the inside you see how much that final quality depends on ideas, strategies, execution, team building, fund raising, and planetary alignment (public markets ;).
IDEAS LIKE CARS. WORK LIKE GAS. GREAT IDEA WITH NO GAS BAD BET AT RACETRACK.
There’s nothing profound or revelatory about noting that an idea alone won’t get you anywhere without work/execution; we all know that. I was merely contesting the statement that “ideas are pretty much worthless”. A Maserati without gas may be a bad bet at the racetrack, but it sure as hell isn’t worthless.
WHEN EVERYONE THINK IDEA ALONE WORTH BILLIONS, SUGGEST IT ONLY WORTH THOUSANDS NOT GET IDEA ACROSS.
Straw man, Dinobot.
THAT MAN NOT MADE OF STRAW, IT MADE OF MAN.ENTRENCHED WRONG IDEA HARD TO MOVE. WEAK STATEMENT FULL OF EXCEPTIONS NOT DO IT. STRONG STATEMENT REQUIRED.BY NATURE, STRONG STATEMENT IGNORE OUTLIERS.
What if the idea is an electric car? ;P
This is how people justify themselves in copying tooNamaste
Fairness is also why you need to burn the boats on the beach and all founders need to quit their day jobs and drop their consulting clients.As for ideas, they’re not worthless, nothing will happen without them, but there’s a reason Michelangelo gets credit for the Pieta, not the quarryman who dug the marble out of the ground.
I love the ‘burn the boats’ metaphor. My friend Eric Norlin (@defrag), founder of the Defrag, Glue + Blur conferences calls it the ‘burn the ships’ moment:”when you make [the decision to start a co] you’re absolutely, unavoidably, burn the ships, leave yourself no out, committed.”
The name of my new band.
http://www.youtube.com/watc…via steve blank from 2009…
What if you work both as a FT job? It’s simply not feasible for some to quit their day job to pursue an idea that might fail and might mean going without salary for up to a year. So you put in the same amount of hours a day/week but you do it at night and on weekends, does that devalue the contribution?
When people say creating a company is a “full time job” it means something different than what most of the world thinks of as a “full time job”.You think about it in the shower, you think about it in the car, you think about it while you eat. I have dreams (literally) about products I am working on. It’s not an issue of hours. All the hours are taken up. So if your other job is mindless and requires little attention I guess you can do it.What I would suggest is sitting down with your family, saying “in six months I intend to start a company but we’re changing our lifestyle to start up mode now.” Cut your expenses to the bone, save like crazy. Then in six months quit and start your company.
I think I should have added the phrase “all other things being equal” to my initial comment. I’d assume that you’d eat, sleep and breathe the business just like the other founders. You’d think about it in the shower, dream about it at night, call in sick to the day job or skip lunch because inspiration hit. Everything that you would expect any other founder to do except report to work from 9-5, instead maybe it’s 6-2.Is that contribution still not equal?
Unless your full time job is being something like a toll booth attendent or the guy who bags groceries at the supermarket I don’t think you can make “all other things equal”. Certainly not if being fair to your employer matters.
Erik is right, it does become an obsession.If you hold on to that Full-Time job and you’re constantly obsessing over your start-up, then you’re going to be tempted to work on your start-up while your at you’re FT job. Which means your employer could try to claim some ownership down the road.Ryan
Don’t wait until you have a wife, mortgage and bambinos to start a company.If you must marry, marry someone who knows that you are nuts before you say — “for richer or poorer” because this is usually a head fake when the poorer shows up.
That would be best.
You crack me up JLM. I know I’ve said that at least a dozen times.Do you play cards? One of my favorite pastimes is playing cards withfriends, shooting the shit, and cracking each other up
I love to play cards particularly hearts. But only if you constantly try to shoot the moon.
DIVIDE SHARES OF HOBBY DIFFERENT FROM DIVIDE SHARES OF STARTUP.
True but time spent <> value created. Obsession doesn’t mean you have to starve, it simply means you have to work hard and contribute alot and I still don’t see why you can’t do that and hold down a day job as well. I think as long as the contribution is equal then the shares should be also.
Of course not. When you are working so hard that you are taxing your physical limits, you are still creating value and you have nothing to feel sensitive about.Life is about keeping a lot of balls in the air — optimization not maximization.But when you are ready to jump — jump.When you are successful you will almost not remember how you suffered to get started and when you go to the pay window, the pleasure will more than compensate for the pain.This is the American dream and it is still happening every day throughout this country.
I can do far more now in 50 hours than I could as a 20 year old with 100 hours a week. How do you perceive the sacrifice of income as a badge of merit, when it’s not equal for all founders?A consultant with 30 years of programming experience can contribute more in 20 hours than the vast majority of college age kids. That’s not considering networks of associates, customer leads, etc. Why would you value their time as equal?
Speaking for myself here; based on my experiences and the way I think/work.It’s not about a badge of merit, it’s about focus. I too am much better at this than when I was 20 or even 25. But if I’m looking for a co-founder I’m looking for an obsessive. If they’re also a major contributor that’s a huge plus (and should be reflected in equity), but the thing that makes them a co-founder rather than an employee is a focus and an obsession with the problem and the customer.
Thanks Erik.That makes it clear. I consider levels of obsession many times a week, while working on different small projects. When something infests every waking (and some sleeping) moments, it summons an energy we hardly know we have.Absolutely want obsessive cofounders. I want obsessive clients, customers, users, and investors. The cult 😉
I have a very different perspective/experience: in a new business (without explicit domain experience) it’s difficult to know what actions gives the better company outcome. Sometimes a timely 8 hours of work and luck gives a better result than weeks or even years.So, it’s important to know that everybody is in the same boat.I can give you an example from my little experience: we invested in a technology for two years with a team of 3 without any economic result (although we believed in the importance of that specific technology).One day, 1.5 years later after we put on hold the work this technology is the core of one of the products of a fortune 100 company.So, it’s difficult to estimate what founder work will give the best outcome in advance.
It’s like wiping the slate clean for a highly unpredictable outcome. Got it.
You still do need to give our anonymous stonecutter credit
I disagree by the way that this is the only way to have fairness.Fairness is keeping the venture separate from the people who participate it. Every person might have a side job, but their responsibility to the venture and the value they contribute determines how much they get out of it.Not everyone is able to just quit their job and work on a startup. People have ongoing cost of living. Usually I have found that it works like this:A) Employee -> B) Consultant -> C) Self-Employed -> D) Hire People -> E) Entrepreneur.I agree to some extent with Peter Thiel about prestigious education being overrated. I often joked that if I didn’t drop out of SOMETHING, my chances of becoming a billionaire would be severely curtailed. School just trains you to start at A. But although that can give you a lot of experience, B and C can give you much more. For example, if you opened a shop with a master who got a lot of projects, after 2 years you would be more prepared to do C and D than if you were an employee those two years. That’s how apprenticeships worked throughout history.Anyway, I don’t think it’s easy to go straight from A to E, unless you really saved up a lot of money. It’s a big jump. Usually people fall back to something. That is why I find it very important to keep people and companies separate. If you are passionate about something, by all means start a company, but make sure it can sustain itself if you take a 2 week vacation. People live lives. Companies create value.
I like the fact that he gives importance perception of fairness. Most discussions and break ups happen because of perceptions, so not focusing only in the facts is really important.
“Nobody who is not working full time counts as a founder.”Can you reword that please? I think it means “Anyone who is working full time counts as a founder”?
I struggled with it too. I was going to exit it. But then my head startedspinning and I decided to leave it as Joel wrote it
Fred, being that we both responded to @mrcai contemporaneously, am I misstating your position or did I nail it?Do you agree with my attempt to clarify your view? Thanks in advance for your response.
Yeah, anyone was the wrong word. Though I’d argue anyone in the top layer are founders. The top layer being anyone who joins the company near the start, when salaries are not being paid.I’ve read the article now and it’s pretty clear in context,”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”
There is a question of material value. Anyone is too broad. You may hire a sales person early or a programmer early. They can perform heroically or be a mistake, but even if they act heroically, there is a limit to the amount of value they can create.A founder has to have executive responsibilities.
Well said. 🙂
I honestly don’t know. I copied Joel’s phrasing verbatim
hehe… okay… fair enough. I appreciate your candor, Fred.
At the risk of putting words in Fred’s mouth (by all means correct me, Fred, if I’m misstating), that statement was already phrased precisely the right way.It means that even if someone thought of the idea, or spent a lot of time thinking about it, or whatever else that makes someone “think” an individual is entitled, they should not be deemed as a “founder” unless they are full-time to the business. So an occasional advisor or mentor or muse, for example, should not be deemed a “founder.”By extension, your statement @mrcai, that “ANYONE (emphasis added) who is working full time counts as a founder” would be even less true to Joel’s post or Fred’s remarks. That would suggest that all full time people working on the project should all be deemed founders. Adding in my own two-cents, those are early employees not founders.I think the bottom line of the advice is… be sparing with whom you designate as official founders. Just being there in the beginning does not a founder make… at least not in and of itself alone. The role is for someone who has had a functional full-time role to play leading up to investment and for some critical time to come.
Joel is saying that going full-time on the company is a requirement for founder status.
egos are so fragile, we can feel slighted so easily…viewing equity allocation as a function of risk taken and not value provided would make things less emotive and more quantifiable.removing ego and self esteem from the equation would make this less of a minefield.
Except when the risks aren’t the same for everyone. If you have 2 years of living expenses in the bank and are a single person with no family, you aren’t arguably taking much risk to quit your job and work for a year salary-free. However, if you have a family with 2-3 months of savings, it’s a much bigger risk.
completely agree.that should all be priced in to the allocation.founder salaries should also be based on what you need depending on your circumstances and not just to achieve parity between everyone.
As someone with a wife, 2 kids, and a mortgage payment (who is currently full-time building a startup for no pay right now)…I would argue it’s more about life-choices than it is risk here.The reality of life is that you can only have it all if you properly plan for it, and do everything you possibly can to execute on that plan…and then get some luck. ;-)Being in my situation doesn’t mean I can’t take a risk on a startup…it just means I have to plan for it longer, get myself into the proper financial situation first…and I have to be smarter about my project choices.
All of that is true but when I look at the recent startups and see that a lot are just web apps with funding, I don’t see why starting a startup as a second job is a bad idea or has brings less value to the table than a founder who does it as his primary. A lot of these things are created over a weekend, launched, iterated over another weekend, relaunched, etc.By the time you need to quit the primary job to work on the startup, you should have funding or profits to sustain you anyway.
That’s def. true of many projects today…but some still do require a lot of upfront effort/time/money before they are ready to generate revenues (or even be useful to users)…and it also depends on what your ‘primary job’ is…if there’s potential conflict or it’s just draining you too much emotionally/mentally then it’s probably time to make the switch…if not to your own startup, then at least to another primary 😉
Agreed – some startups won’t allow for that model, neither will some positions. I just don’t think the rule of quitting your primary needs to be so hard and fast in determining a co-founder, value creation and contribution matters more IMO. Though I do concede the point on aligning goals based on shared misery and obsession.
Like many things related to RISK, it is not whether you are “taking” a risk but whether you are “managing” a risk.In the instance with the single guy with 2 years’ expenses in the bank, he has demonstrated that he is a prudent risk manager. I want this guy on my team.He is taking the exact same professional risk but he has mitigated his personal risk. That shows maturity and thoughtfulness.
My uncle had a sign over the door to his office which read: “Perception is reality.”I’ve always tried to remember this when dealing with anyone, and it’s especially relevant in business.I’m looking forward to checking out Joel’s post when I have time. Something tells me I have something big going on today… 😉
You guys killed it today
Thanks, Fred!I really appreciate all your help, with everything.
Iterating the idea to market acceptance is what creates value. The hard work of sweating the idea into reality.That I agree with totally.’Ideas are worthless’–out of context (maybe even in context) feels like its intended to shock more than inform.Maybe Goethe was talking about what founders do every day:”To think is easy. To act is hard. But the hardest thing in the world is to act in accordance with your thinking.”
On a related note – there’s a story about Bill Gates and Paul Allen and how they split up ownership in the early days of Microsoft in this Vanity Fair excerpt of Allen’s book: http://bit.ly/f1V3dSWho knows if the story unfolded exactly as Allen describes it but the episode certainly seems to have had a big impact on the relationship between Allen and Gates.
These are terms that are constantly changing and evolving as more people create start ups.There is also less structure around an “idea” on a consumer side product. The spontaneous ignition that everyone looks for is mostly in the execution or tweaking of the product.As all “this” moves to the enterprise, I believe that ideas will become core again and will need to be more fleshed out before trial by the market.
It is not for coming up with the idea, writing a patent, or going without a salary.What if you are in business of being a Patent troll?
You should be tarred and feathered and ridden out of town while everyonejeers at you
Fred has his holster on.
Guess some days, feels like Deadwood…others, Mayberry.
I’m telling ya, the world is crying out for a return to settlings things by dueling. We need to return to dueling.
Problem with dueling is people get killed
I have no problem dueling even w/ paint ball guns but we must get back to the idea of individual combat to settle disputes.
The crux of the entire conversation: “[it] is as much about respect as it is about money”. This is not only true in the equity allocation, but as a startup moves into its later years, the respect still has to be there.As Martin Zwilling pointed out last month, one factor of the “Founder’s Syndrome” is where one founder doesn’t have respect for the others:http://blog.startupprofessi…
This is a great post by Joel and his emphasis on perception of fairness stands out. The matter of control that comes with majority shares can be more tricky with two partners than with three or some other odd number since democracy functions more naturally with a majority vote. Looking at Michael Eisner’s book Working Together: Why Great Partnerships Succeed reveals how this 50/50 ideal is often not the mark of great, successful two-person partnerships, though fairness, and an absence of envy, greed, and jealousy is key. There is, in nearly every case reported — Valentino and Giancarlo Giammetti (Valentino), Warren Buffett and Charlie Munger (Berkshire Hathaway), Arthur Blank and Bernie Marcus (The Home Depot) — one person with at least a slight majority or controlling interest. The alternative of always demanding fairness and justice for one’s self can become destructive and can run counter to the kind of sacrifices needed to succeed as a group. Using the principles of vesting and only full-time founders would seem to do a lot to remedy this, though I would like to see any examples that counter the above.
Well brad and I aren’t munger and buffett but we went with 50/50 and it hasserved us very well
In the arena of business management control and decision-making, there is positive control which requires a bit of trust on everybody’s part and there is “negative” control which requires a bit of trust on everybody’s part.They are both drinking out of the same cup.Trust is the most important byproduct of how a consensus is built and how a decision is finally made. Trust often requires compromise to make it work in the real world.Compromise is — circularly — the byproduct of trust.Partnerships are interesting business entities as they imply a consensus built one off decision-making process while they may still require a Managing Partner to construct the actual question and to administer the execution of the final decision.It might be also fair to say that when trust and compromise are not in the room, then nothing really effective or long term gets accomplished.The current political environment is rife with examples of how this has destroyed and diminished the chance of great policy decisions coming forward as nobody trusts anybody and all compromises are perceived as fatal weaknesses. It is sad indeed.
You’ve got a bead on this matter of the virtuous circle of trust and compromise, versus the vicious cycle of distrust and intransigence. Whatever the equity split is, it must feed the former to drive the organization to success. Joel struck on it by laying out the founders’ relative commitment (full-time). That is one essential quality for building trust in a team, both among founders and down the line in investors, employees, and heck, customers. So overall, I agree that we are lacking in models of the former when it comes to policy decisions and I hunger to see more in action.
Almost all the good things in life start with just one guy who is willing to do what he thinks is right rather than listening to the crowd.It all starts with us.When I have done the right thing and it comes together I feel good and give the credit to others.When I do the right thing and it bites me in the ass I have the exact same feeling of good because I would not have changed anything I did what I knew to be right.Doing the right thing always lets me sleep well. And I love to sleep.
Thanks for the e.g., Fred. It’s a great arrangement when there is a “nature” fit with the two partners. Apparently munger and buffet chop it up and debate quite a bit. Yet, they retain respect for each other’s opinions and share a desire to improve their collective understanding. Judging by how you facilitate disqussion here, I would imagine the balance enhances you and Brad’s decision-making. Strength of character never hurts.
While I like the idea of declaring patents worthless (please get rid of the USPTO without delay so real innovators can innovate without fear of some random broadly worded text being used to take all the money), declaring ideas themselves worthless is wrong. Without ideas an entrepreneur isn’t; without ideas VCs are worthless and angel investors are worthless.Ideas are the most valuable thing in the world. But in deciding equity splits, maybe they can be overvalued…
Everybody in tech. in the 90s had an idea for search…only google actually did it.Everybody online since the 90s has had an idea for a ‘social network’…only a tiny fraction have properly executed on it.I suspect, everybody in the world has had an idea for world peace at some point…or an idea/scheme for making millions of dollars…or becoming famous…or changing the world…very few actually execute on it.My point is that ideas = dreams…they are awesome, and they are very badly needed at all times…but without sweat and execution…they are just dreams. And the only equity that dreams bring you is emotional equity…
Everyone had the wrong vision for search. The vision is worth much more than the idea. VIsion is the ability to see how you will reach customers. I would give a 10% strip to a person who could provide a compelling, practically realizable vision, even if that is all they did for the company.
You are good man.Doing the vision thing, moving beyond a ‘one trick pony’ idea, evolving into a herd of ponies and communicate what is out there in that lot takes a lot of time.
“My point is that ideas = dreams.”This statement does you a disservice.So, in particular, ‘ideas’ from research, the USPTO, as in ‘intellectual property’ and ‘trade secrets’, etc. are just “dreams” and need no protection and, as in this thread, are “worthless”.Sorry you believe that.All it would take to settle the question P versus NP would be an ‘idea’. Since Clay Mathematics Institute will give $1 million for the first such idea, they believe that ‘ideas’ are not just “dreams” and not “worthless”.
The P vs NP is the idea…what they will pay for is the theory…the math…the actual work that validates the ‘idea’
This argument is old and is seeming older than that.Likely the most delicate resolution is to say that in information technology (IT) venture capital and corresponding entrepreneurship, an ‘idea’ is only the very short description of the product or service the entrepreneur gives to the venture firm, users, or customers.This definition of ‘idea’ is unusual and strained.Again, my “All it would take to settle the question P versus NP would be an ‘idea’.” is true in mathematics. With the right ‘idea’, writing out the theorems and proofs is regarded as relatively routine.Generally in research, the core challenges is the right, new ‘ideas’.For the USPTO, a common description is that a patent protects an ‘idea’ (yes, implemented in a mechanism). Commonly the ‘intellectual property’ protected by trade secret laws is ‘ideas’.Here’s a worthless idea: A one pill cure for any cancer. Why we don’t have such a pill is that no one has a good ‘idea’ for how to make the pill and make it safe and effective.Saying that ideas are worthless is one heck of an insult to nearly everyone who works hard to create new, powerful, ‘ideas’ and a sign that the speaker is a bit short on understanding ideas, finding them, and applying them.
Maybe there’s a language issue here along with the timezone one. What you are calling an idea I would call a notion or a thought. A business idea to me is something that has gone from a notion (wouldn’t it be great if) and been thought about, worked through and developed as far as it can be taken.It could be that it is because I’m not a tech graduate, I’m a management one, so that might give me a different perspective. Personally I have an idea, by which I mean an Internet service that has had a lot of thought about how it becomes a highly profitable business, and have put together a team with the right skills to execute; it is now a business that is ready to roll that just needs a cash injection to make it a go.Now you can if you like declare my business idea worthless or rate it below all the other components; below the money, below the initial team and below the future employees.But that sounds wrong to me.Yes, I know I need some money, but I’m not asking someone to give me their life savings, I’m expecting the investment to be from a person or people to whom the investment is a fraction of their wealth; yes, I know I will need some employees, but I’m expecting these to be people who will like the pay and flexible working conditions on offer; and for sure I know I need the team I’ve put together, which is why I’m offering a big slice of equity to them. As well as to the investor(s) and to the staff.But my work should be seen as worthless? I think this must be a language issue. Or a cultural one?
Ok, I appear to be the only one in the world who is against vesting. either you are giving it to me or not. You can give me more later if you want to keep me incented. But here is a better question, what happens when the first VC money comes in a year or two after the company founding and the VCs want the founders to start over vesting (so start the clock again on a 3-4 yr vest)? Most VC deals will require this. I view it as the most offensive term/condition i have ever come across.
If you’re a sole founder you don’t need vesting.If you have more than one founder you do.In a sole founder situation with investors I might trade some vesting for a large severance.
If you’re a sole founder and somebody else joins 6 months down the line, who you want to treat as cofounder. Having vesting for him and not for you seems unfair. What is a good way to handle this? Having vesting for even single founder?
If there are two founders you need vesting. Otherwise one can quit and keephalf the company
amen. i lived that. it is hell.
Once burned twice shy
I have to say this is way off the mark.We granted a co-founder equity just recently as he moved on to something else. We did that because he spent his money and some of his time as part of our team. We did that because it is the fair thing to do – not because it doesn’t Jibe with some investor. I care less – then dont fund us if you have a problem with the fact that fairness to me with one of my founders is more important than % to you. (after all thats what this is about – you dont want dead equity because it is an obstacle to you – be honest)Ideas are extremely important. The execution drives the value through the idea for sure – but you cant just NULL the idea.The real question that should be answered:How do you trust a venture investor who has not actually been through the trials and tribulations of actually starting something?i dont like this post for a bunch of reasons.
I think you are misinterpretating it
In your experience the departing cofounder vested (by your definition) and then decided to move on. Sounds practical and fair.My take is Joel seeking alignment strategies between all team members, fromfounders, to investors, to new hires.
well mark without divulging too much, we had a situation where we all had that “100% commitment chat” – many start ups, right or wrong – come out of hobbies, and informal chats and so on and this was no exception.But every start up in my opinion will have that “come to <insert the=”” name=”” of=”” deity=”” here=””> moment where is it shit or get off the pot. ” we go or we go home.Call it an alignment chat, or whatever – but its the one where you have to look your partners square in the eye and tell them you are risking your daughters future and are they willing to do the same. Thats not an over embellishment either. Well this particular chat involved one of us “blinking”. What then results is a speedy and equitable set of discussions to make the exit frictionless and amicable. If that means that the exiting party is granted a measure of shares for time served, then so be it.I took exception to the fact that you cant just arbitrarily ignore or discount the path trodden by entrepreneurs to get to your investment table.
Easy to understand and remember! But what’s your idea about voting rights and board control, how should that be allocated? Could ending up with 25% make company out of founders control?
Joel’s summary was great. His main principle on fairness is of course everyone’s objective. The question is how to get there given lots of factors. I’d argue a few of his points:1. “Let’s just be pals and go 50/50”. That’s only a good formula if both partners are making and continue to make equal contributions/sacrifices. If not true, leads to even more grief. And while burn the boats and vesting is an approach to the problem, burn the boats is simply not realistic in lots of cases. Sounds manly, but it can’t be and doesn’t have to be the answer for lots of entrepreneurs.2. “Use IOUs, not shares” to deal with cash comp and expenses issues. Unless the IOUs carry a cost of capital / risk premium, the fairness principle gets broken. That cash spent or forgone up front in the very risky days deserves an equity-like return.3. “Not a founder if not working full time”. Again, sounds nice right along with the burn the boats speech, but not practical or realistic for many entrepreneurs. Why would I take away from my partners the psychic value and drive that comes from being a co-founder just because they aren’t in a position to “burn the boats”? The fact that they’ve made some of their contributions during moonlighting hours doesn’t make those contributions any less valuable.I think answers like Joel’s can be really helpful so long as they don’t convince people that there is only one way to do things. Situations are different, so get creative and figure out fairness that works given your situation. Most importantly, be super transparent and talk about it a lot. Make sure everyone feels like they’re getting a square deal.To try to be more than just a critic, here’s what we’re doing while in bootstrap mode. 4 co-founders, everyone in a very different situation. We’re allocating founder’s equity based on the $$’s each of us has put into the company. We count both “real dollars” and “sweat equity dollars”. We keep track of it each month in a simple Google Spreadsheet. Our LLC doc references the spreadsheet.If/when we take an outside investment, we’ll have our burn the boats moment. Co-founders will either join the company full time and begin vesting or will get bought out. Probably not for everyone but it’s working for us.
Excellently put, Nate. If I had your experience, it’s exactly what I would’ve said myself:).It’s so true that “burning the boats” sounds “manly”, romantic, etc. And there are still those who mock PT entrepreneurs as not serious and hedging our bets etc. But, as you point out, if you have financial responsibilities and commitments (e.g. I’m a sole parent), it might not be a feasible option.I particularly agree with your last three paragraphs…that while it’s great to gather a multitude of perspectives – especially from those who have been there, done that – no one else’s experience will fit you exactly. With my own startup, I’ve tried various approaches to getting it off the ground. Originally, I thought funding was the only way to go, but several months on and I’m successfully bootstrapping my way along to a soon to be launched MVP. All the while working FT.My burn the boats moment would come with angel investment (VC would be more than we need). Until then, my team (I’m still sole founder) and I work long, hard, extremely productive hours outside of our FT jobs. And it works.
Re Ideas Fred…Maybe someone needs to do a definition that most get. Have idea in the shower and do nothing with it…worthless.Identify issues facing development of a tool that can have a big impact and work ideas into designing a blueprint… worth more.Working the minute details regarding that idea so that it can do more (bigger tool)… worth more again.Working thru funding and over to launch… everyone happy. Just a matter of remembering the guy who had the idea and evangelized it.
Hey, Fred –When I read Joel’s post, I thought ‘holy good lord, that’s a ton of equity for the employees.’How does this work in the context of a fundraise? I’m assuming an option pool equal in size to the founder’s stake isn’t created right away, at the time of the initial funding, since that’d be massively dilutive to the founders — after all, they might sell their company long before they get to employee layer number five. But if such hefty option pools for additional layers are allocated later, after your investment, that’s going to dilute your stake quite a bit.At what point does the size of the option pool stop being a good way to incent employees, and start making you as an investor uncomfortable? Shouldn’t the amount of employee equity be subject to market conditions and prevailing trends, just like the relationship between founders and investors?
Those layers of equity come over time. In the first few years founders willhave way more than half of the total non investor equityBut what happens to founders over time is they get diluted by both theinvestors and hiringI know plenty of companies that are five years old or more where theinvestors own roughly half the business , the founders own a quarter andemployees own a quarter
I’m curious to get Fred’s take on the IOU part. In my experience, VCs are rarely willing to see their cash go toward IOUs. They want to see it build their value, not reimburse on the value already created.
That’s true. But if they were small relative to the overall raise I’d be OKwith it. The founders are diluting for the cash to pay the IOUs
I agree with 90% of the comments. But fairness is not so common in business. In biotech many founders never worked full time in the start-up, sometimes never worked for the company but as an advisor… I have seen strange things but I may not have the full story: in the netscape case, Andreessen had much less than Jim Clark, but Clark may have been an investor in addition to a pure founder. I have seen technical founders with no equity at all. It is a topic I have been passionate about for years (http://www.startup-book.com… and more recent posts, tag: equity). Of course the big variation at the end is how much dilution from investors which depends on how much leverage foudners have with early revenues or traction.
I feel the need for a formula whereby everyone on the team ends up with equity.
I know Joel is being “canonical”, but in practice, 2 things re the employee part bug me:1. The other employees should own as much as the founders(?!) I can understand why some VCs might like that, maybe– makes it less attractive for the founders to sell the company early, or for it to make much sense for them to cash out their own stock via secondaries.2. The ‘layers’ theme confuses me. It assumes that with time, there will be not just ever-growing hiring, but actually *exponential* headcount growth. Each layer gets 1000 shares. Employees in later layers will only get reduced shares if their layer had an increase in hiring. If instead there’s a slow down in hiring later, that layer’s folks would get *more* shares than people working there a lot longer.Also, with continuous hiring, I’m not sure where you’ll draw the partitions between layers.
Fred, it’s spelled “discussion”, mkay?
A discussion held via Disqus is a disqussion in my book
I guess not everyone got your subtle plug for DISQUS. I thought it was clever. Never saw it used that way before and I think they should use it.
Ive used it that way a few times. Hope to make it stick
Hope it sticks too. See? Marketing! ;P
Hey, Fred — what Android phone would you recommend right now? I am getting one for testing purposes.
Love it. Simple and transparent. Clarifies important ownership distinctions: % ownership of employee stock, % ownership of (employee + founder) stock, and % ownership of the whole company.Focus employees on the metrics that matter most to them in terms of what’s fair and reasonable, and unite all founders and employees in their common goal to minimize dilution to investors.
I read that post by Joel a couple days ago (it was on the top of Hacker News). It’s good, but like he said, it’s the most basic situation.Sometimes, you compensate people for the risk, but other times, you compensate them for the value that they put in. So if an investor puts in $100k, that may be the same as a founder contributing $100k worth of work.Here’s an interesting question: if you are starting out, do you want to give 50% to a co-founder, or 50% to an investor who can give you the money to hire 4 employees? Put this way, the investor is like a co-founder who put in money but not necessarily much time. You put in your time, you manage the 4 employees, but the overall capabilities of your team are that much greater.Why do people want to give more equity to co-founders than investors? Because, I believe, of the psychology. Our time is the most valuable thing we have, because we all have the same amount of it. If someone is going to putting a year of full-time work into your project, that is a bigger cost to them than putting in $100k is for an accredited investor. Perhaps not economically, but in terms of their life, it is.here is some empirical research: http://founderresearch.blog…
Well… yes and no.I disagree in that “ideas are pretty much worthless”. Tell that to Jack Dorsey and Twitter.But then Joel has a point when he says “the perception of fairness” is worth more.I’m pretty certain Jack Dorsey’s idea is worth a lot more than the first Twitter implementation him and his team made.But then I’m also certain “the perception of fairness” in the deal they got going was probably worth a lot more in the long run, because it allowed them to get going to make Twitter grow through thick and thin.
What’s funny is my passing out to HS Students the current issue of Fbook regarding the other side who was paying Mark as he (is it still allegedly?) was holding off the twins.Leaving aside the importance of end result re % ownership, this represents a very important lesson regarding the possesion of idea and then moving forward.Team members are just as important as Angel sources.
Right. But how much of his original idea made it into the product vs inputsfrom Noah, Biz, developers who worked on it, the community (@replies,hashtags)
I think that the perception of fairness that says the sum of all minor contributions are bigger than the original concept, is just that, a perception of fairness. And it’s probably not an accurate one.I’m all for cooperative ownership, and I’m all for a perception of fairness that helps to make the ball move forward.But this is a very specifically tuned perception of fairness that shouldn’t be overlooked, or you can risk turning it into an unearned feeling of entitlement, committee “effort”, or undesirable company culture.
Joel mentions other income (paying gigs) as a decision boundary for rewarding effort with IOUs or the possibility of future cash, instead of equity. What about cofounders with other responsibilities like family, dependents, an active social life, a longer sleep cycle or health issues that require time. Isn’t Joel stating that all early team member’s time should be valued equally? If so then almost no one qualifies as a founder and we should all write each other IOUs for cash.How many early startup investors take IOUs for the possibility of future fixed percent gains? They buy equity with their dollars, why should the risk of contributing time be rewarded any less so?If perceived fairness is the bullseye, we must agree on what it means to be fair. Experience shows we tend to shift fairness in favor of the guy or gal with control or capital.
Like many things in life, while it is useful to develop general standards very rarely does “one size fit all”.Equity is both a financial consideration and an emotional consideration. In many ways it is the mortar which holds companies together while also being the special sauce which injects the flavor of the seasoned veteran into the seemingly sterile employer-employee relationship. But it is only one ingredient in a complex recipe for success.Compensation programs at the highest levels should be tailored to provide immediate compensation, excellent benefits, short term incentive compensation, long term incentive compensation and “something special”.One of the things that I think is often overlooked in building companies is the company history — a nice leather bound book with the visual record of the company’s founding and growth. This is an important talisman for any enterprise. It ensures that the company’s campfire fable is consistent and accurate.I say these things because equity is part of a fabric which weaves the company’s mission, vision, values and history into a tapestry in which an individual wants to knot their individual life thread.I don’t think that founders should think that if they simply give followers or employees a one dimensional drop of equity that all is well. Equity has to be delivered in concert with the other elements of the recipe.On a personal note, I would give all others than founders “phantom equity” which looks, feels and plays like equity but is simply not the voting equity of the company. This thought is as a result of having lived through a few horribles. It is the financial equivalent of equity but it is not the control equivalent of equity.
Nothing to do with this post. I’m going to be in Austin next Thursday. Would love to meet. If you’re interested send me an email to [email protected]
Thanks for writing this Fred. This was one of the topics that we discussed last night. Just posted your link in the discussion area here – http://www.ny-entrepreneur-…
Poll question for the day: Who’s the better-known founder, Max Levchin or Peter Thiel?1) You got the idea, congrats. My Grandma is full of great ideas2) Burn the boats3) Be Thiel, hire Levchin
I’m sorry but I think the article should say “ideas alone are pretty much worthless”, but even then I think it’s not entirely fair.An idea for me is a seed. Does a seed alone make a plant? No, you need earth, minerals, water, a caring gardner, good weather conditions etc..is a seed worthless? No, it’s not. It’s the core of your entire operation.So don’t be ungrateful to the person with the idea, and don’t undermine them by saying they came up with it during shower. It’s especially unfair that VC’s and one-time entrepreneurs would earn a lot of money and go back and give people crap about how utterly worthless their ideas are, when they had either one good idea or none at all.
I also ‘certainly the perception of fairness “and deal with them took off was probably worth much more in the long run, because they were planning to do on Twitter to grow better or worse.Contemporary Furniture
Vesting is important Charlie if you are a venture capitalist.Its important for founder too, but lets call a spade a spade – VC’s see vesting as insurance. Thats fine – but i want insurance back (forwards vest) if you fire me.i think there are two issues gettting mixed up here.there is the issue of founding splits, and how they are treated, and there is the issue of tomorrow where a company accepts a new partner and the terms (vesting) that might come along with that.
Your explanation is a good one, for on that note, the one with the idea probably is on the lower end of the ownership. That works if his partners are on the level to bring about what is needed for that idea.Better yet, if the partners are looking at solving a bigger problem (in steps), it probably comes down to the split based on using profit to fund R&D forward.
Charlie,So far we have that in the context of information technology (IT) entrepreneurship a claim that ideas are “worthless”.Again, if what is meant by an ‘idea’ is a description as would give to a customer, etc., of the product or service of the business, then fine.But there can also be other ideas, ‘technical’ ones, with high financial value to the business. Such an idea might be protected with patents or as a trade secret. The idea might enable much better results for the customers and be difficult to duplicate or equal. The results for the customers might be unique and so good that the rest of the business was just routine execution and in total the business was quite valuable. In such a case, the technical idea was not “worthless”.Are such technical ideas common in IT entrepreneurship? Not yet!
I think it’s too simplistic. Eventually, yes, the boats must burn. Or turn around and sail away. But in the early days, I’m not going to be wary of my co-founder who didn’t burn his boat when I burned mine. If I’m wary, then I’ve got the wrong partner.The last thing I’d want is a talented developer freaking out on the beach wondering how he’s going to feed his family. I really think that on this topic, “it depends”.If we force people into absolutes that they can’t and shouldn’t live with we’ll end up with fewer startups.
Too complicated – how do you get SMB to start without some push. A lot of them start out from ones part time life
but then you have money to buy more boats… ;)seriously, tho, this isn’t abt converting resources (which you know), it’s abt absolute commitment wrt the decision chain:- tell people. Peer pressure is powerful- quit your job. You *have* to do the startup now.- just fucking do it. Stop talking + do something.
Is that necessarily bad? I think there are a lot of startups that should never be.There’s a state before a company becomes a startup. By all means you can parallel process during this stage. It can go on for years. It’s the burr under the saddle. It’s musing and dabbling. It’s sketches and prototypes and system diagrams. I’ve killed dozens of things that could have become startups at this stage. IMO lots more things should get killed at this stage.I have spent 20 years wrestling with the ideas and the issues and the problems of what has become my latest company. But after enough sleepless nights thinking about it, and a market that is moving to meet me, and a bit of serendipity (hugely underappreciated in the startup game) and being a a good point in my life to do it, with the blessing of my wife (and that’s a whole other post, she’s threatening to write a book called “Startup Wife”), I closed down all my other projects and went full time on Synchronize.TV.
ME, GRIMLOCK, NOT START ANY BUSINESS WITH GUY THAT SAY “UH, MAYBE WE’LL SUCCEED.”
Congrats on Synchronize.TV….I get the “burr under saddle” image perfectly. That’s Folkstory for me, exactly.I was really talking about the can’t be a co-founder if don’t burn boats argument. I’m really fortunate to be in a position to burn my boat. But I’ve got partners that I think of as co-founders who aren’t and who shouldn’t.Really I’m just having my standard reaction to any form of absolutism…a strong desire to tear it down!hey, after looking at your bio the burn the boats image takes on more meaning! Good luck w S.tv!
This is a good comment. “I’ve killed dozens of things that could have become startups at this stage. IMO lots more things should get killed at this stage”My only worry about the tons of startup financing that is going on right now is what happens with the tons of failure.From a BtoC stage its ok I suppose, but if you are doing BtoB the second B stands for “bent over” which is what happens if you work for a traditional business that picks a start-up that fails.Don’t get me wrong I love to see early stage financing becoming easier. I’ve always been annoyed at the: Lets talk when you get past $5M in revenue with 20% operating margins…why exactly do I need you?However its only logical that if you fund tons more start-ups, you certainly are going to have more net successes, but the percentage of failures will increase even more because more marginal teams will be funded.
maybe we’re just talking about what you have to do to be called a co-founder. I think that label is motivating, so I’m happy to share it with my partners. even though they’re drawing cash comp and I’m the only investor.my real argument is this – there is more than one way up the mountain.
Simplicity is good in some decision making, it gets passed the bs quickly. For me there are two types of companies, the ones I found, and the ones I work for. Determining which makes other decisions much easier.Trust is the currency we live on before customers, pre revenue and funding. Without it we’ve got nothing. Seeing a team commit is a strong signal of trust to each other. Forging a startup is like trying to start a bonfire in a rainstorm, glad yours is sparking to life.
no thats correct charlie you dont. but there are exceptions and in my case i felt it absolutely valid to make one.
Vesting is like air. I can’t imagine building nor recruiting for a start-up without it.I’m a big believer in accelerated vesting on change of control. I’m a big believer in sharing the wealth.But more than anything, equity needs to be earned over time just like value is created over time.
I wrote a post on founder vesting a while back. I bet you will think myapproach is very fair
Haekeye was awesome
That’s happening big-time right now. I can’t say its bad because I am a hugefan of entrepreneurship and taking a shot. But the failure right will bevery high
…remind me of sentences without endings.
True but the risk/reward equation in that case is skewed so much further towards the reward than the risk that it’s almost insane NOT to take the chance.
Yes. and i did – and its very close to what we are following (helps to have Wilmer guidance also).