Changing Equity Structures for Early Startup Employees

Recently someone asked me for advice on how much equity they should give to their early employees. His company had just closed an early round of funding and he wanted to cement the employee relationships. I gave him similar numbers to what I had been given when I was hiring the first few employees for Standout Jobs. And I told him that the numbers were fairly standard, based on guidelines I had seen used in other places. But I also told him that I though the numbers were wrong.

The numbers look quite similar to what is provided by Venture Hacks.

David Crow just posted about this very topic: Founders vs. Early Employees and shows the Venture Hacks chart.

Equity for startups

David’s absolutely correct when he writes, “Remember the goal is to incent early employees to have an emotional ownership of the product and company they are building. Equally said, potential employees need to understand what they are getting into.”

But having thought about this for some time, I’m not sure the numbers provided as guidelines above really do incent early employees to have an emotional ownership of the product and company.

This is especially true when you think of a tech startup, where the first few hires are typically engineers/programmers. 0.5-1% is just not a lot. Those first few hires – done correctly – will be so insanely critical for the success of your startup; I believe they deserve more. Those first employees will take 0.5-1% but they’re not going to be overwhelmed by it, or insanely incentivized by that equity alone. Most people know that the chance of a huge, $100MM exit are very slim (where their 0.5-1% is actually worth something!) The people who join startups would all nod their heads reading Dharmesh Shah’s 17 Pithy Insights for Startup Employees. (If not, you better go check them out.)

Paul Graham offers up a formula for the equity challenge, which I think proves the fact that those first few employees deserve more.

I recognize that it’s challenging to give much more than the accepted guidelines on equity to early startup employees. You can’t have an option pool that takes up 50% of the company’s shares, and you have to leave room for future employees as well. And, I don’t believe that anyone joins a startup exclusively (or even primarily) for the equity; if that’s the case, they’re the wrong employee. But nevertheless, I do think that the first few employees – especially those ever-critical developers – need to be more properly incentivized and made to feel closer to founders than employees. As John Cook puts it, great startup cultures are, in part, equity-driven.

The more that those first employees feel like founders in terms of their ownership, emotional attachment, responsibility and overall understanding of the startup process (including financing, running day-to-day activities, etc.) the better the startup will be.

I do believe that early employees should trade salary for equity. And if the equity values increase, it provides more reasonable wiggle room between salary and equity.

Incidentally, for all startup employees (or potential startup employees) I would strongly encourage you to read Chris Dixon’s blog, including this post: The one number you should know about your equity grant. Chris is putting out a ton of great content, and encouraging exceptional debate and discussion on startups and investing.

September 11, 2009 Posted in Startups by

  • http://bmannconsulting.com boris

    As posted on David's post — those numbers are POST Series A funding — so the numbers are completely wrong for pre-funded startups.

  • http://bmannconsulting.com boris

    As posted on David's post — those numbers are POST Series A funding — so the numbers are completely wrong for pre-funded startups.

  • http://bmannconsulting.com boris

    As posted on David's post — those numbers are POST Series A funding — so the numbers are completely wrong for pre-funded startups.

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Boris – Thanks for commenting. I get that the numbers are post Series A, but even if you assume 50% dilution, you're giving your first hire developer between 1-2%. That's still not THAT much…

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Boris – Thanks for commenting. I get that the numbers are post Series A, but even if you assume 50% dilution, you're giving your first hire developer between 1-2%. That's still not THAT much…

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Boris – Thanks for commenting. I get that the numbers are post Series A, but even if you assume 50% dilution, you're giving your first hire developer between 1-2%. That's still not THAT much…

  • patrickritchie

    That 0.5-1% is even less after you factor in dilution. If it's pre VC the following scenario is very plausible.

    To make round numbers let's say you have 100,000 share outstanding and you give your lead engineer 1000.

    Round 1: 50% total shares out 200000
    Round 2: 33% total shares out 300000
    Round 3: 25% total shares out 400000

    Real % left to your lead engineer: 0.25%. If we assume 5 year to a $100MM exit that's 250k. Not a bad payday. But if you took a 40k / year pay cut to get that equity, at the end of the day you're making about the same as you could have made elsewhere… you just had to wait 5 years to get it! Doesn't sound like much of an incentive to me!

  • patrickritchie

    That 0.5-1% is even less after you factor in dilution. If it's pre VC the following scenario is very plausible.

    To make round numbers let's say you have 100,000 share outstanding and you give your lead engineer 1000.

    Round 1: 50% total shares out 200000
    Round 2: 33% total shares out 300000
    Round 3: 25% total shares out 400000

    Real % left to your lead engineer: 0.25%. If we assume 5 year to a $100MM exit that's 250k. Not a bad payday. But if you took a 40k / year pay cut to get that equity, at the end of the day you're making about the same as you could have made elsewhere… you just had to wait 5 years to get it! Doesn't sound like much of an incentive to me!

  • patrickritchie

    That 0.5-1% is even less after you factor in dilution. If it's pre VC the following scenario is very plausible.

    To make round numbers let's say you have 100,000 share outstanding and you give your lead engineer 1000.

    Round 1: 50% total shares out 200000
    Round 2: 33% total shares out 300000
    Round 3: 25% total shares out 400000

    Real % left to your lead engineer: 0.25%. If we assume 5 year to a $100MM exit that's 250k. Not a bad payday. But if you took a 40k / year pay cut to get that equity, at the end of the day you're making about the same as you could have made elsewhere… you just had to wait 5 years to get it! Doesn't sound like much of an incentive to me!

  • Pingback: VC part 3: Engineers deserve more equity — Some French Guy

  • http://newissuesmag.blogspot.com/ Johns

    In my opinion, giving or not giving employees (especially the early employees in question here) equity in a business is really a tough question, when you look at the trade-off you might be making should the enterprise you are starting really pick. Of course, it is a great idea when you are short of funds but want a way of keeping the best talent you can get for your new enterprise. Otherwise, I think it is better to keep employees as employees and company owners as company owners – where the employees are paid a decent salary for their efforts but with no other stake in the company, but where other motivational methods are employed to get them to give their very best to the new business: because when all is said and done, one need not have a stake in an organization to give it their best. Good human resource management practice can see you motivate your staff to give their very best without necessarily turning them into intrapreneurs, because when all is said and done, most people looking and taking up jobs do so because the don't to get into the intricacies of company ownership. Just my take though :)

  • http://newissuesmag.blogspot.com/ Johns

    In my opinion, giving or not giving employees (especially the early employees in question here) equity in a business is really a tough question, when you look at the trade-off you might be making should the enterprise you are starting really pick. Of course, it is a great idea when you are short of funds but want a way of keeping the best talent you can get for your new enterprise. Otherwise, I think it is better to keep employees as employees and company owners as company owners – where the employees are paid a decent salary for their efforts but with no other stake in the company, but where other motivational methods are employed to get them to give their very best to the new business: because when all is said and done, one need not have a stake in an organization to give it their best. Good human resource management practice can see you motivate your staff to give their very best without necessarily turning them into intrapreneurs, because when all is said and done, most people looking and taking up jobs do so because the don't to get into the intricacies of company ownership. Just my take though :)

  • http://newissuesmag.blogspot.com/ Johns

    In my opinion, giving or not giving employees (especially the early employees in question here) equity in a business is really a tough question, when you look at the trade-off you might be making should the enterprise you are starting really pick. Of course, it is a great idea when you are short of funds but want a way of keeping the best talent you can get for your new enterprise. Otherwise, I think it is better to keep employees as employees and company owners as company owners – where the employees are paid a decent salary for their efforts but with no other stake in the company, but where other motivational methods are employed to get them to give their very best to the new business: because when all is said and done, one need not have a stake in an organization to give it their best. Good human resource management practice can see you motivate your staff to give their very best without necessarily turning them into intrapreneurs, because when all is said and done, most people looking and taking up jobs do so because the don't to get into the intricacies of company ownership. Just my take though :)

  • http://twitter.com/startupcfo Mark MacLeod

    I have seen many cases where early employees were granted founder shares that were not much below grants that senior managers would get later on in a startups' life.

    In the early days, you are usually not constrained by VC convention so should incent your key team members. So, I guess I agree with you

  • http://twitter.com/startupcfo Mark MacLeod

    I have seen many cases where early employees were granted founder shares that were not much below grants that senior managers would get later on in a startups' life.

    In the early days, you are usually not constrained by VC convention so should incent your key team members. So, I guess I agree with you

  • http://twitter.com/startupcfo Mark MacLeod

    I have seen many cases where early employees were granted founder shares that were not much below grants that senior managers would get later on in a startups' life.

    In the early days, you are usually not constrained by VC convention so should incent your key team members. So, I guess I agree with you

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Mark – giving out founder shares to the early employees is an interesting idea. Immediately makes them more like owners than employees, and doesn't have the same vesting timeline. Hhhm…

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Mark – giving out founder shares to the early employees is an interesting idea. Immediately makes them more like owners than employees, and doesn't have the same vesting timeline. Hhhm…

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Mark – giving out founder shares to the early employees is an interesting idea. Immediately makes them more like owners than employees, and doesn't have the same vesting timeline. Hhhm…

  • http://www.venturelawassociates.com/ Suzie Dingwall

    Don't you think that the important variable in here is the particular employees in question? I always think that comp design strategy should attract and retain those key employees you need to create the value you need within the time frame you need it. If you skimp on options and the recipient does not outperform, who's going to be surprised? In the alternate, if you gave options to someone who does not particularly value them,you just threw equity away for no valid HR purpose. A related point is defending why as a start-up you chose to award options at all. If your company is likely to become profitable and stay private in the near term, (rather than be bought in the next few years), a bonus or profit-sharing plan is probably going to incent performance in a more meaningful way anyhow.

  • http://www.venturelawassociates.com/ Suzie Dingwall

    Don't you think that the important variable in here is the particular employees in question? I always think that comp design strategy should attract and retain those key employees you need to create the value you need within the time frame you need it. If you skimp on options and the recipient does not outperform, who's going to be surprised? In the alternate, if you gave options to someone who does not particularly value them,you just threw equity away for no valid HR purpose. A related point is defending why as a start-up you chose to award options at all. If your company is likely to become profitable and stay private in the near term, (rather than be bought in the next few years), a bonus or profit-sharing plan is probably going to incent performance in a more meaningful way anyhow.

  • http://www.venturelawassociates.com/ Suzie Dingwall

    Don't you think that the important variable in here is the particular employees in question? I always think that comp design strategy should attract and retain those key employees you need to create the value you need within the time frame you need it. If you skimp on options and the recipient does not outperform, who's going to be surprised? In the alternate, if you gave options to someone who does not particularly value them,you just threw equity away for no valid HR purpose. A related point is defending why as a start-up you chose to award options at all. If your company is likely to become profitable and stay private in the near term, (rather than be bought in the next few years), a bonus or profit-sharing plan is probably going to incent performance in a more meaningful way anyhow.

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Suzie – Thank you for the comment. I agree that the particular employee is critical. And there are cases I suppose where #30 will be creating more value than #10, for example — but the first handful of employees should be the ones that, at least initially, create the most value.

    The company's goals and the employee's goals have to be aligned for anything like this to work. If the company's goal is to run a lifestyle business, then options/equity is a moot point. If an employee doesn't value options/equity, I agree, there's no point giving them significant amounts. There are lots of different variables and cases.

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Suzie – Thank you for the comment. I agree that the particular employee is critical. And there are cases I suppose where #30 will be creating more value than #10, for example — but the first handful of employees should be the ones that, at least initially, create the most value.

    The company's goals and the employee's goals have to be aligned for anything like this to work. If the company's goal is to run a lifestyle business, then options/equity is a moot point. If an employee doesn't value options/equity, I agree, there's no point giving them significant amounts. There are lots of different variables and cases.

  • http://www.instigatorblog.com Benjamin Yoskovitz

    Suzie – Thank you for the comment. I agree that the particular employee is critical. And there are cases I suppose where #30 will be creating more value than #10, for example — but the first handful of employees should be the ones that, at least initially, create the most value.

    The company's goals and the employee's goals have to be aligned for anything like this to work. If the company's goal is to run a lifestyle business, then options/equity is a moot point. If an employee doesn't value options/equity, I agree, there's no point giving them significant amounts. There are lots of different variables and cases.

  • http://www.mashstix.com/ Mashup

    I was looking for a chart like this as I had the same question. Thank you and great post bud.

  • http://www.mashstix.com/ Mashup

    I was looking for a chart like this as I had the same question. Thank you and great post bud.

  • http://www.mashstix.com/ Mashup

    I was looking for a chart like this as I had the same question. Thank you and great post bud.

  • turtlebarbeque

    I always believed the equity distribution is primarily based on the worth of the contribution. Early stage funding often bets subsatntial equity because the founders have liitle choices and thus the worth of the investor is really quite high. The same is true of employees. A standard programmer who writes “generic” LAMP or C++ is easily replaceable and therefor warrants little ownership unless finding cash to pay a replacement is tight.

  • turtlebarbeque

    I always believed the equity distribution is primarily based on the worth of the contribution. Early stage funding often bets subsatntial equity because the founders have liitle choices and thus the worth of the investor is really quite high. The same is true of employees. A standard programmer who writes “generic” LAMP or C++ is easily replaceable and therefor warrants little ownership unless finding cash to pay a replacement is tight.

  • turtlebarbeque

    I always believed the equity distribution is primarily based on the worth of the contribution. Early stage funding often bets subsatntial equity because the founders have liitle choices and thus the worth of the investor is really quite high. The same is true of employees. A standard programmer who writes “generic” LAMP or C++ is easily replaceable and therefor warrants little ownership unless finding cash to pay a replacement is tight.

  • stockexplosion

    I completely agree with you.. This is a great post. Thanks for sharing!

    Jason
    Penny Stocks

  • stockexplosion

    I completely agree with you.. This is a great post. Thanks for sharing!

    Jason
    Penny Stocks

  • stockexplosion

    I completely agree with you.. This is a great post. Thanks for sharing!

    Jason
    Penny Stocks

  • http://www.rakebackleader.com poker rakeback

    Employees that feel they have a vested interest in their company will work much harder than those who don't. So, giving them early incentives to promote loyalty and foster a great working relationship is essential to a businesses success.

  • http://www.rakebackleader.com poker rakeback

    Employees that feel they have a vested interest in their company will work much harder than those who don't. So, giving them early incentives to promote loyalty and foster a great working relationship is essential to a businesses success.

  • http://www.rakebackleader.com poker rakeback

    Employees that feel they have a vested interest in their company will work much harder than those who don't. So, giving them early incentives to promote loyalty and foster a great working relationship is essential to a businesses success.

  • Atornysmax

    Interesting lines,”The more that those first employees feel like founders in terms of their ownership, emotional attachment, responsibility and overall understanding of the startup process (including financing, running day-to-day activities, etc.) the better the startup will be”.
    http://www.attorneysmax.com/

  • jerryvintagetshirts

    Hi there! I agree with you somewhere. I liked this post very much. I like to read such an article. It is very helpful. It is very interesting and informative. Thanks for sharing such a nice article. Keep on sharing such a great article. Best of luck for ahead.

  • http://panamamark.wordpress.com/ PanamaMark

    I agree Johns, it's a tough question with plenty of variables. One of the first things to think about is where the new employee is coming from. Most if not all new hires will be 'needs driven'. Not nec financial needs but psych needs. It takes a little time to get 'buy in' and all the new employees values to come out. I suggest giving any employee a share of the company needs to be a values based decision and one which can only be made after time. Mark

  • http://panamamark.wordpress.com/ PanamaMark

    I agree Johns, it's a tough question with plenty of variables. One of the first things to think about is where the new employee is coming from. Most if not all new hires will be 'needs driven'. Not nec financial needs but psych needs. It takes a little time to get 'buy in' and all the new employees values to come out. I suggest giving any employee a share of the company needs to be a values based decision and one which can only be made after time. Mark

  • PanamaMark

    I agree Johns, it's a tough question with plenty of variables. One of the first things to think about is where the new employee is coming from. Most if not all new hires will be 'needs driven'. Not nec financial needs but psych needs. It takes a little time to get 'buy in' and all the new employees values to come out. I suggest giving any employee a share of the company needs to be a values based decision and one which can only be made after time.

  • http://www.brokersense.com/ Michael Comeau

    Good piece. I agree about the engineers. It's easy for them to get burnt out working hard to get a company up and running. They need a shot at a pot of gold.

  • http://www.brokersense.com/ Michael Comeau

    Good piece. I agree about the engineers. It's easy for them to get burnt out working hard to get a company up and running. They need a shot at a pot of gold.

  • http://www.brokersense.com/ Michael Comeau

    Good piece. I agree about the engineers. It's easy for them to get burnt out working hard to get a company up and running. They need a shot at a pot of gold.

  • http://www.brokersense.com/ Michael Comeau

    Good piece. I agree about the engineers. It's easy for them to get burnt out working hard to get a company up and running. They need a shot at a pot of gold.

  • Pingback: Equity for Early Employees in Early Stage Startups | Venture Funding Blog

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Ben Yoskovitz
I'm VP Product at Codified (makers of VarageSale).

I'm also a Founding Partner at Year One Labs, an early stage accelerator in Montreal. Previously I founded Standout Jobs (and sold it).

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