Joel Spolsky gives a strong case in favor of fairness for early startup equity distribution. Thanks to Fred Wilson for pointing out Joel's answer. I pickup plenty of great startup advice from the AVC community, and on this particular post more than usual. I've extracted a few key points from Joel's post below, but if you're interested in startups I suggest you read his entire answer.
Here's the principle. As your company grows, you tend to add people in "layers".
- The top layer is the first founder or founders. There may be 1, 2, 3, or more of you, but you all start working about the same time, and you all take the same risk... quitting your jobs to go work for a new and unproven company.
- The second layer is the first real employees. By the time you hire this layer, you've got cash coming in from somewhere (investors or customers--doesn't matter). These people didn't take as much risk because they got a salary from day one, and honestly, they didn't start the company, they joined it as a job.
- The third layer are later employees. By the time they joined the company, it was going pretty well.
What happens if you raise an investment? The investment can come from anywhere... an angel, a VC, or someone's dad. Basically, the answer is simple: the investment just dilutes everyone.
Using the example from above... we're two founders, we gave ourselves 2500 shares each, so we each own 50%, and now we go to a VC and he offers to give us a million dollars in exchange for 1/3rd of the company.
1/3rd of the company is 2500 shares. So you make another 2500 shares and give them to the VC. He owns 1/3rd and you each own 1/3rd. That's all there is to it.
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. Anyone who holds on to their day job gets a salary or IOUs, but not equity. If they hang onto that day job until the VC puts in funding and then comes to work for the company full time, they didn't take nearly as much risk and they deserve to receive equity along with the first layer of employees.
What I really appreciated about Joel's equity split:
- It cuts quickly past the immeasurable contribution arguments and focuses on a balanced split
- It has tiered layers of dilution as the company grows
- Investors act as just another dilution layer
But there was one detail of Joel's split I couldn't fully comprehend. He labels any early team member with alternative income creating responsibilities as a non cofounder. Instead of an equity split, he suggests these contributions be rewarded with IOUs, or the promise of future compensation when the company is capable of paying. I described why I took issue with this arbitrary time boundary in my comment on AVC which is copied below:
Joel mentions other sources of income 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.