What is the best way to adjust options?


3

Me and my partner are about to start a new startup. I'm much more financially prepared than he is so we've agreed on the following structure.

I would fund the company with half a million for the first year's operations. My partner would not put in any money as he cannot afford to. His skill set is critical to the success of the company so I've decided to award him options over the period of three years where he can exercise for 50% of the company. The strike price will be set at half a million.

The structure works good as we both think it's fair. He gets half of the company by working hard and I get half the company by taking all the financial risk. However the issue arise when the company needs additional funding from me say another half a million in the second year. What should we do then? Readjust his options' strike price to 1 million? But what if the options are given on a pro rated basis annually?

What's a straight forward way to solve this?

Getting Started Funding Equity Stock Options

asked Nov 30 '11 at 10:49
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Erotsppa
139 points

5 Answers


3

If you spend half a million in year one and still need another half million in year two, you should probably stop. Also, how does your partner afford the options if they are working full time on a company that still needs funding?

For me, you say "His skill set is critical to the success of the company...", so why not give the 50% for nothing? Well, not for nothing, for a whole bunch of hard work actually, for probably not much reward in the early days.

answered Dec 2 '11 at 19:12
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Steve Jones
3,239 points

2

It is very hard to find the right advice to give you, given the limited information I have...

What are you going to spend the money on? Does the potential partner get a salary, if so, of how much?

Half a million is a lot of money, especially for a pre-seed round. Did you test the market to make sure it makes sense to pure in that much cash, and raise more soon after that? It is very rare that you would need that much money to prove that your business plan works or to see if you need to chance it.

I suggest learning the lean-startup philosophy, and reading books by 37 signals reading books by 37 Do you really need your partner's money? Why not have his stock simply vested, so that if he leaves the company too early he looses most of his shares? If he performs well, then he deserves the shares, and if not, you can fire him.

As for the funding issues, if you are still set on the structure you described here, it should not affect future investors, as they will be able to take into account the additional stock, especially if you have them vested when you set up the company. It is true that Google gave away too many options, leading to millionaire cooks and the likes, and that Zynga wishes now that they wouldn't have given options to their programers (which seems more like greed then anything else) but a co-founder with vested options is something that investors like... If anything, they would like your stock vested as well to make sure you stay in the company (assuming that you have a role in the company other then funding it).

All and all, there are a lot of options (no pun intended) and I need a lot more information about your status to give you any meaningful advice

Good luck!

answered Dec 3 '11 at 19:02
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Ron Ga
2,181 points

1

I have experienced a similar constellation.

I am assuming some facts:
Your partner will not have enough money to work for free for one or two years.
You, it seems, will only finance the company, but not actively work for it.
You see yourself as equal partners in this venture, and both want to have a company and earn a lot of money after two years.

Make a business case, how much money will you need until the company is profitable. And how many hours from you and your partner. And make the business case with some buffer money/hours to be on the safe side.

Now set up the partnership like this:
You pay the money, and share the company 50% each. Each of you has to work the agreed amount of money for minmum wages (whatever you agree on is a "minimum wage").

Find some milestones, agree on a reasonable work amount and timeline, and pay bonuses per planned working hours. Yes, money from the company.

And if any partner does not work the agreed amount, or wants to stop working, or doesn't provide the agreed resources, the other partner receives the shares of the quitting partner in relation to the hours/resources not done.

This has the following advantages:

  • You are 50% partners from the beginning, all decisions will be decided by both of you.
  • No partner needs to work other jobs to eat/live, taking away working hours from the company.
  • The bonuses in cash help raise morale because minimum wages make it tough to live on for two years.
  • And if a partner doesn't stay on board, he looses his shares accordingly to the work, he did not do.

This should be a fair set up.
And in case it doesn't work out, and your estimation was wrong, do the same as above for the next round, starting with the business case. But if the new contributions from both partners are not valued equally, their additional shares should also be divided accordingly.

This worked for a company I know of. The most important point was the business case. The costs need to be real, buffers included, bonuses included, holidays, illness, whatever.
And the income should not be wishful thinking. And use the milestones as approval for the estimated working hours until this milestone from each partner.

My 0.02$

answered Dec 6 '11 at 22:19
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Gmg
11 points

0

His option should be updated to reflect the same share you end up with, for the same 500k.

unless you are putting more money along with the first round of dilution. If not, all you put for your share was 500K, so he should have the same at the end.

answered Dec 6 '11 at 08:12
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Gcb
101 points

0

There is no one true way but there are a range of factors you can use to consider.
I think you need to find a common factor between your money and his skilled sweat equity.

Currently you have $500,000 / 1 year (1920 hours is a standard year working 160 hours a month 8 hours a week day). In a startup this could include weekends and longer days so lets say 2200 hours.
This means you value his sweat equity at $227 per hour. Which is not unreasonable if you view it as you are giving him a sweat equity multiplier of 3x or 4x (thus hourly rate is more like $56 per hour) ... generous but well within bounds.

The factors I would consider.

  • give your money a risk Multiplier say 2x or 3x
  • give his hours a value ongoing (say $100 per hour to make my math easier) and a sweat multiplier say 3x or 4x
This does several things,

  • it lets you see the long term trend over
  • it implies he has to "earn his way", if he only does half the hours you now have a ratio by which to judge his input.
  • When it comes to the second round you then have a yardstick to judge it by. At that stage your risk on your $500,000 is going to be less than it is today ... his is probably going to be earning something out of the revenue of the business. You can adjust these factors between you to come up with the new "input" from each side.
  • It gives you a variable and pattern to judge employees 2 through 10 with as well.
Rules on sunset.

If you sell out who gets paid out first in what order ... I would suggest you take out $2 to every $1 of his dollars until you reach the middle ground implied by the multipliers then you pay evenly after that ... if you sell for $2M then you get your money back with interest and he gets something if you sell for $20M then it really doesn't matter that much either way.

answered Dec 6 '11 at 15:46
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Robin Vessey
8,394 points

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