What percent of equity is fair for first engineer?


4

I am interested in joining a very early formation phase startup and would like to get some idea as to what to expect. The startup will consist of 4-5 people all on the marketing and PR side. They have done their research and have a fairly solid business plan in place. So the business side of the house is in check. I will be joining as the first engineer and will kick off the prototype development. Everything with regards to the technology aspect will be built from scratch so I will initially be responsible to get it going and will soon be joined by more developers. There is no technical design in place but there are some similar products and services that they want to base the technology on (it is a "Big Data" with mobile and back end services setup).

I will be joining on a part time basis with a combination of equity and deferred compensation arrangement. The deferred compensation hourly is going to be approximately 60-70% of market rate. What percent of equity would be fair in this situation ?

Equity

asked Jul 21 '13 at 04:46
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Guest User
21 points
Get up to $750K in working capital to finance your business: Clarify Capital Business Loans
  • Compensation that is deferred until when? If the business never makes money, will you ever get paid? – rbwhitaker 9 years ago
  • How much capital has been raised so far and how many shares have been issued? – Frenchie 9 years ago
  • Compensation will be deferred until capital is raised, there has not been any capital raised at this point. I need to negotiate how things will be handled if business never makes money. The outstanding shares are 10M with a 15% options pool. – Guest User 9 years ago

4 Answers


4

I can't tell you the number, but I can tell you how to calculate it.

For easy math, let's say that market salary for that position is $100k/year. You'll be paid 60% of that in deferred cash, which is $60k.

Think of the $40k that you're not being paid as an investment in the company.

To calculate how much $40k is worth you need to know the valuation of the company. If there was a funding round, use the the valuation from the funding round. If not, come up with a number.

Let's say, for easy math, the valuation is $1mil. $40k is 4%. That is the minimum you should ask and you should get 4% after every year of full-time work i.e. you should get 4% after first year, 8% after second year etc., as long as you make below-market salary.

However, you should also take risk into account. Let's say there's 90% chance the business will fail. In economics value adjusted for risk is called expected value and in that case it would be $400k (because there's 10% chance you'll get everything, 90% chance you'll get nothing and 10% * $400k + 90% * $0 = $400k * 0.1 = $40k).

So the fair value of your time investment is 40%.

Notice that I can't tell you a final number because all the intermediary numbers I used will be different than numbers for your specific case. This is just a rational method at arriving at the final number that you can present to your partners to argue for your compensation. Also, it doesn't mean that you'll get that compensation - at the end of the day it'll be a result of negotiation between you and the other guys where both parties present their arguments to get what they want.

That being said: run in the opposite direction. You're taking a terrible risk of working for nothing (the rumor has it 90% of startups die).

Furthermore, if the 6th person (i.e. you) is the only one doing any actual work, it smells like a big disaster. In early days of the business you need all the people to be makers, not business plan or marketing people.

Do you need any of them if you're doing the work of building the product? Do you have hour own ideas you could build? At the end of the day, the best business is one that you own 100%, not scraps of someone else's business.

If you really believe in the idea and can't build it yourself, maybe you can convince the smartest of the 5 to do it in a 50/50 business.

answered Jul 24 '13 at 08:19
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Krzysztof Kowalczyk
1,950 points
  • +1 for "run in the other direction"... this sounds like a lot of pie-in-the-sky, but not enough people actually pitching in. – Theao 9 years ago
  • This math is on the right track. It;s a good approach, but this means you have to have a valuation. The dynamic model (described below) is a better solution to accommodate changes. The author refers to a book and spreadsheet (I wrote them). Let me know if you need copies ([email protected]) – Mike Moyer 9 years ago

2

Deferred compensation is a risky proposition - esp. when the terms / trigger conditions are not clearly specified.

Since you mention that other developers will be joining you in the effort, your / the companies ability to retain their services will likely become a issue as well.

Rather than blending deferred compensation plus a equity component, you may want to consider a variable equity assignment based on contribution. This way, you can agree to the value that you bring to the company (based on your market rate or whatever you are able to negotiate), and then track your contributions (and allotment) on a weekly basis. You get assigned what you contribute.

In addition, this approach can help when you bring on additional workers with different time constraints and skill levels.

A spreadsheet (complete with a video) on how to track / apply this approach can be found here. The author, Mike Moyer, has a blog that describes multiple approaches similar to your situation, and offers a book that goes into further detail. I've read it - its a good read and an excellent resource when attempting to assign equity in a early stage company.

While variable equity approaches are not for everyone / every scenario, it is a valuable tool to consider and can be easily converted into other equity assignment models when the business model dictates.

answered Aug 25 '13 at 01:12
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Jim Galley
9,952 points
  • As I'm the author of the book referenced in this solution I have to give it a thumbs up! If you need a copy of the book or spreadsheet email me at [email protected]. The only point I disagree with is that it might not be for everyone. I think everyone can use this model!! :) – Mike Moyer 9 years ago

1

If is your project you can work without salary...but if isn't your idea or project..mmm you
must think if you believe in the concept or maybe you can learn a new technology to find a better job in the future.

answered Jul 23 '13 at 15:49
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Zao Tao Bao
121 points

0

The book by Mike Moyer Slicing Pie advocates dynamic allocation which I find very compelling. You create a Fund and start allocating value to everyone's contribution without fixed equity assignment. This allows for great flexibility to address all possible unpredictable issues that can arise on the way. I would give it a try.

Disclaimer. I am not affiliated with the author, just a thankful reader.

answered Aug 24 '13 at 17:19
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Dmitri Zaitsev
181 points
  • While the book is good and provides valuable advice, leading your answer with a link to the book and not applying the dynamic equity concept directly to the question makes your answer look spammy. – Jim Galley 9 years ago
  • Applying the concept directly??? The book has extensive analysis with a lot of aspects and variables. I am really curious how you would see it applying directly given the little information provided. – Dmitri Zaitsev 9 years ago
  • BTW, I've been researching the topic for few years and only recently came across the book. And nobody mentioned it here as far as I could see. I myself would be very thankful to anyone who mentioned it to me. Anything but "spammy". And then I am grown up to read it myself :) – Dmitri Zaitsev 9 years ago
  • You're missing the point - I'm not discounting Mikes book. Nor did I downvote your answer or flagged your post as spam (which another user did). I offered suggestions on how to improve your answer - which you can ignore if you so desire. As for "applying the concept directly **to the question**", see my answer. – Jim Galley 9 years ago
  • I am sorry if I missed the point but with the word "spammy" it really did not feel like suggestion. I see you put your time and gave some more details of what Mark writes, which is valuable if the reader is busy and has no time to check the site herself. But otherwise she is directed to the same source of information. – Dmitri Zaitsev 9 years ago
  • I'm the author of the book and I really appreciate the plug Dmitri! Whenever I personally post to forums like this I like to offer a free copy of the book to those who want to read it so I don't sound like I'm trying to sell! My email is [email protected]. I'm happy to answer questions through my site. This topic is near and dear to my heart. I want every entrepreneur to get what they deserve to get! – Mike Moyer 9 years ago
  • I have re-read my and other answers and really feel the word "spammy" is out of place here. And very surprised to see it used by moderator. I refered the asker to new information she did not seem to have. Even without comments (which I give) this can change this person's life. I am surprised and disappointed by negativity such honest and well meant answer can generate here. – Dmitri Zaitsev 9 years ago
  • Here I directed to the same source of information but the asker gave some details that I found compelling to address: [link][http://www.brightjourney.com/q/startup-co-founder-stuck-tricky-equity-position] – Dmitri Zaitsev 9 years ago

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