What percent of equity is fair for first engineer?

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 ?

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.

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.

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.

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.