equity, co-founder, employee-compensationI was recently approached by a family member who has a great idea for a subscription-based software product. He is a CTO, well-versed in tech, and has designed and created (through programmers) several great products in the past (internal, or business-to-business software). I am a sr. software engineer and have worked with him to deliver several of the aforementioned products.
Startup costs are negligible. What is necessary is that we both invest considerable time. Because this product is his idea, I have been offered equity compensation. Essentially, I would be a founding employee (not co-founder), and he would maintain controlling interest in the company (he has verbally expressed that he wants to make the business decisions but that I would have input). The highest number that has been thrown around is 20%.
My personal bias and valuation of what I bring to the table makes it difficult for me to look at the offer objectively. Based on the research that I’ve done, the idea for a product alone doesn’t justify controlling interest, assuming that both employee #1 and employee #2 invest time and money equally from day 1. It looks like that’s what is being advocated here:
https://startups.stackexchange.com/questions/5582/how-to-distribute-ownership-fairly-amongst-founders
Question: Is there ever a scenario where the offer above would be considered fair (an 80/20 or 70/30 split between the founder and a founding employee)?
Based on my reading, and this handy calulator (even assuming a modicum of accuracy, it shows that the 80/20 isn’t close), it seems like the offer isn’t great.
Family politics aside, I would politely decline to work with him.
The fact that he wants to call you a “founding employee” and not a “cofounder” is a huge red flag. He doesn’t want a partner, he wants an employee that who will do what he is told to do.
He’s clearly stated that he will “make the business decisions.”
He wants 4x the equity that you have.
As a senior software developer, you have a lot of options so you can find something better.
PS. I wouldn’t take less than 40%.
Richard Branson has a reputation for bringing branding and expertise to ventures, while partners pick up the tab and give Virgin Group a controlling interest. Whether that’s true I don’t know, but it illustrates an important truth: proven execution ability has high value.
If someone you didn’t know called you up and offered to pay you handsomely to create a product they would own, your default answer might be “yes.” If they offered a small equity stake instead of cash and all they were bringing was the idea, that’s a “no.” Somewhere between those two extremes there’s a deal you could do.
So in this case, what you need isn’t some fancy theory about equity splits in startups, you just need to go and think about the dimensions of what’s a good deal for both of you, use that to inform a conversation, and work your way towards either a negotiation or a polite and firm withdrawal.
I’m going to guess that retaining a majority stake could be a red line for your family member - and that given their track record that’s a deal many others would accept. In such a situation, there are a couple of tools to consider. I’ll use 20% to represent your offer.
First, look at how dilution is going to work, when new people or investors fine on board. If (for instance) shares and options come out of the 80%, over time your holding is going to look great. If new shares are issued, then your position is different. If your family member dilutes down to 51%, at that point you have 13%, still double digits but you need to believe there’s a great exit route to feel motivated by sweat equity alone.
Second, look at the value of your time, and how you could receive that. You can’t expect a market salary on top of a significant equity position, but as a minority shareholder you need to see a path to getting paid. There are a number of ways I’ve seen this tackled. One is additional equity over time. Another is what you might call a virtual salary, accruing into a pot you can claim at a given date (or that crystallises in any liquidity event). Still another is to give you some rights in the asset you’re creating, so that you enjoy some protection in the case that the business and you become separated.
Investors don’t usually like fancy deals, but family members might. So be constructive and creative and maybe you’ll find an awesome win-win deal that will smooth the path to another success for the two of you.
I personally think there are four main factors to consider when distributing shares before / while founding.
The person that has the higher risk should get more revenue. If you quit your job to work full time, if you invest more money, if you could lose more money or otherwise have a higher risk, that should be valued.
Most startups need money. If you ivnest more, you get more. Pretty straightforward.
Time is money. Need I say more?
This is tricky. You bring the software expertise, he brings the idea. Both should be valued.
In your case, both of you bring almost the same value to the table. An idea itself doesn’t make a company. Work does. If he wants to, he can pay somebody for coding the idea and market it himself.
I’d suggest 50% + 1 share for the idea or 50-50.
But all this is theory, what really matters is - talk to him. If you do not feel valued, don’t take the offer. If you do, take it. So let him convince you that 20% is fair or convince him that it isn’t. At the end, who cares for advice from the internet.
All content is licensed under CC BY-SA 3.0.