equityI have recently received a proposition from a friend to go into business creating an app which he has conceptualized and specced out over the last few years. I am developer with 10+ years of experience and I would be driving the technical direction and initial development as well as probably managing the dev team once we hire one after we receive funding after the prototype is built. Details still need to be fully fleshed out. He is not a developer but is a technically oriented business guy with a track record for marketing digital products. He has even started to build a prototype - since this will be a game and we are using Unity, he has been able to figure out how to do some basic things in Unity. I haven’t seen this prototype yet though. He is more of a marketing, business and ‘idea guy’ who also may know investors. I’ll have a lot more details on the 2 roles we have initially after a call with him soon, but I wanted to be armed with the information I’m missing before that.
He has offered me 10% over 5 ‘phases’ he laid out, each phase he estimates would take 1 year except one of the phases would take 1-2 years. He offered that I vest 2% in the company per completion of the phase. As part of this offer, I would also receive ‘payment/salary’ after the first round of funding which would come after completion of phase 1 (protoype completion).
I have done a bunch of research and read on these forums that typically the way this works is a 4 year vesting period which is laid out here. I have also fooled around with the calculator found at foundrs.com.
I have a few questions I’m hoping I can get answers to:
Thank you SO much for taking the time to read this! Any help is GREATLY appreciated!
In my opinion, 10% is way too low. It depends on the relative value of the contributions of the co-founders. Read my below allocation methodology and my comments on same.
(Full disclosure: IMHO, writing code is 1 million times more difficult and crucial for success than marketing.)
That said, in startups, I always advocate allocating shares, not percentages. Allocating shares instead of percentages has the following advantages:
Shares have the following disadvantages:
Using your scenario, let's assume Alice has an idea and asks Bob to build it and they form a company to execute this project and call it Newco.
In Newco's shareholder agreement, let's say Alice and Bob agree that a unanimous vote of the board of directors is required to issue any new shares. And that both Alice and Bob will each control one permanent seat on the board. This means (either of them could essentially veto the issuance of new shares.) Further, let's say they also agreed that today all of Newco's assets (the idea) are worth (let's make up a number), say, $10k. Let's also assume Alice and Bob agree to authorize 3 million shares of common stock and place a mutually agreed value of $1 per share. Now, remember, they have only authorized the 3 million shares. They haven't issued any yet.
Now it's time for Newco to issue Alice equity in exchange for contributing her idea and IP. So Newco will issue Alice 10,000 shares at inception. And Newco will receive ownership of the idea and any intellectual property that goes with it.
Now, let's assume Bob is a web developer who's services are valued on the open market at $100/hr. But Bob has agreed to exchange his web development services in exchange for equity (stock) instead of cash. So Bob should make his contributions and receive 100 shares for every hour of time he puts into the project.
Now let's assume Alice does marketing for the company and her marketing services are valued at, say, $25/hr. Same allocation method applies to Alice as to Bob. Except the hourly allocation rate is different.
See how this works? The co-founders are actually paid in stock shares. Not percentages! And it doesn't matter what the initial value per share is either. As long as it's the same value for both co-founders their ratio will remain constant under all share price selections. The share price will self-calibrate to the correct (market-driven) value the moment new stock is sold for cash; because the capital investors will determine and negotiate a pre-money valuation on the company as a whole. And that mechanism will set the correct value of the share price. Simply divide the pre-money valuation by the number of outstanding shares at the time of the valuation to get the new (market-calibrated) share price and continue with the allocation method above described.
With this share allocation method, there is no need to create an artificial vesting schedule. Vesting occurs as soon as the work is done. Any co-founder who works one day then quits will find their shares naturally diluted as new work is done by other co-founders who are also compensated with shares.
It's easy to see how to add any number of new co-founders and pay them in shares instead of percentages. If they were using percentages instead of shares, adding (and deleting) new co-founders to the team would not be nearly as seamless.
The key to making this share allocation model work is transparency. Create a Google spreadsheet which is essentially a time card that shows how many hours Alice and Bob worked each day, the market value of their contribution and how many new shares were allocated as a result.
https://startups.stackexchange.com/a/9282/5273
In that case, my favorite method is to actually pay co-founders for their work in the form of shares. For example, let's agree that writing code pays 100 shares per day. Doing a presentation pays 1 share per day. Something like that. Then keep people accountable for the number of shares they earn by posting the ownership on a shared Google Sheet for transparency and showing their work product to give the other co-founders an opportunity to object if they think someone earned shares without doing the appropriate amount of work.
And make a cutoff period when one can raise objections about share allocation. Say, two weeks. So if there is no objection, say, two weeks after issuance, it's a done deal. No more arguing about it. You had your chance. Again, a shared Google Sheet helps a lot with this for transparency.
Yes, a 4 year vesting term with a 1yr cliff is very typical for a startup. I’ve also seen vesting for milestones that are met - so a “phase” completion could be considered a milestone. If that doesn’t work for you, you can always negotiate a better measure.
This depends on the written agreement - typically you would vest monthly. So you would own the first shares after the first month. If you were offered 48,000 shares total over 4yrs then you would own 1,000 after the first month. Make sure you are negotiating shares and not options. You should also know how many total company shares will be allocated (so you know when/if your shares get diluted). Use a cap table to ensure tracking and transparency.
The calculator does not account for a variety of factors, so IMO it’s not the most accurate indicator. This really comes down to deliverables - what each of you bring to the business. You should map out responsibilities and goals with the Founder (this should help your argument & give the company structure). The product does not get built without you.
3a. I would start with Phase 1. You will be doing coding work for 20hrs/week. How much would that cost in real dollars to replicate? What is the Founder doing until the prototype is built & how much time is he spending? If you are doing the lion’s share of the work - and responsible for the development & launch of the first product you should be rewarded accordingly. You should really consider yourself a co-founder. I don’t think 35%-40% of shares is unreasonable - and you can probably make a good argument for way more especially if vesting is over 4yrs (so start high when negotiating).
3b. Post funding: your standing in the company will change to an employee and manager. You should negotiate your salary and stock/options for this new role as independent from phase 1. You are now getting paid to do your job and the stock should be an incentive. IMPORTANT: You should also have an agreement in place if the company does not receive funding after phase 1, like acquiring more shares over a shorter vesting period. If there isn’t enough revenue to pay a salary, you want to protect yourself.
Yes, single founders always want to hold on to the majority of shares. In the case of co-founders it is easier to implement 4yr vesting for each founder. So yes, 10% is way too low IMO. If you are truly the “technical” side of the business, you should be compensated as such. If the Founder does not view you in that light, do you want to really move forward? It really comes down to what the sacrifice of 20hrs/week of nights and weekends mean to you. Yes, he can find someone else, but make sure whatever you agree to makes sense for you. Consider what happens if the app is not a success.
As mentioned in #4 above, he considers himself as a single Founder. So unless you make a compelling argument as to being a co-founder it is difficult to force his hand to create vesting. But this can always be negotiated.
Don’t sell yourself short - especially if you’ve never sacrificed the 20hrs/week on nights/weekends (it’s rough). It’s OK to say no - you can find other opportunities at sites like CoFounderlab/Founderdating or at startup events. Good luck!
All content is licensed under CC BY-SA 3.0.