tech-company, mobile-apps, equityIf I have a startup that produces apps, is there a clean way of dividing profits gained from each app amongst only the developers that worked on it?
For instance if my startup were to make an app that simply used native widgets and required no design work, it doesn’t really make sense that the designer should share fully in the revenue from that app. It’s far to much book keeping to keep track of everyone who worked on every app. Even more so when you try to factor in time spent or effort put in. In addition, it seems to me that splitting profits in this way would work to divide the members of the startup. Does anyone have a clean solution to this problem, one that gives credit where credit is due but also keeps unity?
This is a post by Joel Spolsky in answer to an extremely similar question posted on the old answers.onstartups.com (a SE 1.0 site). The original post is no longer online, although the data dump for answers.onstartups.com can be found at http://area51.stackexchange.com/proposals/6243/startup-business. For related meta discussion, see How should we handle questions that were previously answered on a StackExchange "startups" site?
This is such a common question here and elsewhere that I will attempt to write the world's most canonical answer to this question. Hopefully in the future when someone on answers.onstartups asks how to split up the ownership of their new company, you can simply point to this answer.
The most important principle: Fairness, and the perception of fairness, is much more valuable than owning a large stake. Almost everything that can go wrong in a startup will go wrong, and one of the biggest things that can go wrong is huge, angry, shouting matches between the founders as to who worked harder, who owns more, whose idea was it anyway, etc. That is why I would always rather split a new company 50-50 with a friend than insist on owning 60% because "it was my idea," or because "I was more experienced" or anything else. Why? Because if I split the company 60-40, the company is going to fail when we argue ourselves to death. And if you just say, "to heck with it, we can NEVER figure out what the correct split is, so let's just be pals and go 50-50," you'll stay friends and the company will survive.
Thus, I present you with Joel's Totally Fair Method to Divide Up The Ownership of Any Startup.
For simplicity sake, I'm going to start by assuming that you are not going to raise venture capital and you are not going to have outside investors. Later, I'll explain how to deal with venture capital, but for now assume no investors.
Also for simplicity sake, let's temporarily assume that the founders all quit their jobs and start working on the new company full time at the same time. Later, I'll explain how to deal with founders who do not start at the same time.
Here's the principle. As your company grows, you tend to add people in "layers".
The top layer is the first founder or founders. There may be 1, 2, 3, or more of you, but you all start working about the same time, and you all take the same risk... quitting your jobs to go work for a new and unproven company.
The second layer is the first real employees. By the time you hire this layer, you've got cash coming in from somewhere (investors or customers--doesn't matter). These people didn't take as much risk because they got a salary from day one, and honestly, they didn't start the company, they joined it as a job.
The third layer are later employees. By the time they joined the company, it was going pretty well.
For many companies, each "layer" will be approximately one year long. By the time your company is big enough to sell to Google or go public or whatever, you probably have about 6 layers: the founders and roughly five layers of employees. Each successive layer is larger. There might be two founders, five early employees in layer 2, 25 employees in layer 3, and 200 employees in layer 4. The later layers took less risk.
OK, now here's how you use that information:
The founders should end up with about 50% of the company, total. Each of the next five layers should end up with about 10% of the company, split equally among everyone in the layer.
Example:
Two founders start the company. They each take 2500 shares. There are 5000 shares outstanding, so each founder owns half.
They hire four employees in year one. These four employees each take 250 shares. There are 6000 shares outstanding.
They hire another 20 employees in year two. Each one takes 50 shares. They get fewer shares because they took less risk, and they get 50 shares because we're giving each layer 1000 shares to divide up.
By the time the company has six layers, you have given out 10,000 shares. Each founder ends up owning 25%. Each employee layer owns 10% collectively. The earliest employees who took the most risk own the most shares.
Make sense? You don't have to follow this exact formula but the basic idea is that you set up "stripes" of seniority, where the top stripe took the most risk and the bottom stripe took the least, and each "stripe" shares an equal number of shares, which magically gives employees more shares for joining early.
A slightly different way to use the stripes is for seniority. Your top stripe is the founders, below that you reserve a whole stripe for the fancy CEO that you recruited who insisted on owning 10%, the stripe below that is for the early employees and also the top managers, etc. However you organize the stripes, it should be simple and clear and easy to understand and not prone to arguments.
Now that we have a fair system set out, there is one important principle. You must have vesting. Preferably 4 or 5 years. Nobody earns their shares until they've stayed with the company for a year. A good vesting schedule is 25% in the first year, 2% each additional month. Otherwise your co-founder is going to quit after three weeks and show up, 7 years later, claiming he owns 25% of the company. It never makes sense to give anyone equity without vesting. This is an extremely common mistake and it's terrible when it happens. You have these companies where 3 cofounders have been working day and night for five years, and then you discover there's some jerk that quit after two weeks and he still thinks he owns 25% of the company for his two weeks of work.
Now, let me clear up some little things that often complicate the picture.
What happens if you raise an investment? The investment can come from anywhere... an angel, a VC, or someone's dad. Basically, the answer is simple: the investment just dilutes everyone.
Using the example from above... we're two founders, we gave ourselves 2500 shares each, so we each own 50%, and now we go to a VC and he offers to give us a million dollars in exchange for 1/3rd of the company.
1/3rd of the company is 2500 shares. So you make another 2500 shares and give them to the VC. He owns 1/3rd and you each own 1/3rd. That's all there is to it.
What happens if not all the early employees need to take a salary? A lot of times you have one founder who has a little bit of money saved up, so she decides to go without a salary for a while, while the other founder, who needs the money, takes a salary. It is tempting just to give the founder who went without pay more shares to make up for it. The trouble is that you can never figure out the right amount of shares to give. This is just going to cause conflicts. Don't resolve these problems with shares. Instead, just keep a ledger of how much you paid each of the founders, and if someone goes without salary, give them an IOU. Later, when you have money, you'll pay them back in cash. In a few years when the money comes rolling in, or even after the first VC investment, you can pay back each founder so that each founder has taken exactly the same amount of salary from the company.
Shouldn't I get more equity because it was my idea? No. Ideas are pretty much worthless. It is not worth the arguments it would cause to pay someone in equity for an idea. If one of you had the idea but you both quit your jobs and started working at the same time, you should both get the same amount of equity. Working on the company is what causes value, not thinking up some crazy invention in the shower.
What if one of the founders doesn't work full time on the company? Then they're not a founder. In my book nobody who is not working full time counts as a founder. Anyone who holds on to their day job gets a salary or IOUs, but not equity. If they hang onto that day job until the VC puts in funding and then comes to work for the company full time, they didn't take nearly as much risk and they deserve to receive equity along with the first layer of employees.
What if someone contributes equipment or other valuable goods (patents, domain names, etc) to the company? Great. Pay for that in cash or IOUs, not shares. Figure out the right price for that computer they brought with them, or their clever word-processing patent, and give them an IOU to be paid off when you're doing well. Trying to buy things with equity at this early stage just creates inequality, arguments, and unfairness.
How much should the investors own vs. the founders and employees? That depends on market conditions. Realistically, if the investors end up owning more than 50%, the founders are going to feel like sharecroppers and lose motivation, so good investors don't get greedy that way. If the company can bootstrap without investors, the founders and employees might end up owning 100% of the company. Interestingly enough, the pressure is pretty strong to keep things balanced between investors and founders/employees; an old rule of thumb was that at IPO time (when you had hired all the employees and raised as much money as you were going to raise) the investors would have 50% and the founders/employees would have 50%, but with hot Internet companies in 2011, investors may end up owning a lot less than 50%.
There is no one-size-fits-all solution to this problem, but anything you can do to make it simple, transparent, straightforward, and, above-all, fair, will make your company much more likely to be successful.
For instance if my startup were to make an app that simply used native widgets and required no design work, it doesn’t really make sense that the designer should share fully in the revenue from that app.
But if he/she did some work on it, then he/she should be paid for it.
It’s far to much book keeping to keep track of everyone who worked on every app. Even more so when you try to factor in time spent or effort put in.
I think a fair way to distribute the profit would be to pay them depending on their average hour-salary. Let’s suppose your app sells a total of $100, and one developer and one designer worked on it (no matter what time have been spent). Let’s say the developer has been paid $25/hour in a previous project, and the designer has been paid $20/hour in a similar project. The relation between those hourly rates are $25/$20, or 5/4. Therefore, the total revenue ($100) should be split in a 5/4 relation. In the end, the developer will receive $100/95 = $55.55, and the designer will receive $100/94 = $44.45
Does that make sense? e.g>
Total = $100
Developer average salary = $25/hour
Designer average salary = $20/hour
Rate between the salaries = $25/$20 = 5/4
> that means you have 5 + 4 = 9 money-units to give away
Developer should be paid: Total / total-money-units * Developer-money-units
$100 / 9 * 5 = $55.55
Designer should be paid: Total / total-money-units * Designer-money-units
$100 / 9 * 4 = $44.45
Taking into account their previous salaries make this a fair option to me.
Also, please note that the equation above does not include the money that is kept by the company… is not common at all that a company gives away all its money to its employees :)
If you only need a designer for one app, it makes more sense to pay them either a set rate or a percentage of revenue from that app.
On the other hand, if your startup is co-founded by developers and designers it becomes a little bit more complicated. This is an issue that should be taken care of before work begins. You should always have a common understanding of roles and responsibilities when distributing shares of ownership. If you know your designer co-founder will have much less work to do in the company, you should discuss giving them a lower percentage of ownership.
I would be a bit cautious about not engaging a designer when you are developing digital products, simply because there is a lot of evidence around to suggest that the polish as well as the substance in your product both contribute in different ways to making the product successful.
Having said that, I think it really depends on the size of your team. Once it gets too big, you have to consider a different model to both keep the people you want and the people you need, rather than straight out profit sharing. I would also consider that in a small size team you need some multi-skilled people that can fit into different roles as required so you don’t retain people but not have work for them to do.
Having said that, I don’t think time always equate to the value of the work, because if someone is good at what they are doing it might mean that they can get through something faster than another person can, and you are punishing them for being efficient. On the other hand, if someone is dealing with a more complex problem and require more time, then they should be compensated accordingly.
What I am really trying to get to is that you should be able to divide the work and manage it well among the people in your team so that everyone is busy, and if you put the right value on everyone’s contributions then this won’t be an issue. The ultimate way you can tell if your method is good is to see how many stay and how many leave.
It depends on what kind of a Mobile Application development are you looking for,
Applications used in daily use and other basic needs such as image processing, or location based don’t require intense graphic designing, so you need to aim towards good developers which in turn will require more salary for them then them,
Gaming Applications require good graphic designers, thus you have to aim for good designers.
So it will depend on what application are you aiming for that will be the deciding factor for the deciding the salaries for each.
Here in Austria, a developer would earn between 2.5k€ to 7k€ per month based on a 38.5 hours week. A designer is usually a bit lower. You can use This hour based approach to pay them or you can pay them a fixed amount, lets say 15% for The dev and 10% of the revenue. Choose either one, the guys will probably prefer the first method whereas it is easier for you to pay them from the income.
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