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Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

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Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#21

Post by pan69 »

tptacek wrote: post #10
n72 wrote: post #4

"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." The IOU solution is not a good one: 1. Not taking salary when a startup starts is basically a very risky loan. An IOU simply doesn't take into account the risk involved. 2. This is not symmetrical to how investors are treated. In both cases there is a…

So don't use a dollar-for-dollar IOU. You can pay interest. What you're trying to avoid is bringing company valuation into totally mundane cash flow problems like "who pays for plane tickets to first customer meeting". It's a sign of very bad founding team cohesion when the founders look at each other as negotiating adversaries. Founders should prefer solutions that have a quick and intuitive sense of fairness over t…

Honest question, what happens to IOU's when the company fails? E.g. in the described scenario, one founder takes a salary and the other takes IOU's (+ 5% interest). The founder with the salary took less risk but still received 50% of the shares (even though they are worth zero when the company failed).

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#22

Post by tptacek »

geebee wrote: post #14

Interesting bit about diluting shares when new investment comes in. Joel's answer is very simple and seems extremely fair. How common is this straightforward approach, where everyone is diluted in the same ratio of existing shares to new shares? I'd be interested in hearing about experience/knowledge other people may have had here.

Not super common in my experience; typical equity schemes are both much fussier and way more opaque.

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#24

Post by tptacek »

pan69 wrote: post #21
tptacek wrote: post #10

Earlier quoted context omitted.

So don't use a dollar-for-dollar IOU. You can pay interest. What you're trying to avoid is bringing company valuation into totally mundane cash flow problems like "who pays for plane tickets to first customer meeting". It's a sign of very bad founding team cohesion when the founders look at each other as negotiating adversaries. Founders should prefer solutions that have a quick and intuitive sense of fairness over t…

Honest question, what happens to IOU's when the company fails? E.g. in the described scenario, one founder takes a salary and the other takes IOU's (+ 5% interest). The founder with the salary took less risk but still received 50% of the shares (even though they are worth zero when the company failed).

They're zeroed out.

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#25

Post by tptacek »

jamesblonde wrote: post #16

"Now that we have a fair system set out," I had to laugh at that line. Our IT startup model is the poster child for the inequality that defines our age. Founders own 50%, everyone else should be happy on the crumbs.... There's got to be a better way. Hang on, there is. It's called the partnership model, from the Law Industry. If you work really hard, you can become a joint owner (no matter when you start), and share…

It's fair for law firms. It's not fair for product companies:

(a) It only works when employees have control over revenue; the partner model disenfranchises important company roles that happen to be distant from revenues.

(b) It rewards the best salespeople and punishes people who prefer less business-facing and more technical-facing work.

(c) It works for investments/companies who are valued on continuing revenues from services, but breaks down totally when the company is valued based on forward revenues, which almost every software firm is.

(d) It creates an up-or-out model in which it is almost axiomatic that team members who fail to make partner will leave; in other words, it creates teams comprised of short-timers led by an aristocracy of long-term strivers. It also begs for churn and selects for ladder-climbers.

Even lawyers don't like the biglaw partner model. It does work, but know what you're getting into.

(I co-manage a consultancy that is larger than most YC companies).

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#26

Post by zeteo »

tptacek wrote: post #15
zeteo wrote: post #9

Umm that's a whole bunch of pulling numbers out of thin air. The 50-10-10-10-10-10 progression is proportionate to what exactly? The article would sound just the same if he recommended 75-5-5-5-5-5 or 40-30-20-10 instead.

This would be a trenchant criticism if Spolsky hadn't addressed it directly: 75-5-5-5-5-5-5 or 77-3-1-4-1-5-9, it doesn't matter as long as everyone agrees that it makes sense.

Yeah, it's quite symptomatic of pulling numbers out of thin air to then claim a large amount of imprecision. No system that nonchalantly allows say, a six-fold variation for the first employee can be said to be absolutely fair and correct. And "it doesn't matter as long as everyone agrees that it makes sense" just begs the question.

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#27

Post by tptacek »

chasing wrote: post #19
n72 wrote: post #4

"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." The IOU solution is not a good one: 1. Not taking salary when a startup starts is basically a very risky loan. An IOU simply doesn't take into account the risk involved. 2. This is not symmetrical to how investors are treated. In both cases there is a…

I've heard advice that giving up salary like this should be considered equivalent to investing seed money. If you get $50k for your first year with the company and I get no money, treat that as if I gave the company $50k and work things out like that. This is probably a bit more complicated in practice, but seems fair on the face. Curious what other folks think.

You're mixing valuation into mundane cash-flow problems, and also letting arbitrary circumstance help determine equity allocation; however you chop it up when the cofounder ponies up for plane tickets or whatnot, it'll seem fair at the time and a lot less fair after every member of the team has broken their backs getting the business off the ground.

Reasonable people can disagree on this point, but one thing that YC has said for years now that rings perfectly true to me: cofounder disputes can kill a company more abruptly than almost anything else. Rig your startup to minimize the possibility of resentment; you'll need all the unimpeded communications capacity you can get to resolve the problems that will arise intrinsically from your business.

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#28

Post by tptacek »

zeteo wrote: post #26
tptacek wrote: post #15

Earlier quoted context omitted.

This would be a trenchant criticism if Spolsky hadn't addressed it directly: 75-5-5-5-5-5-5 or 77-3-1-4-1-5-9, it doesn't matter as long as everyone agrees that it makes sense.

Yeah, it's quite symptomatic of pulling numbers out of thin air to then claim a large amount of imprecision. No system that nonchalantly allows say, a six-fold variation for the first employee can be said to be absolutely fair and correct. And "it doesn't matter as long as everyone agrees that it makes sense" just begs the question.

No, it does not beg the question, because the question Spolsky is answering is practical, not epistemological. He's describing the best, simplest structure for equity allocation. He didn't give you a magic calculator.

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#29

Post by YokoZar »

tptacek wrote: post #24
pan69 wrote: post #21

Earlier quoted context omitted.

Honest question, what happens to IOU's when the company fails? E.g. in the described scenario, one founder takes a salary and the other takes IOU's (+ 5% interest). The founder with the salary took less risk but still received 50% of the shares (even though they are worth zero when the company failed).

They're zeroed out.

Perhaps more specifically, in a liquidation the IOU-holder is a creditor in line behind others (but ahead of common stock-holder)

Re: Joel Sposky's Take On Equity Allocation In A New Software Startup (2011)

#30

Post by zeteo »

tptacek wrote: post #28
zeteo wrote: post #26

Earlier quoted context omitted.

Yeah, it's quite symptomatic of pulling numbers out of thin air to then claim a large amount of imprecision. No system that nonchalantly allows say, a six-fold variation for the first employee can be said to be absolutely fair and correct. And "it doesn't matter as long as everyone agrees that it makes sense" just begs the question.

No, it does not beg the question, because the question Spolsky is answering is practical, not epistemological. He's describing the best, simplest structure for equity allocation. He didn't give you a magic calculator.

Well, you know, you're working in the kitchen and I'm waiting tables. Last night's tips were $100 and I have a perfectly fair system for dividing them. I get $50, here's $40 for you, and I'll give $10 to the busboy. Or maybe it's $80 for me, $20 for you, and screw the busboy. It doesn't really matter as long as everyone agrees and it makes sense. But my system is really fair, you know.
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