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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)

#41

Post by msandford »

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…

Law is consulting. The business is selling hours. You can only sell as many hours as you have lawyers. Highly motivated lawyers might bill 2-5x the hours of less motivated ones, or at a much, much higher rate.

The "enterprise value" of a law firm is very near zero because as the partners stop paying attention to everything the company falls apart.

Most startups make a product which can be sold largely independent of the number of hours worked by the employees. Certainly in a non-linear fashion. As a result a startup might have a substantial non-zero enterprise value.

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

#42

Post by tptacek »

msandford wrote: post #40
tptacek wrote: post #27

Earlier quoted context omitted.

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…

Cashflow is cashflow is cashflow, it doesn't matter if it's more cash in or less cash out. They're mathematically equivalent. When pursuing a startup cashflow is the biggest problem of all, you're bleeding out and trying to staunch the flow. Someone plugging a hole is just as valuable as someone providing a pint.

All sorts of things cofounders do for each other have value. The best measure of a cofounder relationship is the tacit assumption that they have each others' back.

Again, the issues here are simple: dragging valuation into day-to-day operational discussions turns those discussions into negotiations, which I think isn't good for cohesion.

Reasonable people can disagree.

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

#43

Post by patio11 »

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…

Our IT startup model is the poster child for the inequality that defines our age.

Funded startups end with a pretty radically egalitarian share distribution by the standards of other industries. They'll generally IPO with regular working stiffs owning ~10% of the company. Do you know how much of the company non-management employees own at e.g. McDonalds? Wal-Mart? FedEx? The New York Times? NBC?

The only major industry which has as high a degree of employee ownership is -- and I'm aware of the irony -- finance.

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

#44

Post by codinghorror »

vitovito wrote: post #6

Can a mod change the date? It's a repost of his original answer from 2011: https://web.archive.org/web/20110416041922/http://answers.on... There's been a lot of discussion since, including https://news.ycombinator.com/item?id=2445447 and https://news.ycombinator.com/item?id=3489719 . Also, at the time, Dan Shapiro argued against it here: http://www.quora.com/What-do-you-think-about-Joel-Spolskys-a... I also think the…

Also, some people prefer to avoid conflict, and this approach maximizes conflict avoidance. Not saying you should seek out conflict, but you can err on the side of going too far out of your way to avoid it as well.

Why do I say this? Oh, no reason.. I just like typing things in boxes on the Internet!

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

#45

Post by wanderr »

vitovito wrote: post #6

Can a mod change the date? It's a repost of his original answer from 2011: https://web.archive.org/web/20110416041922/http://answers.on... There's been a lot of discussion since, including https://news.ycombinator.com/item?id=2445447 and https://news.ycombinator.com/item?id=3489719 . Also, at the time, Dan Shapiro argued against it here: http://www.quora.com/What-do-you-think-about-Joel-Spolskys-a... I also think the…

Can a mod also fix his name in the title? SpoLsky, not Sposky...

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

#46

Post by greggman »

tptacek wrote: post #27
chasing wrote: post #19

Earlier quoted context omitted.

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…

I'm curious why you see these 2 things as different.

Situation #1. 2 founders, one investor. 2 founders quit their jobs, have no money in the back. Investor invests $1 million. Money is used to buy equipment, rent office space, play living wages, hire contractors.

Situation #2. 2 founders, one has $1 million, the other has nothing. Money is used similarly.

It seems like the founder contributing $1 million in the 2nd case should get all the same considerations as the investor in the 1st case.

In other words.

    2 founders
    founder #1 1/2
    founder #2 1/2

    2 founders, 1 investor
    founder #1 1/3
    founder #2 1/3
    investor   1/3
which seems like it should lead to

    2 founders only one of which investing

    non-investing founder  1/3
    investing founder      2/3s (1/3 for being a founder, 1/3 for investing)
I know it's not that easy but I can't see any reasonable way to resolve this. The founder who contributes no cash will likely feel like a 2nd class founder because there's no reasonable way they can own half the company. They can agree they both get the same number of shares but then that makes the founder who contributed the money feel like he took all the risk and got nothing for it.

Off the top of my head, one possible way to resolve it might be to let the founder contributing cash to vest quicker. So day one 25% of his shares have vested and he starts vest 2% a month immediately. That means in 3 years he'll have 100% of his shares where as the founder contributing no cash will require 4 years to vest at which point they'll be equal 50/50?

Of course arguably that's still not quite fair to the founder that contributed cash because his deal is not as good as if he was split into 2 people, founder and investor.

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

#47

Post by ojosilva »

My startup does not fit well with Joel's model of employee layered risk. I've bootstrapped early and every layer the last 3 years got payed a normal, market salary, and on time every month. We also payed bonuses and the CTO even drives a company car from day one. Almost everyone was hired either straight out of college or was unemployed, although that was not intentional but probably my subconscious deflecting the extra pressure of being responsible for screwing up someone's career. Now I'm boarding our first investor and we're planning what our option pool will look like. I feel nobody but myself took any considerable risk coming to work here, and whenever there were troubled waters, my compensation was the only one that suffered.

I finally decided I favor giving stock as bonuses based on individual merit, as a payback for any extra effort and dedication in the past and as a motivational tool in the future. Unlike Joel, I'm reluctant to see employee risk-taking as relevant or even measurable or fair, and I wonder if that is really the case at other startups. I mean, can one say their new hires are actually assuming uncompensated risk, beyond the reasonable risk anyone assumes switching jobs, as to be entitled to equity mainly for that reason.

Employee risk seems like an oxymoron to me.

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

#48

Post by kansface »

This sounds like very bad advice for tax consequences. Is an IOU tax deductible? Does one declare IOUs in an 83b election?

Beyond tax implications and VCs, the IOU system strikes me as particularly terrible advice. In what realm is it reasonable to simply ignore hard interpersonal problems until they go away? If some group of people can't quickly come to an equitable arrangement for the division of equity, they shouldn't form a business. After all, founder breakups are a leading cause of failure.

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

#49

Post by tptacek »

greggman wrote: post #46
tptacek wrote: post #27

Earlier quoted context omitted.

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…

I'm curious why you see these 2 things as different. Situation #1. 2 founders, one investor. 2 founders quit their jobs, have no money in the back. Investor invests $1 million. Money is used to buy equipment, rent office space, play living wages, hire contractors. Situation #2. 2 founders, one has $1 million, the other has nothing. Money is used similarly. It seems like the founder contributing $1 million in the 2nd…

If we were talking about a million dollars, I wouldn't see things differently from you. Of course, if your founder role at a startup exists at the pleasure of someone paying your salary, rent, and expenses, you're not really a founder, are you? You're an employee. Whatever control you have on paper, the funding founder trumps with their bank account.

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

#50

Post by tptacek »

kansface wrote: post #48

This sounds like very bad advice for tax consequences. Is an IOU tax deductible? Does one declare IOUs in an 83b election? Beyond tax implications and VCs, the IOU system strikes me as particularly terrible advice. In what realm is it reasonable to simply ignore hard interpersonal problems until they go away? If some group of people can't quickly come to an equitable arrangement for the division of equity, they shoul…

No, one doesn't declare IOUs on an 83b election, because the 83b is about up-front valuation of equity, not about loans.

Different loans have different tax implications. If the "IOU" you're taking is a deferred salary arrangement, and you are eventually paid a year's salary as a lump sum, that will obviously be taxed as income. If you're paid back a loan you made to fund operational expenses, and the loan carried no interest, the tax implications are likely to be minimal.

In any case, if your equity is worth anything, you're working with an accountant. Actually: if there's money changing hands in any direction, you're working with an accountant.

An IOU doesn't "ignore hard interpersonal problems". It's one of several resolutions to those problems. Your last sentence can be true without IOUs being unreasonable.

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