How to Divide Equity to Startup Founders, Advisors, and Employees

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Since returning from MIT back in June I’ve been focusing on the growth of the company. It has been pretty much on mind non-stop for months now. The part that I’d like to zero in on is when you’ve got a high growth company what are some of the best practices out there to distribute equity to the founders, advisors, and employees?

Equity for Founders

The Founders’ Pie Calculator by Frank Demmler, an Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University invented an interesting way to divide equity between founders in a way that is both logical and fair. Sometimes when people start up a company they make decision to divide up the equity evenly because it’s “fair”. Demmler’s approach is a bit different in that the calculator provides a way to quantify the elements of the decision making process, and that it appears to be logical and fair. The elements of the decision making process are 1) Idea; 2) Business Plan Preparation; 3) Domain Expertise; 4) Commitment and Risk; 5) Responsibilities.

The idea behind the calculator is to come up with a weight for each of these five elements and then assign a value to each founder on a scale of 0-to-10. Then you take the weight and multiple it by the founders score to come up with the weighted score. From there you can get the percentage of equity. I like this a lot better than splitting things equally because it allows you to quantify what is important. See table below for example of how this works.

WeightFounder 1 (Contribution)Founder 1 (Weighted Score)Founder 2 (Contribution)Founder 2 (Weighted Score)
Idea71070321
Business Plan236816
Domain Expertise5630420
Commitment & Risk700749
Responsibilities600636
Total Points106142
% of Total43%57%

Equity for Board of Directors and Advisory Board

When figuring out how to provide equity to advisors, you can use this chart as a guideline. Typically for an Advisory Board it ranges from 1/10th of percent to 1/2% and for Board of Directors from 1/2% to 2%.
equity distribution advisory board How to Divide Equity to Startup Founders, Advisors, and Employees

Equity for Employees

It’s important to figure out how much equity you give to your employees. David Crow writes in his article “Founders versus Early Employees“, “Remember the goal is to incent early employees to have an emotional ownership of the product and company they are building. Equally said, potential employees need to understand what they are getting into”. The one thing that I think is missing is distributing equity to every single employee in the company regardless of title. Quite honestly, it takes an entire team to build a company and giving each employee a piece is important so that employees are rewarded in the upside of the company as they have made a decision to work for you instead of some other opportunity. Giving equity to employees also helps foster the “act like an owner” kind of mentality. Below is an example of how some companies may approach distributing equity to employees.

TitleRange (%)
CEO5 - 10
COO2 - 5
VP1 - 2
Board Member1
Director0.4 - 1.25
Lead Engineer0.5 - 1
5+ years Experience Engineer0.33 - 0.66
Manager or Junior Engineer0.2 - 0.33
By Nevi on VentureHacks.com

Number of shares = Meaningless. Just the % Matters

Chris Dixon wrote a blog post about “The one number you should know about your equity grant“. The one number you should know about your equity grant is the percent of the company you are being granted (in options, shares, whatever – it doesn’t matter – just the % matters).

  • Number of shares: meaningless.
  • Price of shares: meaningless.
  • Percent of the outstanding option pool: meaningless.
  • Your equity in relation to other employees: meaningless.
  • Strike price of options: meaningless.

All this information that I’ve gathered up here seems rather logical. Are there other tools that you’ve used that you think would be helpful to share with other entrepreneurs and founders? Are there principles that you live by that you’ve implemented in your startup that have worked really well? How long should people vest – four years? Five years? No cliff? Should founders have anti-dilution rights? I would really like to hear your thoughts on this.

115 replies
  1. Joe Stansell
    Joe Stansell says:

    Peter, this is another interesting post, and one that ties well into your previous post about single founders and dealing with disagreements. 

    Specifically, what’s interesting to me about the owner allocation formula in your example is that part of the allocation is based on “what has been done” and another part is based on “what needs to be done.” In the example, founder 2 scores 57% of the founder shares and, yet, most of founder 2′s score is on account of “commitment and risk” and “responsibilities” — presumably things that “need to be done.” But what if founder 2 doesn’t follow through? Founder 2 receives more shares but doesn’t really deserve them based on the agreed formula!That’s where a good partner agreement comes into play. Not only do you want to allocate ownership, but you want to re-allocate ownership if either partner fails to deliver. Investors routinely subject founder shares to vesting, but there is no rule that says that founders cannot, or should not, impose vesting on themselves. Indeed, to allocate founder shares based on expected performance is foolish, unless there is a mechanism for holding co-founders accountable. And the vesting doesn’t necessarily need to be time-based either. The founders could agree on a set of objective goals that, when met, release a specific number of a founder’s shares from a right of repurchase.

    Finally, I might also add that, at least in my view, founders tend to give too much weight to things that have been done and far too little weight to things that need to be done, in allocating founder shares. Yes, the idea gets things started and definitely excites. But at the end of the day, its execution that really matters.

    Reply
    • Peter Chee
      Peter Chee says:

      Joe thanks for the insightful comment. Last weekend at Seattle MindCamp we had a session on this topic of “How to divide co-founder equity” and we did talk about there being too much emphasis on what was done in the past and not enough about what is actually going to get done. One idea that we came up with was to allocate a portion of equity to the co-founders and set aside another portion of of co-founder equity that could be allocated or earned by the co-founders in the future. We’re also working on an iPhone app to build this kind of calculator so that people can figure this out in a meaningful way rather than just agreeing to split the equity evenly among the co-founders.

      Reply
    • PHP Veteran
      PHP Veteran says:

      Your last paragraph actually describes a situation I am in.

      I was originally hired as a contractor, developing a SaaS app from scratch, including DB design and coding. Along the way, I was hired full time (I believe about 8 months after I started), a coder from India was hired and another contractor was added to the team. The salary offered (and accepted) was quite low. 65k when the industry standard is 120k.

      Now this application is being spun off by the founder as it’s own company. I am being offered a single digit percentage of outstanding shares, which I believe is based on the founder’s application of a share distribution as though I am in a CTO or a Director Of Engineering role. I feel that my gamble of 55k/yr (or 220k over 4 yrs. of vesting) deserves more of a share distribution as that of a co-founder. After all, I essentially created the product.

      What I’m wondering is am I off base in this? In relation to the founder, is there an equity percentage that would be fair?

      Thanks for any thoughts!

      Reply
      • Joe Stansell
        Joe Stansell says:

        Mr. Veteran,

        It’s hard to say whether, in the abstract, what you’re being offered is “fair.” In my experience, though, most equity splits reach the point of being fair when all the principals agree that it feels about right; clearly you don’t think so, which means it’s arguably not fair.

        I’m happy to chat with you further about it if you want to give me a call. I can probably help you develop a negotiating strategy, and am willing to consult initially by phone free of charge. 

      • PHP Veteran
        PHP Veteran says:

        Thanks for the offer Joe.  I’d like to take you up on it. How shall I contact you? You can email me at thnkspc (aatt) impressthenet dot com.

      • PHP Veteran
        PHP Veteran says:

        P.S. I was having email issues earlier which have since been resolved. If you sent an email already, please resend.

        Thanks.

  2. Chris Zaharias
    Chris Zaharias says:

    Your blog post does a great job of helping startup founders know a bit
    more about how to approach big equity decisions; between you and David Crow, there’s also good acknowledgement of the value of giving enough equity to non-founding startup execs to ensure they truly feel they’re owners of the business & vested in its success.  Not nearly as much information exists,
    however, to help non-founding startup execs know what they need to know
    to avoid getting taken for a ride by investors & founders, who very
    often take advantage of severe knowledge asymmetry.  The employee buys a
    dream (a big part of making them feel emotionally attached) of making $X on equity, but reality is usually some fraction of
    that, in part due to lack of knowledge on the part of the employee, and
    omissions/lies on the part of founders & investors. 

    I’m doing research on this topic right now and created a survey asking
    non-founding startup employees 10 questions to gauge their level of
    equity knowledge:

    http://www.surveymonkey.com/s/CTL3V93

    So far, the results confirm this knowledge asymmetry and its impact on common shareholder equity outcomes. 

    Reply
    • Harrison Rose
      Harrison Rose says:

      Knowledge asymmetry is the primary basis for profit in equity transactions.  Consider the stock exchange, knowing something that will effect the price of a stock before it is well known allows you to make the right move with the stock.

      The same is true with employee equity.  The greater the inequity of knowledge about the company, the easier it is for the seller, in this case founders and investors through the Board of Directors, to provide the fantasy that improves the value of the equity involved.  This is like the notorious used car salesman who sells you a car that may be a lemon, and he knows it.

      Reply
  3. dilone
    dilone says:

    Peter, this is a great approach for founder equity. What approach would you suggest, however, in establishing founding equity for three partners, where two of them have their individual companies that are being merged to create the new one? How do you determine what the third partner’s equity share should be? 

    Reply
    • Peter Chee
      Peter Chee says:

      Dilone, I hope you figured out a solution to this. It’s not a easy one to figure out. It’s way more complex when you have people that have other companies being merged into one. If I had to take stab at this I would have probably need to know what the value of the those other companies are. Like hire a company to determine what the fair market value is for each of those companies as if they were to sell it. From there you would be able to determine how much equity they would get in the formation of the new company. For the third partner’s equity since they don’t have a company they would need to put in cash to match or they would end up with a significantly less equity percentage.

      Reply
      • Harrison Rose
        Harrison Rose says:

        Your answer is quite clear, with an exception.  If the gestalt of the merger is expected to be significantly greater than the sum of the company values and cash, then the difference may be used as founders’ shares and split appropriately.

  4. Startup Employee
    Startup Employee says:

    If an employee joins for 10% equity with 10 shares out of 100shares. Can a founder further make this 100 shares into 1000 and give himself 990 shares keeping employee with 10 shares? Thus employee ownership goes down to 1%. Is is possible?

    Reply
    • Peter Chee
      Peter Chee says:

      You’d have to look at your stock options contract. You would want to check and see if your shares can be diluted. Yes, you could be diluted from 10% down to 1% and there’s a number of reason why that could occur.

      If the company raises money and they are acting fairly about it, then you should expect to see your percentage of equity also become diluted as well as theirs. Dilution should occur across the board. However, there’s been instances where some people’s shares dilute while others do not. You’d have to be read the fine print and consult a person that understands contracts really well.

      Reply
      • Startup Employee
        Startup Employee says:

        It is fine if money is raised and even founders equity is proportionally diluted. But is it legally possible for him to do so without raising money just as a fraud. What caution should be taken by anyone before joining for equity?

      • Peter Chee
        Peter Chee says:

        If you’re working for equity and you want to make sure that your percentage does not get diluted then you would need to make sure that you have an anti-dilution clause in your stock option contract. You can have it worded in a way where it does not dilute unless the company raises money and then it will dilute proportionally across the board of all shareholders… or something to that effect.

      • Peter Chee
        Peter Chee says:

        I was doing more reading and I think these are some good questions an employee with stock options would want to know the answers to:

        Do you know the total number of shares outstanding in the startup you work at?

        Is the preference structure for preferred shareholders at the startup you work at Standard Preferred or Participating Preferred?

        Should your startup be acquired, do you have legal control over what role, title and responsibilities you’ll have post-acquisition?

        What type of trigger clause do you have in your startup options agreement?

        If you have a trigger in your options agreement and are aware of what type of trigger you have, did you negotiate the trigger language or accept what the startup proposed to you?

      • Harrison Rose
        Harrison Rose says:

        This depends on the state in which the company was incorporated.  I believe in California, without actually buying shares or having a grant from a non-biased Board of Directors, the situation as described is fraud as the CEO is breaking his fiduciary duty to the minority shareholders.  I would seek legal counsel on this matter knowledgeable of the corporate laws of the state in which the company was incorporated. 

  5. Uri Bendor
    Uri Bendor says:

    Hi,
    I have a question – I’m in a situation where I was offered to establish a start up, be the first employee, gather a team and be positioned as VP R&D. The idea is not mine and there is an initial funding for it. What is the equity I should expect (protected from dilution)?

    Reply
    • Harrison Rose
      Harrison Rose says:

      I wonder what you decided.  In general, if the company is paying market rates in salary, then the table above plus a founder’s bonus grant, is appropriate.  If on the other hand you are being paid anywhere between nothing and 20% below market rates, then you should receive a proportionate rise in the equity offer.  After all, you have to build a business and generate your own salary.  The further the concept is from coming to market, the bigger should be your equity piece.

      Reply
      • Peter Chee
        Peter Chee says:

        Sorry I missed Uri’s first comment… just catching up on this.

        Thanks Harrison for posting a comment… I agree with you. Uri, every thing is negotiable and it really depends — if there is
        already some initial funding does the company already have a valuation?
        Is the company a billion dollar business or a million dollar idea. I
        would say those kinds of things also should be factored in when determining
        how much equity might be granted to you.

  6. Kofols
    Kofols says:

    Hi, Great post. I have a few questions and I would love to get your thoughts about some specific situations which might work in different ways.

    Can you post also a few template stock option scenarios for employee, Board of Directors and Advisory Board? It is possible to explain more about how stock option price should be determined when startup is looking for 1round? When is the most appopriate time for founders to make agreemnet with others; before or after 1round or is to too early? What obligations are common for employee, Board of Directors and Advisory Board when they execute their stock option and become owners? Which triggers are very common when someone want to sell a few stock? How internal stock price should be determined in closed companies and who is able to buy/sell stock and in which order or %.

    Thanks, Samo

    Reply
  7. Don
    Don says:

    Hi, I just started my first Business Venture. I am 60 years old and decided to create my own Company, as a resources for my retirement. Based on the Economy, It seemed to be my only option.That is to create not only a residual retirement income for me, but for my children and grandchildren to be passed down to each generation. Like I said it is my first Venture and I am still in the building and implementation process stages of development . I have not only been able to teach my self SEO but I have already built my own Website for the Business. My question is then, I would like to forecast a projected value on my Business, divide it into shares  & sell 30 to 40 shares to gain capital investment for my Business. Can any one help…..   Thanks.

    Reply
    • Peter Chee
      Peter Chee says:

      That’s a nice approach to create a business for your retirement and to leave a legacy for future generations. Regarding your question on coming up with a valuation for your business and figuring out how to divide shares for investors, I would recommend that you talk with a startup attorney. They will likely be able to guide you in that process. If they really like your business idea they may even make introductions to investors that might want to even fund your idea.

      Reply
  8. Mike Moyer
    Mike Moyer says:

    Hi Peter, I like your comments and I reviewed the founders pie calculator for the first time today. I just finished writing a book on this topic (also about pie) and I would love your thoughts. The book is called Slicing Pie (www.SlicingPie.com) and if you send me your address I’ll mail you a copy.

    Reply
  9. Rajive
    Rajive says:

    I’m experiencing an issue with folks who may be good as advisors and facilitators, don’t want to join full time, are not techies at all and would like to keep their current jobs. Yet they expect 20% to help out with connections ? How does that work out ? Wouldn’t that be ‘equity suicide’ ?

    Reply
    • Peter Chee
      Peter Chee says:

      Hi Rajive, 20% of equity to make connections sounds like a lot of equity to give up. Perhaps you want to let them know what the industry standards are for advisors in terms of what a advisory board member would receive.

      Since I don’t know anything about your startup, your idea or how much money you company could actually make it really hard to tell you what to do. I would make sure that if you give up equity you have that equity vest over time. Do not do immediate vesting.

      Making an introduction to a contact doesn’t guarantee that anything will happen. That doesn’t mean that person will be a customer or commit to buying anything. What happens if you decide to give up 20% to advisors and nothing ever happens? It would kind of suck to have you work for the next five years and give away 20% to people who just happened to make a few introductions to you.

      Reply
  10. Ali
    Ali says:

    Good article, I am in the process of developing a tool for oil and gas industry. I have two co-founders. We are in the design stage and have not tetsed anything. When do you think it’s a good time to talk about deviding the future company share?

    Reply
    • Peter Chee
      Peter Chee says:

      For me it’s always been best to have the serious discussions about equity in the beginning. Get the tough questions addressed and flushed out while everyone is calm and not under stress. Inevitably things will go sideways and you don’t want to have discussions about things like this at that time. It helps remove drama and hopefully keeps friendships together when things do go sideways.

      Reply
  11. Mister
    Mister says:

    Peter, thanks so much for the information. Question for you. The percentage as described for the founders, I would assume would be 100 percent. When you start talking about equity/owership percentages for everyone else (CEO, Director), are you diluting this from the 100 percent between the 2 founders?

    Reply
    • Cosmo Cramer
      Cosmo Cramer says:

      Mister – interested what you ended up deciding? did you dilute from the 100% of the shares between the 2 founders? Or did you had set aside shares for such cases?

      Reply
    • Peter Chee
      Peter Chee says:

      Mister, yes, start with the whole 100% and carve up some for the two founders. Think about whether or not you’re going to have investors, going to give away some for employees. You could even set aside some unallocated for surviving founders (assuming both partners don’t stay the same duration).

      Reply
  12. Sam
    Sam says:

    What is the difference between standard preferred and participating preferred?
    Great article, this really helped me get an understanding on this subject.

    Reply
  13. Nguyen
    Nguyen says:

    wonderful information Peter. One of those posts where the comment stream caused is just as valuable.

    Peter, I am looking to hire a COO to begin putting in the structure needed to increase our marketshare. We have a guy with great experience working as a consultant we would like to give an offer. My five year old funded startup (3 years building software) has built a solid, valuable technology with a growing customer base that has us close to breakeven ($180k a month). Its time we go into broader markets. We, 12 of us, still have startup salaries and I think I can get past that with him, but the equity is where we are farther apart. You speak a lot of what is fair. I provided the above information to see if you could help me understand what is fair. We need growth capital and are about to start a round and I think he can help with that, but should his equity percentage be based on todays numbers or where we will be 3-4 months after he is hired. IOW, is it fair to hire and then dilute? Lastly, how much stock is appropriate? How much of that should be incentive based? THANK YOU SO MUCH!

    Reply
  14. Peter Chee
    Peter Chee says:

    Perhaps it would be best for you to think about what you are really good at and then hire people that fill your knowledge and experience gaps. If I were in your situation, I would write a complete job description with the roles, responsibilities, and what you would see as a successful outcome for that position. Define what is an A Player in that position. If I were not able to do this I would not hire anyone because I know I would end up making a bad hire.

    Reply
  15. carlokrouzianarlo
    carlokrouzianarlo says:

    Peter, thanks for the site. My partner & I have been working on a SaaS model for past 2 years. He invested 50k and is bringing contacts who will use software. I started working on the project 2 years ago and was offered 40% of early on, and accepted. So far, we have paid programmers to help get it to is point. We’re one month from launch and are starting to think of our long term team. We have a senior level programmer / architect that is inerested in joining our team part time until we ramp up and is willing o come on full time. What type of percentage is fair if he will oversee software development? Or is that the right way to go? we dont have much more capital so we cant just pay high salaries at this point. Thanks a million for any input!

    Reply
    • Peter Chee
      Peter Chee says:

      I have a hard time giving up much equity to a person that is part-time. Since you’re already 2 years into this and a month away from launch, I would think a full-time lead developer would be 1% or less. If you’re looking for a CTO you will need to give up more than 2-5%.

      The amount of equity a person should get should be dependent on a couple different factors. Firstly, you and your partner have already devoted 2 years into this. Years of time and money to get to this point. Hands down you guys get most of the equity. A person stepping in now is not even close to the same kind of risk exposure, they didn’t quit their job, they didn’t put their savings into this, they also are not assuming any of the liability that you both have put into this. I see and hear this often where someone thinks they should get double digit equity and the company has been already operating for years. They fail to look at the risk and liability that the founders have taken on and just look at what they think they are going to be contributing. Plus when a person isn’t going full-time, they have one foot in and one foot out, I could not even call that as being committed.

      I suspect that you and your partner are the business / sales experts? If yes, I’d think that you’d want to just crank on the sales as hard as possible and get as much cash generated as possible. Once you show that you have revenue, the person that steps in will get even less equity. Equity goes to the one’s that take on the most risk. If this developer person were to quit and jump in now before launch, I would say that shows how much they really are committed to seeing this be successful. There’s no shortage of high salaried developers.

      Reply
      • carlokrouzian
        carlokrouzian says:

        Thanks for the reply Peter. It cleared up several things for me. When you mentioned a cot getting between 3-5%. Do you mean that on top of their salary? And what would you discount their salary if that’s the case? I appreciate your input!

  16. Peter Chee
    Peter Chee says:

    Very hard for me to answer your question, I don’t have enough information… however, have you considered doing a mix of options: perhaps give the person two different options. One where the salary is higher plus 3% equity (vested evenly over four years) and then a second option with a lower salary plus 6% equity?

    Reply
  17. Arun
    Arun says:

    Now if I give you idea about our profile:
    Me (A)- 4 years of exp, engineering degree from India then MS from US. I can invest 50 to 60 percent of capital needed.
    second partner (B)- Engineer and has around 9 years of exp. He can invest upto 50% of capital needed.
    Third partner (C)- Fresh engineer with no capital and no exp but committed and will work with no salary.

    It was my idea to start the business but yes definitely need a committed team. Using your calculation chart I have assigned 50 to myself, 40 to B and 10 to C.

    Pleas advise on this.

    Thanks

    Reply
  18. Arun
    Arun says:

    Sorry Peter my some portion of my above comment didnt post. Earlier I said that two of us decided to start a company. A that is me is full time devoted to it. My other partner B has his job too (he needs approx 4 hours per day for his job). we both can invest capital. 3rd partner cant invest anything right now. Please help us in distributing equity.

    Reply
  19. Arun
    Arun says:

    Weight A A B B C C
    Idea 7 9 63 8 56 1 7
    Business Plan 5 8 40 6 30 1 5
    Domain Expertise 3 3 9 4 12 3 9
    Commitment & Risk 7 10 70 7 49 2 14
    Responsibilities 6 8 48 6 36 2 12
    Total points 230 183 47
    % of total 50% 40% 10%

    This is how i used your chart. Apologize for improper headings as i had hard time in pasting chart here.

    Reply
  20. Brandon
    Brandon says:

    Peter,
    Your article was great and it really helped clarify some of the things I have been dealing with. I am in a startup company with seven other co-founders. This is the first startup I have been in that has actual potential. We have been putting off trying to figure out the equity structure and corporate agreements for several months. Now we have serious investors looking at us as we have had lots of positive feedback. I have a love for entrepreneurship and startups, I always have. However I am completely utterly new to the legal side. I am 19 years old, I know I have lots of value that I have given this company. Our other cofounders consist of people that have more experience in the legal set up of companies side than me. I really just want to know if the offer that was given to me was one that is something I should feel confortable with. I would greatly appreciate it if you would offer me some guidance as this is becoming extremely difficult. Thank you.
    Brandon

    Reply
    • Peter Chee
      Peter Chee says:

      Brandon, thanks for taking the time to read this blog post. I’m glad you found it to be informative. My recommendation to you is hopefully you have advisors, people outside of these seven co-founders, that you can talk with. Perhaps other entrepreneurs who have been there and done things in the past to review something like this. Before you sign anything I hope you have good legal council.

      Reply
  21. Brandon
    Brandon says:

    Peter, thank you for responding to my message. I really appreciate it. I hired a lawyer to look over the documents and ensure that it is something that I should feel confortable with. I will definitely try to find someone to that has done this in the past, however I am finding that to be quite difficult as many of the entrepreneurial people in my area know one of the other cofounders and have heard about what we are doing. Thank you.
    Brandon

    Reply
  22. John
    John says:

    Hi Peter, being an engineer, I definitely am in tune with quantifiable methods to most analysis, therefore I like your simple, but quantitative approach. I am in the process of starting an microbrewery. In anticipation of this, I went to school and acquired my Master Brewer certification in 2011 from the American Brewers Guild. In 2012, I left my day job and started and completed writing the business plan. Then I took that plan and started fund raising. I am just 60K shy of my 750K target, having set up a number of personal loans to me from “family, friends, and fools” (giving up no equity) as well local economic development agency loans, requiring my house as collateral. I am in the process of recruiting key personnel, and placed an advert seeking potential “partners” who could bring considerable funding to the table. I’ve found two persons, one who would contribute 40K and one who would contribute 20K, thus rounding out to target of 750K. But neither of these candidates will be on the hook for any of the loan repayments or provide any collateral. Further, I will need to do the brewery build-out for the next 9 months collecting no salary, while those two individuals retain their current day jobs. But I would expect if they commit that they will provide some level of sweat equity during that 9 month time-frame. Then they would join 1 month before I open up for production. The 40K contributor is willing to work for no or reduced salary for up to a year or two after joining to ensure we have adequate cash flow buffer. The 20K contributor has made no such offer. It seems that perhaps one missing row in your spreadsheet should be “financial risk to individuals”. While I know that I can not go it alone, I will need this key help to get up and running. There are probably other options from the two persons I’m currently engaged with, but I have not yet fished extensively for other talent. The 40K contributor who is also willing to work for “sweat equity” wants to be considered a partner. What is your advice, along with pros and cons, on how to negotiate this situation? Thanks very much.

    Reply
    • Peter Chee
      Peter Chee says:

      John, it seems like you have to figure out what would be the salary for each of you and put a dollar value to your sweat equity. Instead of just issuing stock/equity convert that into actual dollars if you had to pay yourselves back later in the future. Once you determine that value of your time you can convert that into equity percentages.

      Reply
  23. Jeff
    Jeff says:

    About to launch our SaaS product. An uninvolved contact of mine introduced us to someone who is now going to become our CEO, and this CEO has now raised $3m in financing. This contact now wants to become one of our very first employees, which we are happy about. The question is what sort of equity do we give this person, under the unique circumstances (introduced us to our CEO, who then raised $3m in funding for us). I feel like this contact of mine has connected us to huge value, even though they didn’t directly create it. Anybody have any advice or thoughts?

    Reply
    • Peter Chee
      Peter Chee says:

      Hi Jeff,

      Thanks for posting this. One thing that is expected of advisors is that they open doors and make connections, not just give advice. Perhaps since this contact now wants to be an employee, you treat the act of making the introduction similar to that of an advisor and provide this person with what you’d give to an advisor which would be another 1/2 – 1%.

      Reply
  24. John
    John says:

    Hi Peter,

    Your article is so on point!. My situation is as follows. My partner and I ( I own 75% and he own 25%) have been building a software startup for almost a year now. We both have business backgrounds and because of this we had to hire a software firm based out of Santa Cruz to build our application. Our relationship with the owner of the company is amazing and he has delivered on all of his promises. Our problem is that we recently ran out of money (this has happen a couple times) to fund the project. The app is roughly 80% complete and raising capital this time around will probably be easier then previous times, but instead of me not executing (spending 1-4 months trying to find an investor who will bring nothing to the table but cash) I want to grow my business and fill one of the biggest gaps we currently have i.e. asking the developer/ceo to complete our app and become a quasi CTO. He seems really interested in our project and is open to the conversation.

    My question:
    How should I structure the equity deal and how much equity should I offer him to finish the build and become our quasi CTO?

    There is roughly 15-30k of work left for version 1.0 to be complete.

    Reply
  25. Peter Chee
    Peter Chee says:

    Hi John, thanks for the comment. If you don’t mind me asking why do you want to give equity to a person that has a quasi title? I may be just knit picking at your words here. However, I feel like if I were to give equity to anyone it would be a person that is going to give everything they have got. It’s tough to want to give any equity to a person that isn’t all-in.

    Now if this person is the one that did the first 80% of the work I can understand why you might want to give equity to a person that has made that kind of contribution. Perhaps instead of paying that person cash you can defer the payment until after the app is complete and starts to generate revenue? After that you can pay him back + interest from the cash flow of the business?

    Have you considered looking for developers at a Startup Weekend event and see if you can find someone at one of those events that can either help you finish the last 20%? Just a thought if I were in your shoes and trying to give you a few other suggestions on how to work this.

    Reply
    • John
      John says:

      Hi Peter,

      Thank you for your timely response. To answer your question on why I was considering offering equity to someone who is not all in is as follows. I’m looking at all options on how to skin the cat and the developer we’ve been paying to code our app owns his own software firm i.e. is very busy managing other projects. Furthermore, I thought about approaching him with a deal that would allow him to earn a specified amount of equity for specific mile stones met. For example Mile stone 1 Completing version one, with the bulk of the equity being released at this point. Mile Stone 2 become a advisor/quasi CTO releasing 1-3% of equity across a 2-4 year span. My logic behind this is if version 1.0 is executed properly funding will come knocking, which will allow us to bring on a full time CTO and a couple developers to fill the current needs of the team.

      What are your thoughts on this approach?

      P.S. I really like your suggestion on attending startup weekend events.

      Reply
  26. Peter Chee
    Peter Chee says:

    John, I would think that if you can complete version 1.0 and get users or paid users before you approach investors for another round? It seems like everyone right now is looking for traction, paying customers. Once you have that raising money to fund the growth seems likely. Just my two cents.

    Reply
  27. jim angelopoulos
    jim angelopoulos says:

    i recently formed a corp and brought in a team to help me with my tech start up. my main question has to do with the programmer. i am relying on him to develop the software but am paying him less than half what he would be getting in the open market. he would like equity in the company. my team of advisers would like equity in the company. i am lost in what % to give each especially the programmer. my domain expertise is in restaurants so i am a little off base here but i have a great conceptual idea that my team has bought into.

    Reply
  28. Biggie
    Biggie says:

    hi,
    i like the article,came in just in time,i recently founded a startup,the idea business plan and put in 100% commitment, including the funding.i have a co founder with domain experience and when i was at the idea stage,we split equally since it seemed” fair “at the time,i now want to review the shares as it is proving to be a weighty issue especially risking the future of the company.please advice on how i can make logical splits with the future in mind.

    Reply
  29. Cardguy
    Cardguy says:

    Peter,

    AWESOME post and follow-up conversation. THIS is what the internet is all about. Would appreciate your advice on how top allocate founder equity between me and my friend of 25 years, keeping in mind i have three other people that I’m planning to give 5%-10% each to.

    ME: Five years as founder and CEO in same space (prepaid Visa cards) of company that was acquired by Fortune 500 company) so lots of domain expertise and knowledge across all functional areas. Developed new execution play for the space (unique distribution method) and decided to start company. Have worked on it on it 50% of time for 18 months. Have everything ready to go (product definition, sales strategy, sales resources, and a prominent partner (one of the investors on ABC show Shark Tank) contracts to outsource back-office. Have other investors interested but no commitments yet.

    MY FRIEND: Financial modeler, also has experience in credit cards as I do, but not prepaid cards which are quite different. He has developed an elaborate financial model, which is important in the financial products where numbers are your business to great extent. But i have had to educate him on the business and have fed him most of the assumptions that drive the model. He has been working 50% for past 8 months. I use him for a sounding board, but his advice isn’t so hot.

    Going forward he will be a cfo (small c as he is not an accountant), and be heavily involved in the back-office, overseeing our partners.

    Soooo….question is how much of the 100% should i give to him? I am inclined to be generous, but my last start-up i started with 35% and ended up with 8% after dilution and got burned on preference for preferred investors.

    Reply
    • Peter Chee
      Peter Chee says:

      Cardguy, perhaps you want to consider tracking your approximate hours and calculating out a pay rate for your hours and for your friend. From there you can take a pre-money valuation and convert that to equity percentage. The other thing that I’m picking up from your comment is that your friend might not be the right fit for the CFO position. You can always have your friend be in a different role where he is stronger at it and bring in an advisor that is a CFO. There are also companies out there that have virtual CFO services. You could tap into a person for a few hours a week to really help you out instead of having someone that might not be suitable for that role. It’s important to put people into a role that they are really good at and that you have complete trust in them.

      Reply
      • Cardguy
        Cardguy says:

        Peter, Re your suggestion to use hours but, i tend to think the value should be more based on output than input. For example, the one hour conversation I had with one of the investors on Shark Tank might who in now on the team might be worth about a 1,000 hours of excel modeling if not more. To continue this logic, its my idea, i developed the strategy, defined the product, arranged for the partnership with a bank and a card processor, and have been handling fundraising. He has developed a model (based on my direction) and served as a sounding board.
        Since I wrote to you we discussed this, and I learned he expects 50%. I was thinking more like 10% . Plus i still need to allocate another 40% to other key employees/partners and an option pool.
        Needless to say, things are a bit uncomfortable right now.
        Don’t mean to put you on the spot, but what do you think ??? 90/10, 50/50. 0r something in between?
        Thanks

  30. ed
    ed says:

    Med device Co 4 years in
    I am the sole founder 25 yrs experience in the clinical and scientific space, previous grant recipient and known in my field.
    A recent PhD joins to help company write grants do project management. He understands there is no salary unless we get grants then he will get some pay.
    We get a grant for 170k and he gets a salary at 30% to 50% the going rate and supervisies the data collection done by him and students. Then money runs out and he has other new part time positions to sustain him. He has been granted 0.5% of the company no vesting no schedule.
    A second grant is written followup to the first and gets funded for 500k for 2 yrs.
    He cannot accept salary money due to other commitments, and we have a difference of opinion regarding the direction and scope of how to proceed. He also now requests 30% of the co. He argues this is pre-dilution and feels responsible for this 700k funding in part.
    I feel as founder with the deep experience, and he was a non-founder with little experience and 50% time for 2 yr 10% time a 3rd yr, 20 % time the 4th year, this is wrong. I think he is putting himself in a founder category when he is not. My concern is that i will commit “equity suicide” for the company if I negotiate with him. I feel CTO equity of 1-2% is appropriate (factors are early commitment, his relative lack of experience, and non-displacement of other salaried positions when he signed on). Furthermore I don’t think based on these discussions we have a good working relationship and trust going forward. I want to do what is fair for what he has contributed and probably move on without him. I am looking for some advice.

    Reply
    • Peter Chee
      Peter Chee says:

      Ed, thanks for the comment. I can’t give you specific advice on how to handle this but you might want to consider providing him with information on the right and wrong ways to provide equity distribution. The person that you’re bringing in sounds like a smart guy. You could send him information about equity distribution, introduce him to a few other entrepreneurs who have been there and done this before, allow him to come up with a number. While it might take a while to get through the discussions it will definitely create a strong foundation for communication and trust. Nothing worse than going in and not feeling like you’re getting a reasonable amount of equity. I have always subscribed to “a rising tide lifts all boats”. Good luck with those conversations.

      Reply
  31. Cardguy
    Cardguy says:

    peter, just wanted to close the loop on my situation.My friend and agreed to an 80/20 split on equity and we will each be diluted proportionally as more people come in. The rationale was based on a combo of the value of experience brought to the table, value of OUTPUT that got us to where we are, and time put in. I also sweetned the offer by establishing an option pool of 20% so lots of oppportunity to add to holdings, a COO title and a committment to keep his salary at 90% of mine. Im happy to say it all worked out. Now back to growing the company!

    Reply
    • Peter Chee
      Peter Chee says:

      Cardguy, thanks for the update! Great idea to create an option pool of 20%, important to know there’s a way to get an additional amount for those that deliver results!

      Reply
  32. TM
    TM says:

    I just lost my shirt on “start up” sweat equity.

    In late 2010, I was contacted by a start up software company to join their “founding executive team”. The start up time was anticipated to be a few months (4 max) and I would get 480 shares of stock they said was “recently valued” at $150 each and then 10K (1%) options when I was hired with salary when they got finding or a customer order. I ended up not getting “hired” for 8 months, no options were granted and they eliminated my VP position 2 years after paying with no stock whatsoever (nor severance).

    I built products and services for a certain market, and when I go there there was no product nor knowledge nor expertise nor contacts in this area of the industry. They now have a suite of products, two anchor accounts, continued revenue, and a funnel for this year. I called the state last week they were licensed in and there was never more than 10K common stock authorized in total, so my initial offer was based on incorrect information. This has been a disaster for our family. I went through all of my savings and am now unemployed.

    I am probably the “bad” example of what you can lose if you do not check out the company, managers, and shares appropriately.

    Reply
  33. DN
    DN says:

    Hi Peter,
    Recently my friend approached me to join his start-up as co-fonder as he see the value I can bring into the company. He is full time working on the project without salary and I get to keep my full time job but need to put in at least 5-10 hours weekly to complete the tasks allocated. Based on this, he is giving me 1% of the share with an investment of 10K. The prototype of our product is out; we are still in seeding stage but he felt that since he did all the work earlier and even thou the capital he pump in is only 100K; I shouldn’t be getting 10% but 1% instead. Is this the right way to distribute?

    Reply
    • Peter Chee
      Peter Chee says:

      DN, if you haven’t already done so, you should work through the calculation above. The value of the company is not just the $110K that you both put money towards. You can’t do straight math based on percentages of money contributed. There’s a lot more to it… the idea, the business plan, commitment/risk, and responsibilities. Working full-time on something versus working part-time while holding another job is no where near the same risk level, it’s like in poker, you go all-in versus making a small bet. I don’t think that most people understand this part very well. If an employee wants a large part of the equity they should be willing to take on large part of the liabilities too. You have to consider the role that you’re taking on too — which I can’t tell what that is from what you’ve written. It feels like your equity percentage should be lower than 10%.

      Reply
  34. MK
    MK says:

    Hi, I have played a critical role in the establishment of a start-up which has four members. 1st member has the idea and I have proved its economic potential. Other two are advisers. We have already put together proposals for federal funding and identifying other funding bodies. Given this scenario, could you please advise % of equity shares you think I can demand for? Please let me know if you need any more details. Thanks in advance.

    Reply
  35. Gary Arouchian
    Gary Arouchian says:

    Hello, I have just recieved an offer from a family member and i feel greatful. Wanted to take an oppetunity to get some expert advise. My aunt who is elderly has developed a salad dressing. She has invested $100,000.00 to develope, bottle,and try to launch the product. This idea has been dorment for ten years and now I was approached by my cousin to help them launch it. I’m bringing sales, business ownership,motivation,management,and accounting expertise to the table and they offered me 20% ownership. They also feel that my aunt needs to get paid the $100,000.00. How should i respond. What is fair and being a 20% owner, does that mean i wont see any profits untill the $100,00.00 is paid off?

    Reply
  36. Gary Arouchian
    Gary Arouchian says:

    Gary Arouchian says:
    Reply

    8 hours ago

    Hello, I have just recieved an offer from a family member and i feel greatful. Wanted to take an oppetunity to get some expert advise. My aunt who is elderly has developed a salad dressing. She has invested $100,000.00 to develope, bottle,and try to launch the product. This idea has been dorment for ten years and now I was approached by my cousin to help them launch it. I’m bringing sales, business ownership,motivation,management,and accounting expertise to the table and they offered me 20% ownership. They also feel that my aunt needs to get paid the $100,000.00. How should i respond. What is fair and being a 20% owner, does that mean i wont see any profits untill the $100,00.00 is paid off?

    Reply
  37. LeeRit
    LeeRit says:

    What I haven’t quite understood is why there is a limit for employee share options?

    If (s)he contributes a lot, would it increase the %?

    Thanks for elucidating.

    Reply
    • Peter Chee
      Peter Chee says:

      This calculation is for the initial stock grant. You can always increase and give more to employees that contribute a lot. It would always be wise to keep a pool of shares available to employees, there will be shares that get issued that are never fully vested and those would return to the employee stock option pool.

      Reply
  38. Alvin
    Alvin says:

    Hi Peter, great post! Is the process of giving weights and rating per criteria will be done in a brainstorming type of an exercise along with the other founders of the company? I am in the process of starting a SaaS and BPaaS business here in Asia Pacific where I do most of the heavy lifting at this point, e.g. Business Concept/IdeaGeneration, Business Plan Preparation, Engagement with Potential investors, Research, etc. I do have two partners who are doing the IT Infra Planning and Software Development planning, which at the onset have agreed to have 20% and 5% respectively. While I do have money to invest, this will not be enough to fund the start-up capital and that’s the reason why I’d been talking to potential “angels”. Having said this, how should I approach/determine my portion of share given that I am doing all the heavy lifting and obviously I would like to have control over the equity of the company? If the real % allocation based on pure investments would be: Me – 20%; “Angel 1″ – 35%; “Angel 2″ – 20%; Co-Founder 1 – 5%; and, Co-Founder 2 – 20%. Looking forward to you guidance on this matter. Thanks :)

    Reply
    • Peter Chee
      Peter Chee says:

      Hello Alvin, based on the quick math, you have allocated 100% of the equity of the company between both founders and investors. You might want to consider separating out the equity first between the co-founders. From there figure out what percentage you want to dilute the founder shares so that there’s some set aside for the investors, advisors, and employees. If you chat with an attorney that specializes in equity distribution for startups, you might hear a rule of thumb being 30% set aside toward investors and another 10% split between employees & advisors. That leaves the remaining 60% set aside for the co-founders. I also would consider leaving some of the founder shares unassigned and something that is allocated in the future for the founders that actually stay with the company and continue to make strong contributions.

      Reply
      • Alvin
        Alvin says:

        Thanks for the response Peter :) Just a clarification on your last point, how will the unassigned shares appear in the incorporation documents? Thanks.

  39. COstas
    COstas says:

    Dear Peter,

    I and two other business background friends have a set up a small company assisting small business founders to maximize sales and profit. we have an offer to assist a guy with an already established company- ready product- being in business for 4 years now, self funded and owenr of the idea. he has no experise or the cash flow now to hire a consulting business company to assist him with maximizing sales nor he has the capital to hire employees work full time on this. We come in the picture. There will be no salary and we will fully dedicate our selves to go global. The issue here is what should be a fair revenue for us, what could be the main terms, vesting time, cliff period, and equity as well a portion of equity up front and upon succession of sales/revenue target.

    I am simply asking what would be good for us to ask, to secure our dedication, time, energy and ofcourse resourses money as well as marketing budget.

    Costas

    Reply
    • Peter Chee
      Peter Chee says:

      Hello Costas,

      Your situation is much different than what this blog post is about. I think there’s a few different ways to go about this. One might be for him to give you guys a straight commission on sales that you guys make as well as a profit sharing model after expenses are paid. If he’s got a business that is servicing people locally right now, you could form a new company together and do an asset sale from the existing company into the new company. From there you can divide equity using the model described in this article. The new company could focus on all new growth. In this case, I think everyone would vest over a four year period, first stake being at year one followed by one year cliffs until fully vested. It takes a lot of time to build and grow a company and it’s unlikely that all of you will make it to the full vesting mark. I don’t think anyone should have equity up front. That would be called a guaranteed equity percentage and any of you could walk away without having to do any work leaving the others to do all the work.

      Reply
  40. Cornell Edwards
    Cornell Edwards says:

    Gentleman,
    Trying to establish my ownership percentage in a business that I started out as a 10% sweat equity partner in, with plans to grow my percentage as the business grew. I brought the vision from a previous company that I owned and paired with an investment partner, who started at 90% ownership, his money, his risk. Great guy, very easy to work with. We both work at the business day in, day out. Responsibilities are the same. Here we are two plus years later with no said plan of my partner recovering his investment. The tangible net worth of our company is now around 225% of the initial investment. Am I wrong in thinking that since the business has grown to a net worth more than double the investment that my percentage of ownership should be growing?

    Thanks,
    Cornell

    Reply
    • Peter Chee
      Peter Chee says:

      Cornell, I don’t think that is unreasonable to think that your percentage of the company should be increasing as the value is increasing. That said there’s more than one way to compensate a person that helps a company grow: additional stock options, profit sharing, bonuses, autonomy, and flexibility. When was the last time you both had a conversation about this? Can you ask a question like “What would need to happen in the company in terms of revenue, growth, or profit in order to you to receive more equity in the business?” That would come across as a much more non-threatening and would not look like you’re making a demand. Just a thought.

      Reply
    • Scott
      Scott says:

      Cornell,
      There is no reason your % should change in the scenario as you have described it. Nothing has changed that should change the equity split. This would be true even if the 90% partner was a silent partner.

      I assume you both are taking a reasonable salary for your work?

      I see only two basic ways for your to increase the % of your ownership.
      1. You invest cash into the business to develop it.
      2. Your partner takes a normal salary but You take a lower than market salary and use the difference to “buy” more shares /of the company.

      Reply
  41. Scott
    Scott says:

    Peter,
    I have a small startup artistic wood product company that I self funded with about $200k cash and have built over the last 4 years. We are now to the point where we want to raise some capital to upgrade machinery and open a showroom to take the business to the next level. I have not taken a salary for the last 4 years in order to keep more cash in the company for growth. However, now that I am planning on bringing on an investor or two I feel I need to account for the lack of salary lest my ownership % be unduly diluted. Would it be reasonable to increase my owner’s equity amount to include a salary of say $75k/yr – i.e. 75k x 4yrs = $300k? This would mean that my investment on the balance sheet would show $500k in owner’s equity.

    what kind of entries would need to go on the financials to show this?

    Reply
  42. Annie
    Annie says:

    Hi Peter,

    I am first time tech start-up founder…I created an LLC and partnered with a developer that runs his own business. I approached him with my idea/concept which he bought in to. My Rolodex and book of business (clients) is what will give us the necessary exposure. He build the MVP which originally is far away from my original concept but we both have the understandig that we will test and iterate and change the concept/idea to fit the pain points of the market.

    In order to do so, I took a job full-time to work closely with my target customer. We both have synergies to make this work and so far he says that he wants to work together on this project. However, we have no agreement between each other. He is saying that he is “developing me” on the technical stand of point of view so that we can be better “mutually beneficial partners” in the future. I don’t have a problem with this but I want to make sure that I am protected. I could wait and hire a developer but we have a good working relationship and he is an executor.

    I am the founder and CEO of my LLC. I have a PPA filing date that drops in a few months which doesn’t really matters since we will be continously building and filing for patents a long the way.

    My question is:

    What kind of agreement can we sign moving forward that will be just to both of our contributions so that we can continue to move forward and built and test?
    I want to add that a problem that we faced in order to make it work was how to get users – to test around…I have solved that problem and I now have a valuable pool of digital info that we need in order to go out there and pitch to get businesses to sign up.

    Even though he will be building the technology it will be built based on my work (research etc) and our brainstorming sessions etc…My clientele and users will be of tremendous value. I have the feeling that he will/can continue building this out (and then license it to my LLC) but that isn’t fair since it will be built on the findings from testing on my customer base.

    Reply
    • Peter Chee
      Peter Chee says:

      Hi Annie, I’m just now getting to this comment and based on the date, I am assuming that you have contacted an attorney who specializes in partnership agreements to best protect you. I would definitely have separate attorney’s from your potential partner. On a side note, I think that’s very interesting of you to take a full-time job to work closely with your target customer. That’s admirable in figuring out exactly what their needs are and building the connections inside that company.

      Reply
  43. Richard
    Richard says:

    Hi Peter, great forum,

    I’m a start-up and I’m beginnng the process of selling a confectionery product. I’m going to use farmers’ markets as a test for this to prove the concept as much as I can. I have a friend who would like to be involved but on an equity basis (26% for him 74% for me). The start up money required at this point is in the hundreds of pounds only. Whilst the money would be useful it is more the man power that I need, but I doubt he would support me without the equity share. As I am just about to finish my MSC and have no other income I am not sure if the business can bring in enough money to support me let alone give 26% away to someone else. I know there are so many variables it is probably difficult for you to advise but I wondered if you could give me a steer on how to approach this? Should I take his offer or wait until I have some knowledge about whether the idea is viable or not?

    Thanks

    Richard

    Reply
  44. Richard
    Richard says:

    Just as an addition to the above post I made: my friend is willing to put 26% of the physical effort involved in making the business work.

    Thanks

    Richard

    Reply
    • Peter Chee
      Peter Chee says:

      Richard, if the amount of money is not significant then don’t give up the equity. There are tons of creative ways to hire inexpensive labor such as training and giving some people without skills an opportunity to learn something.

      Reply
      • Joe Ryu
        Joe Ryu says:

        Hi Peter,

        A friend of mine is planning to buy a restaurant where he currently work since the owner is planning to retire. The owner will sell the restaurant for $350K and the restaurant gross profit for FY2013 was equal to $1.2M. Assuming the initial operating cost required for 18 months is equal to $100K on top of the sales price of $350K. How much % in stake or ownership should I expect if I’m planning to invest $100K in this venture giving 2 scenario where the first scenario I will be actively involve in running the restaurant and take some responsibility, and second I will be a passive owner and let him run the restaurant? FYI, my friend is planning to form S Corp for this venture and he will be the CEO since he did have previous experience managing a restaurant.

        Thanks,

        Joe

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  46. wineman
    wineman says:

    Hello Peter

    this is the case with my start up, if u could assist me with the decision i would be very thankful.
    according to our business plan, the whole investment required is divided 50% equity and 50% loan.
    one partner brings all the cash requiredfor equity investment, however the second partner is the one with the idea and business plan, takes 100% of the management duties, also brings in the loan (secured by his own assets), brings in the land on which the factory will be built and most ipmortantly brings in the sales contract of the product to be produced. and from this contract company receives 100% of revenues next 5 years.

    please advise how to divide equity among these 2 founders of start-up?

    thank you in advance

    Reply

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