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I didn't think his IOU solution for founders that either don't take a salary or contribute property made much sense. For that to be fair, you'd have to set a s

I didn't think his IOU solution for founders that either don't take a salary or contribute property made much sense. For that to be fair, you'd have to set a super high interest rate on the loan. At the same time, I see the difficulty with assigning a concrete value to the shares early on. The angel investment world solves this exact problem using convertible debt. Why not take the same approach with investments-in-kind made by the founders? If a founder forgoes a salary, why not agree to convert the pay difference relative to the other founders into stock at the time of the first equity financing at the share price negotiated with the VCs?

Chocobean 16y ago
in an ideal world, none of the founds will need the money to pay rent or pay for child care etc, they'd all be young guys with no debt living at home. The fact that one founder may have bills to pay, and him being the only guy having to cash in very early, will beat the morale out of him: he'll be working as an employee. This is also your guy whose tolerance for risk is the lowest precisely because he's got bills to pay. He might as well quit and go work 9-5 for steady pay in that case.
zyfo 16y ago
For that to be fair, you'd have to set a super high interest rate on the loan. Why? Hypothetically someone could take a standard loan and use that. That would be cumbersome, and sometimes impossible, but it wouldn't require a "super high" interest rate. They both work as hard and they both share the same risks. If they fail, the IOU still applies. One just happen to have more money stashed away.
- agmiklas 16y ago
  Is there such a thing as a "standard" interest rate? One of the main factors in determining the rate on a loan is the risk of default. For a newly incorporated company -- that's going to be high. Both partners might work as hard, but they don't share the same risks. One has put X thousand more into the business, and they should be compensated for that additional investment. The fairest way to do that is to consider what terms you'd find reasonable on an investment of similar risk.
  - zyfo 16y ago
    The way I understood Spolsky the IOU was between the founders, i.e. it would even apply if the company went bankrupt. If that is the correct interpretation, they share the same risk. I re-read the entry and it isn't clear to me if Spolsky thinks the IOU should be there even if the company ceases to exists. Me and my two co-founders had a similiar arrangement, albeit with very small amounts, and after the company died they paid me back the unofficial loan. We were all students and I happened to have some more disposable money for initial investments (under $3000 though).
    - bruce511 16y ago
      The IOU should be from the company to the person who puts in the money. The interest rate agreed upon should be balance to the risk.
michaelochurch 16y ago
Deferred pay, without equity, is a bad idea. First of all, seasoned people aren't going to work for deferred cash only, knowing that companies rarely pay it back until they're roaring successes. Deferred pay arrangements usually are, "we'll pay you $X when we have the cash on hand" but the problem is that the cash is never truly "on hand"; in a growing business, there's always a better use for the money than paying zero-interest debt to employees. Venture capitalists don't want their infusions to be spent on back salary, and most CEOs want to invest revenues back into the business. In lieu of equity, deferred pay is a bad deal for the employee: no upside, only downside, and usually on terms that are a lot less creditor-friendly than what banks can negotiate. A further problem with deferred pay is that when things become difficult, it's not much of a motivator. After a year or two, people assume they're never going to get it back and become resentful. It's better off for them to have equity, where they knew full well they might not be repaid. If a founder forgoes a salary, why not agree to convert the pay difference relative to the other founders into stock at the time of the first equity financing at the share price negotiated with the VCs? This is a decent first-order approximation, but for true fairness, the valuation should be set at the time the deferred-payment arrangement is made and should be lower than what is expected from a VC in the future. Because a deal may not happen, the fair valuation when this arrangement is set is lower than the expected VC valuation.
balloot 16y ago
Yeah I found that part especially wrong too. His article is all about fairness, and it seems especially unfair to me that someone would work and have a huge chunk of compensation deferred with a nontrivial chance the company never pays. If I work for someone, they need to compensate me right away. This may mean I receive an option grant that is eventually worthless, but at least in that case I would have had an upside to my risk. The IOU has no upside but has the same possibility of worthlessness.
- kgo 16y ago
  He's talking about founders, not employees. Made up numbers, but say you get 500,000 from investors. And the going rate for engineers is 100,000. Two founders can take a salary and hire two, maybe three, employees. If they can afford not to take a salary, they've doubled their staff size. Since each one of them owns 25% of the company, it may be worth the risk to them. It's obviously not worth the same risk to the first round of employees, who each end up with 2.5% of the company.

Chocobean 16y ago

in an ideal world, none of the founds will need the money to pay rent or pay for child care etc, they'd all be young guys with no debt living at home. The fact that one founder may have bills to pay, and him being the only guy having to cash in very early, will beat the morale out of him: he'll be working as an employee. This is also your guy whose tolerance for risk is the lowest precisely because he's got bills to pay. He might as well quit and go work 9-5 for steady pay in that case.

zyfo 16y ago

For that to be fair, you'd have to set a super high interest rate on the loan. Why? Hypothetically someone could take a standard loan and use that. That would be cumbersome, and sometimes impossible, but it wouldn't require a "super high" interest rate. They both work as hard and they both share the same risks. If they fail, the IOU still applies. One just happen to have more money stashed away.

agmiklas 16y ago
Is there such a thing as a "standard" interest rate? One of the main factors in determining the rate on a loan is the risk of default. For a newly incorporated company -- that's going to be high. Both partners might work as hard, but they don't share the same risks. One has put X thousand more into the business, and they should be compensated for that additional investment. The fairest way to do that is to consider what terms you'd find reasonable on an investment of similar risk.
- zyfo 16y ago
  The way I understood Spolsky the IOU was between the founders, i.e. it would even apply if the company went bankrupt. If that is the correct interpretation, they share the same risk. I re-read the entry and it isn't clear to me if Spolsky thinks the IOU should be there even if the company ceases to exists. Me and my two co-founders had a similiar arrangement, albeit with very small amounts, and after the company died they paid me back the unofficial loan. We were all students and I happened to have some more disposable money for initial investments (under $3000 though).
  - bruce511 16y ago
    The IOU should be from the company to the person who puts in the money. The interest rate agreed upon should be balance to the risk.

michaelochurch 16y ago

Deferred pay, without equity, is a bad idea. First of all, seasoned people aren't going to work for deferred cash only, knowing that companies rarely pay it back until they're roaring successes. Deferred pay arrangements usually are, "we'll pay you $X when we have the cash on hand" but the problem is that the cash is never truly "on hand"; in a growing business, there's always a better use for the money than paying zero-interest debt to employees. Venture capitalists don't want their infusions to be spent on back salary, and most CEOs want to invest revenues back into the business. In lieu of equity, deferred pay is a bad deal for the employee: no upside, only downside, and usually on terms that are a lot less creditor-friendly than what banks can negotiate. A further problem with deferred pay is that when things become difficult, it's not much of a motivator. After a year or two, people assume they're never going to get it back and become resentful. It's better off for them to have equity, where they knew full well they might not be repaid. If a founder forgoes a salary, why not agree to convert the pay difference relative to the other founders into stock at the time of the first equity financing at the share price negotiated with the VCs? This is a decent first-order approximation, but for true fairness, the valuation should be set at the time the deferred-payment arrangement is made and should be lower than what is expected from a VC in the future. Because a deal may not happen, the fair valuation when this arrangement is set is lower than the expected VC valuation.

balloot 16y ago

Yeah I found that part especially wrong too. His article is all about fairness, and it seems especially unfair to me that someone would work and have a huge chunk of compensation deferred with a nontrivial chance the company never pays. If I work for someone, they need to compensate me right away. This may mean I receive an option grant that is eventually worthless, but at least in that case I would have had an upside to my risk. The IOU has no upside but has the same possibility of worthlessness.

kgo 16y ago
He's talking about founders, not employees. Made up numbers, but say you get 500,000 from investors. And the going rate for engineers is 100,000. Two founders can take a salary and hire two, maybe three, employees. If they can afford not to take a salary, they've doubled their staff size. Since each one of them owns 25% of the company, it may be worth the risk to them. It's obviously not worth the same risk to the first round of employees, who each end up with 2.5% of the company.