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

133 points by Thieum22 12y ago

colinbartlett 12y ago
Can someone explain to me why being hired in a later round of hiring is really that much less risk? It sounds right on the surface, but is that really the case in practice? Not in my experience. I've never known startups to be steady long-term job providers. Seems like most live on the edge, always with not more than 3 months cash in the bank. Even when you get a big round of funding and hire more people, the investors want to use that money even faster than your last round.
- n72 12y ago
  I think risk can be defined in many cases as taking less money than you could get with an established company. Basically, this discrepancy has to be made up and the one way to do that is via shares.
- pdq 12y ago
  It's based on survival. If you have survived two years, there's a much better chance you will survive for the next two years, than the chance of two additional years of survival after only the first 6 months. The longer you have survived, the more mature you likely have become. This means you go from a demo, to a prototype, to a working product, to having a pilot customer, to have paying customers. It's certainly true that some companies get tons of money without really being a mature company (especially in these days). The investors backing them are really pushing for a moonshot, so they invest tons of money and expect to spend the money quickly. Those are cases of less mature companies basically playing the lottery, and I'd agree it's pretty risky.
- moron4hire 12y ago
  Because as bad as it is for early employees, it's even worse for founders. Founders may expect for themselves to work without pay, if times get tough. Employees should either get paid or the company is done.
- gatehouse 12y ago
  1. Investors see it that way when they participate in later rounds at higher valuations. When you disconnect from "market" it creates serious problems. 2. Skills risk, being at the top of your profession globally requires constant focus and professional support. The atmosphere at a very small company is hostile to this level of focus by necessity. It has a dulling effect.
  - colinbartlett 12y ago
    Your second point is something I hadn't thought of, thanks!
- tptacek 12y ago
  Risk accumulates as the company operates. A risk faced by a layer 3 employee is also faced by layer 2 equity holders, even if they've left the firm. Founder equity also compensates the founders for more than the risk that the company will fail and zero out their contributions; it also implicitly covers the upside risk of the founders, which upside was demonstrated by the fact that the founders created a company and presumably could have created others (or done something comparably lucrative) instead.
- reality_czech 12y ago
  Personally, I don't think being a pre-VC employee is any less risky than being a founder. In both cases, if the company fails, you're going to put "worked on no-name startup that you've never heard of" on your resume and go on your merry way. But most people don't have the connections, money, and drive to become founders. So those who do pay themselves well, relatively speaking. It's really just that simple.
andruby 12y ago
I really like the fairness and simplicity of this system. The resolution for not taking a salary could be made fairer by adding interest to the IOU (eg: 5%).
n72 12y ago
"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 an investment in the company which can be measured in terms of dollars. In the case of the employee he is only getting an IOU, but in the case of the investor, he is getting shares. I don't see any reason why these should be treated differently.
- tptacek 12y ago
  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 technical solutions that attempt to ensure fairness.
  - pan69 12y ago
    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).
    - tptacek 12y ago
      They're zeroed out.
      - YokoZar 12y ago
        Perhaps more specifically, in a liquidation the IOU-holder is a creditor in line behind others (but ahead of common stock-holder)
vitovito 12y ago
Can a mod change the date? It's a repost of his original answer from 2011: https://web.archive.org/web/20110416041922/http://answers.onstartups.com/questions/6949/forming-a-new-software-startup-how-do-i-allocate-ownership-fairly/23326 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 https://news.ycombinator.com/item?id=2445447 and https://news.ycombinator.com/item?id=3489719 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-advice-to-split-equity-50-50?share=1 http://www.quora.com/What-do-you-think-about-Joel-Spolskys-a... I also think the share distribution Wizards of the Coast (Pokemon, Magic the Gathering) accidentally used was interesting: founders had no shares, and worked their way up into the single digits, which supported small, individual investors, but it's probably not recommended if you're planning for traditional investment: http://www.peteradkison.com/blog-entry-2-wizards-of-the-coast-equity-distributions-part-1/ http://www.peteradkison.com/blog-entry-2-wizards-of-the-coas... and http://www.peteradkison.com/blog-entry-3-wizards-of-the-coast-equity-distributions-part-2/ http://www.peteradkison.com/blog-entry-3-wizards-of-the-coas...
- diziet 12y ago
  WOTC's share distribution was interesting in the sense that it was terrible for the founder. What did work out well was Garfield's equity share, etc.
- tptacek 12y ago
  The "if you're going to argue yourselves to death, do it now" advice seems incomplete to me. It presumes a model where a team is either going to argue itself to death or not; the outcome is predestined, and so it's better to know early. But reality as I've experienced it is that arguments degrade teams (and relationships of all sorts). A team that might have survived can be killed by inviting a pointless argument. A team has a capacity for arguments that depletes over time as arguments exhaust the team members. Arguments happening in rapid succession set up a vicious cycle, because there's a migraine aura of bad communications surrounding any big argument, and difficult decisions that happen in that aura spark needless new arguments. Lots of arguments also carry a potential for resentment, which creates a longer-term communication problem which sometimes insidiously builds as the company runs. The "trial arguments" theory that Quora comment suggests seems to me a little like those parents who throw "chicken pox parties". It's probably fine and maybe even pragmatic, but it's a risk.
zeteo 12y ago
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.
- tptacek 12y ago
  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.
  - zeteo 12y ago
    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.
    - tptacek 12y ago
      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.
      - zeteo 12y ago
        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.
        tptacek 12y ago
acgourley 12y ago
Honest question - wouldn't a large stack of IOUs (say, 200k) tend to cause problems in the next investment deal? Wouldn't most investors demand to wipe that out before they are putting money in?
- tptacek 12y ago
  Maybe (I've had friends who tried to negotiated deferred salary into A-rounds). But there's also no rule saying that the IOU has to be paid back at the A-around.
- reality_czech 12y ago
  Yes, investors _hate_ IOUs and often demand that they get wiped out before they invest. This is one of the reasons why Spolsky's advice is bad (in my opinion.) If a founder can't live with a slightly unequal share distribution, he is probably going to be the kind of guy who measures office sizes with a ruler. You're doomed anyway. It's probably good to avoid a hugely skewed share distribution, but if you really have to pay people different amounts of cash, the loser in that deal ought to get shares.
geebee 12y ago
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.
- tptacek 12y ago
  Not super common in my experience; typical equity schemes are both much fussier and way more opaque.
jamesblonde 12y ago
"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 in the profits. When you leave, you get nothing. That model is fair!
- tptacek 12y ago
  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).
- n72 12y ago
  So, as a founder I quit my lucrative job, max out my credit card, work 18 hour days for a year giving up a social life, vacations etc. Once we're making money and I hire you to do QA where you work 8 hours a day and take no risk. There is no circumstance under which you should get even close to what I as founder get.
- msandford 12y ago
  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.
jamesblonde 12y ago
"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 in the profits. When you leave, you get nothing. That model is fair!
tptacek 12y ago
The most important bit of advice in this post pertains to vesting. If you do nothing else Spolsky advises, make damn sure you pay attention regarding vesting.
midas007 12y ago
TL;DR equal shares in the same layers and vesting are the big points. For the top layer: the real nature of a person comes out when they have a perceived opportunity to win big at someone's expense... hence good friends can make good cofounders. Failing that, find someone that plays well with others and considers the long-game of their actions. (You're gonna stick together for the next venture if this app doesn't work out, right?) For the second layer: should be people you'd like to work with that may be founders in the future or people that have been recommended. Third layer are more/less startup employees. So not regular corporate like employees that need to be thought for or are super niche, but T-shaped folks that can take initiative and worry a little more about details.
ojosilva 12y ago
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.
- Taek 12y ago
  I think it really depends on your agreement with your employees, more than the risk. Do they feel like they are being treated fairly? For me personally, I want my employees to feel vested in the company. They are helping to build it, they are helping to mold it and shape it into something that will hopefully be very great. I want them to have equity because it gives them responsibility. (We don't have any employees at the moment, so it's easy for me to say this now). Most importantly, I want the employee to feel like they are in an arrangement that they are comfortable with. If they are doing it as just a job, working exactly 40 hours per week, then a salary without equity makes sense.
- peterjancelis 12y ago
  If you were profitable when paying that company car and those salaries, and your cash flow was secure in that you either had a lot of clients or long terms contracts, then yeah I agree your employees did take on zero risk. If you were profitable from day one, I assume you run a services business?
kansface 12y ago
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.
- tptacek 12y ago
  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.
stackthatcode 12y ago
Open question: how do you look at the equity where one of the co-founders (Founder A) does not have to work for X number of years, since they've cashed out of another company. They have the capacity to work full time, whereas the other "co-founder" (Founder B) is only able to work part-time. Founder A has the means to not work for a lengthy period of time. While they're taking on an opportunity cost, is their risk viewed the same as some other guy that quits his job (kills his income) and maxes out his credit cards? EDIT: According to Spolsky in his hypothetical situation, Founder B was not a co-founder because he kept his job. Founder A, OTOH was essentially unemployed and took on all the risk, and therefore was a "legitimate" founder.
gdubs 12y ago
50/50 splits can be a terrible idea. If you're stuck with an unreasonable partner, the company can be deadlocked at every decision.
- g42gregory 12y ago
  If you're stuck with an unreasonable partner, the company will fail anyway, so I don't think deadlock will be a problem here. :-) Also, the moment you have investors, the person's shares go below 50% and deadlock goes away.

133 points by Thieum22 12y ago

Can someone explain to me why being hired in a later round of hiring is really that much less risk? It sounds right on the surface, but is that really the case in practice? Not in my experience. I've never known startups to be steady long-term job providers. Seems like most live on the edge, always with not more than 3 months cash in the bank. Even when you get a big round of funding and hire more people, the investors want to use that money even faster than your last round.

n72 12y ago
I think risk can be defined in many cases as taking less money than you could get with an established company. Basically, this discrepancy has to be made up and the one way to do that is via shares.
pdq 12y ago
It's based on survival. If you have survived two years, there's a much better chance you will survive for the next two years, than the chance of two additional years of survival after only the first 6 months. The longer you have survived, the more mature you likely have become. This means you go from a demo, to a prototype, to a working product, to having a pilot customer, to have paying customers. It's certainly true that some companies get tons of money without really being a mature company (especially in these days). The investors backing them are really pushing for a moonshot, so they invest tons of money and expect to spend the money quickly. Those are cases of less mature companies basically playing the lottery, and I'd agree it's pretty risky.
moron4hire 12y ago
Because as bad as it is for early employees, it's even worse for founders. Founders may expect for themselves to work without pay, if times get tough. Employees should either get paid or the company is done.
gatehouse 12y ago
1. Investors see it that way when they participate in later rounds at higher valuations. When you disconnect from "market" it creates serious problems. 2. Skills risk, being at the top of your profession globally requires constant focus and professional support. The atmosphere at a very small company is hostile to this level of focus by necessity. It has a dulling effect.
- colinbartlett 12y ago
  Your second point is something I hadn't thought of, thanks!
tptacek 12y ago
Risk accumulates as the company operates. A risk faced by a layer 3 employee is also faced by layer 2 equity holders, even if they've left the firm. Founder equity also compensates the founders for more than the risk that the company will fail and zero out their contributions; it also implicitly covers the upside risk of the founders, which upside was demonstrated by the fact that the founders created a company and presumably could have created others (or done something comparably lucrative) instead.
reality_czech 12y ago
Personally, I don't think being a pre-VC employee is any less risky than being a founder. In both cases, if the company fails, you're going to put "worked on no-name startup that you've never heard of" on your resume and go on your merry way. But most people don't have the connections, money, and drive to become founders. So those who do pay themselves well, relatively speaking. It's really just that simple.

andruby 12y ago

I really like the fairness and simplicity of this system. The resolution for not taking a salary could be made fairer by adding interest to the IOU (eg: 5%).

n72 12y ago

"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 an investment in the company which can be measured in terms of dollars. In the case of the employee he is only getting an IOU, but in the case of the investor, he is getting shares. I don't see any reason why these should be treated differently.

tptacek 12y ago
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 technical solutions that attempt to ensure fairness.
- pan69 12y ago
  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).
  - tptacek 12y ago
    They're zeroed out.
    - YokoZar 12y ago
      Perhaps more specifically, in a liquidation the IOU-holder is a creditor in line behind others (but ahead of common stock-holder)

vitovito 12y ago

Can a mod change the date? It's a repost of his original answer from 2011: https://web.archive.org/web/20110416041922/http://answers.onstartups.com/questions/6949/forming-a-new-software-startup-how-do-i-allocate-ownership-fairly/23326 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 https://news.ycombinator.com/item?id=2445447 and https://news.ycombinator.com/item?id=3489719 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-advice-to-split-equity-50-50?share=1 http://www.quora.com/What-do-you-think-about-Joel-Spolskys-a... I also think the share distribution Wizards of the Coast (Pokemon, Magic the Gathering) accidentally used was interesting: founders had no shares, and worked their way up into the single digits, which supported small, individual investors, but it's probably not recommended if you're planning for traditional investment: http://www.peteradkison.com/blog-entry-2-wizards-of-the-coast-equity-distributions-part-1/ http://www.peteradkison.com/blog-entry-2-wizards-of-the-coas... and http://www.peteradkison.com/blog-entry-3-wizards-of-the-coast-equity-distributions-part-2/ http://www.peteradkison.com/blog-entry-3-wizards-of-the-coas...

diziet 12y ago
WOTC's share distribution was interesting in the sense that it was terrible for the founder. What did work out well was Garfield's equity share, etc.
tptacek 12y ago
The "if you're going to argue yourselves to death, do it now" advice seems incomplete to me. It presumes a model where a team is either going to argue itself to death or not; the outcome is predestined, and so it's better to know early. But reality as I've experienced it is that arguments degrade teams (and relationships of all sorts). A team that might have survived can be killed by inviting a pointless argument. A team has a capacity for arguments that depletes over time as arguments exhaust the team members. Arguments happening in rapid succession set up a vicious cycle, because there's a migraine aura of bad communications surrounding any big argument, and difficult decisions that happen in that aura spark needless new arguments. Lots of arguments also carry a potential for resentment, which creates a longer-term communication problem which sometimes insidiously builds as the company runs. The "trial arguments" theory that Quora comment suggests seems to me a little like those parents who throw "chicken pox parties". It's probably fine and maybe even pragmatic, but it's a risk.

zeteo 12y ago

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.

tptacek 12y ago
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.
- zeteo 12y ago
  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.
  - tptacek 12y ago
    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.
    - zeteo 12y ago
      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.
      - tptacek 12y ago

acgourley 12y ago

Honest question - wouldn't a large stack of IOUs (say, 200k) tend to cause problems in the next investment deal? Wouldn't most investors demand to wipe that out before they are putting money in?

tptacek 12y ago
Maybe (I've had friends who tried to negotiated deferred salary into A-rounds). But there's also no rule saying that the IOU has to be paid back at the A-around.
reality_czech 12y ago
Yes, investors _hate_ IOUs and often demand that they get wiped out before they invest. This is one of the reasons why Spolsky's advice is bad (in my opinion.) If a founder can't live with a slightly unequal share distribution, he is probably going to be the kind of guy who measures office sizes with a ruler. You're doomed anyway. It's probably good to avoid a hugely skewed share distribution, but if you really have to pay people different amounts of cash, the loser in that deal ought to get shares.

geebee 12y ago

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.

tptacek 12y ago
Not super common in my experience; typical equity schemes are both much fussier and way more opaque.

jamesblonde 12y ago

"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 in the profits. When you leave, you get nothing. That model is fair!

tptacek 12y ago
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).
n72 12y ago
So, as a founder I quit my lucrative job, max out my credit card, work 18 hour days for a year giving up a social life, vacations etc. Once we're making money and I hire you to do QA where you work 8 hours a day and take no risk. There is no circumstance under which you should get even close to what I as founder get.
msandford 12y ago
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.

jamesblonde 12y ago

tptacek 12y ago

The most important bit of advice in this post pertains to vesting. If you do nothing else Spolsky advises, make damn sure you pay attention regarding vesting.

midas007 12y ago

TL;DR equal shares in the same layers and vesting are the big points. For the top layer: the real nature of a person comes out when they have a perceived opportunity to win big at someone's expense... hence good friends can make good cofounders. Failing that, find someone that plays well with others and considers the long-game of their actions. (You're gonna stick together for the next venture if this app doesn't work out, right?) For the second layer: should be people you'd like to work with that may be founders in the future or people that have been recommended. Third layer are more/less startup employees. So not regular corporate like employees that need to be thought for or are super niche, but T-shaped folks that can take initiative and worry a little more about details.

ojosilva 12y ago

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.

Taek 12y ago
I think it really depends on your agreement with your employees, more than the risk. Do they feel like they are being treated fairly? For me personally, I want my employees to feel vested in the company. They are helping to build it, they are helping to mold it and shape it into something that will hopefully be very great. I want them to have equity because it gives them responsibility. (We don't have any employees at the moment, so it's easy for me to say this now). Most importantly, I want the employee to feel like they are in an arrangement that they are comfortable with. If they are doing it as just a job, working exactly 40 hours per week, then a salary without equity makes sense.
peterjancelis 12y ago
If you were profitable when paying that company car and those salaries, and your cash flow was secure in that you either had a lot of clients or long terms contracts, then yeah I agree your employees did take on zero risk. If you were profitable from day one, I assume you run a services business?

kansface 12y ago

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.

tptacek 12y ago
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.

stackthatcode 12y ago

Open question: how do you look at the equity where one of the co-founders (Founder A) does not have to work for X number of years, since they've cashed out of another company. They have the capacity to work full time, whereas the other "co-founder" (Founder B) is only able to work part-time. Founder A has the means to not work for a lengthy period of time. While they're taking on an opportunity cost, is their risk viewed the same as some other guy that quits his job (kills his income) and maxes out his credit cards? EDIT: According to Spolsky in his hypothetical situation, Founder B was not a co-founder because he kept his job. Founder A, OTOH was essentially unemployed and took on all the risk, and therefore was a "legitimate" founder.

gdubs 12y ago

50/50 splits can be a terrible idea. If you're stuck with an unreasonable partner, the company can be deadlocked at every decision.

g42gregory 12y ago
If you're stuck with an unreasonable partner, the company will fail anyway, so I don't think deadlock will be a problem here. :-) Also, the moment you have investors, the person's shares go below 50% and deadlock goes away.