Ask HN: 3 co-founders or 2 co-founders and employee?
8 comments
I love companies that say they are "pre-revenue" as well as pre "product/market fit". In the infamous words of Kevin O'Leary you are pre-business, or what some might call a hobby.
Nevertheless, I don't say this just to rain on your parade. Businesses all start somewhere. But what you are saying is you have no cash on hand or ability to take on debt to pay for a software engineer to build your main product. Let's make it relatively clear, you cannot pay a person in equity in lieu of monetary payment. Why not? Because your equity isn't worth anything right now. If you have no revenue, no product, and no investment, you have no value. So if you were to "hire" an engineer who, at market value, might make $100,000 per year, how much would you pay them in equity? You cannot make the equation work.
So you are stuck with some other sort of agreement. You can make them a co-founder. But you don't want to dilute your equity. That's a major issue. The question then becomes how much benefit are you bringing to the organization in comparison to them? I've been asked this, personally, a number of times in my career. "Will you take 5%? If we take off with this production we will become a $1,000,000,000 company and you'll be worth $50 MILLION!" My answer, when the company is at your stage is no, I will not take .5%, 1%, or 5%. I will take 50%.
Of course, co-founders choke on this. But I have a lot of issues to weigh as a potential co-founder. First, often times the other co-founders aren't working on the product or the company full time. The aren't making any revenue and so how will they live without a second job? On the other hand, as an engineer, I must get that product out the door quick, so I am heads down full time. Second, this is a huge risk for me and I do not want my co-founders making poor decisions while I stand there with my tiny, non-voting amount of equity.
Some might say "But what happens when we need investors!" and this is a reasonable question which does come up. I give up a percentage of my equity to gain investors at the same rate as my partners. If we need to do a raise as 20%, I now have 40% and my co-founders have 40%. The math follows down to just about any level. We make those decisions together.
Anyway, I just wanted to give you the other side of this sort of discussion. Most entrepreneurs want to value their idea very high, while reducing the value of product execution. By sticking to my principles, I have been quite successful, starting 2 businesses and partnering in 2 others, all sold successfully. I hope you find the right fit for you!
Nevertheless, I don't say this just to rain on your parade. Businesses all start somewhere. But what you are saying is you have no cash on hand or ability to take on debt to pay for a software engineer to build your main product. Let's make it relatively clear, you cannot pay a person in equity in lieu of monetary payment. Why not? Because your equity isn't worth anything right now. If you have no revenue, no product, and no investment, you have no value. So if you were to "hire" an engineer who, at market value, might make $100,000 per year, how much would you pay them in equity? You cannot make the equation work.
So you are stuck with some other sort of agreement. You can make them a co-founder. But you don't want to dilute your equity. That's a major issue. The question then becomes how much benefit are you bringing to the organization in comparison to them? I've been asked this, personally, a number of times in my career. "Will you take 5%? If we take off with this production we will become a $1,000,000,000 company and you'll be worth $50 MILLION!" My answer, when the company is at your stage is no, I will not take .5%, 1%, or 5%. I will take 50%.
Of course, co-founders choke on this. But I have a lot of issues to weigh as a potential co-founder. First, often times the other co-founders aren't working on the product or the company full time. The aren't making any revenue and so how will they live without a second job? On the other hand, as an engineer, I must get that product out the door quick, so I am heads down full time. Second, this is a huge risk for me and I do not want my co-founders making poor decisions while I stand there with my tiny, non-voting amount of equity.
Some might say "But what happens when we need investors!" and this is a reasonable question which does come up. I give up a percentage of my equity to gain investors at the same rate as my partners. If we need to do a raise as 20%, I now have 40% and my co-founders have 40%. The math follows down to just about any level. We make those decisions together.
Anyway, I just wanted to give you the other side of this sort of discussion. Most entrepreneurs want to value their idea very high, while reducing the value of product execution. By sticking to my principles, I have been quite successful, starting 2 businesses and partnering in 2 others, all sold successfully. I hope you find the right fit for you!
Thanks, I really appreciate your frank thoughts and sharing the perspective of a potential co-founder before I actually insult anyone.
My initial thoughts were to have an equal split amongst 3 people. I was warned that 3 co-founders would be too many and would not leave much on the table but I don't fully agree with that notion. I was willing to bet that anyone would want an equal share in return for what they bring to the table.
Just for clarification, when we raise at 20%, then all 3 of us would share the 80%? And how much do companies usually leave aside for employees?
My initial thoughts were to have an equal split amongst 3 people. I was warned that 3 co-founders would be too many and would not leave much on the table but I don't fully agree with that notion. I was willing to bet that anyone would want an equal share in return for what they bring to the table.
Just for clarification, when we raise at 20%, then all 3 of us would share the 80%? And how much do companies usually leave aside for employees?
If you were to come to me and say "Hey, we have this idea, we have a prototype, and we'd like to make it a product. We'd like to get it in front of investors and make you a partner. We know you are going to put in a lot of time and effort to build it. We can offer you 33%, as we're both going to take 1/3 ourselves..." I would not be offended by that. That is actually a very fair assessment and a good starting point for a fair negotiation.
As for splitting equity that is a bit more of a complicated conversation. Not all equity is the same. In a fair world you might say: 10% reserved for employees, 20% for investors, and 70% for us. That seems fair on the outside right? You would each get 23.3% and you could each outvote any investor you bring on board. However, often times you don't have straight equity deals when raising funds. You might take a convertible note. You might have an investor who will only accept preferred shares of equity with special arrangements. Even relatively simple and underfunded start ups can sometimes have very complex cap tables with multiple levels of shares of stock being given different rules and right. If you're not careful, the cap table can easily run away from you. I have known quite a few successful entrepreneurs who have gotten screwed in the end, not because of co-founders, but because the cap table went sideways. For example, one small start up was offered north of $80MM 4.5 years after starting up. The co-founders each, after taxes, walked away with a few hundred thousand.
So, to answer your actual question, it really depends. Getting a partner who has been through those whole ordeal before can be priceless.
As for splitting equity that is a bit more of a complicated conversation. Not all equity is the same. In a fair world you might say: 10% reserved for employees, 20% for investors, and 70% for us. That seems fair on the outside right? You would each get 23.3% and you could each outvote any investor you bring on board. However, often times you don't have straight equity deals when raising funds. You might take a convertible note. You might have an investor who will only accept preferred shares of equity with special arrangements. Even relatively simple and underfunded start ups can sometimes have very complex cap tables with multiple levels of shares of stock being given different rules and right. If you're not careful, the cap table can easily run away from you. I have known quite a few successful entrepreneurs who have gotten screwed in the end, not because of co-founders, but because the cap table went sideways. For example, one small start up was offered north of $80MM 4.5 years after starting up. The co-founders each, after taxes, walked away with a few hundred thousand.
So, to answer your actual question, it really depends. Getting a partner who has been through those whole ordeal before can be priceless.
Thanks for your thoughts! I really appreciate your time to write the post out.
Sivers' advice on valuing ideas:
https://sivers.org/multiply
https://sivers.org/multiply
If you are only paying him equity and no salary, he is a co-founder. How much equity he gets depends on what each of you bring to the table and on the negotiations with him. Google "founder equity calculator" to get a good idea of what factors to think of. Those calculators are not perfect, but make for a good starting point.
Assuming you can convince him to join at whatever stock distribution is acceptable to him, you, and your other founder, you might not need to worry about what's left for future investors. That will be a separate negotiation, and everyone will likely get diluted then, whether they own 5% or 50%.
3 founders can work fine. Many would consider it better than 2, all else being equal, since with 3 you can break some decision logjams. But that assumes all 3 are good, and that you have developed a strong working relationship. Reading your post, where you are technical, you are bringing someone on to help, and eventually he may be promoted to CTO, makes me wonder if you view him as more junior, currently. And whether he views himself more junior. That might drive both the equity split, and whether he participates as an equal in routine operational (or even technical) decisions.
3 founders can work fine. Many would consider it better than 2, all else being equal, since with 3 you can break some decision logjams. But that assumes all 3 are good, and that you have developed a strong working relationship. Reading your post, where you are technical, you are bringing someone on to help, and eventually he may be promoted to CTO, makes me wonder if you view him as more junior, currently. And whether he views himself more junior. That might drive both the equity split, and whether he participates as an equal in routine operational (or even technical) decisions.
Thanks. Yes, those are very good points for me to take into consideration. Given this early stage, I was hoping to get something going faster without having to worry too much about future dilution, etc. but I do worry about his participation and perception of equality from his end of things.
That being said, I had a quick chat with him and apparently, he's doing another startup so looks like the decision has already been made for me for the time being.
That being said, I had a quick chat with him and apparently, he's doing another startup so looks like the decision has already been made for me for the time being.
Why are you worried about reducing equity when all that amounts to right now is a bigger slice of zero? And if everything works out dreamily, the difference is whether you spend your days rolling around on a 12" stack of money or a 10" stack?
The reason not to bring in a third cofounder is that you don't have access to the right person...a cofounder is like your spouse only there's more money at stake and you spend more time together.
Finally, if you find the right cofounder, you can bootstrap, generate revenue and have better control over the terms at which others may be offered the opportunity to invest in your company. Having investors is not a goal, it is a means to an end, just like bringing in technical talent.
Good luck.
The reason not to bring in a third cofounder is that you don't have access to the right person...a cofounder is like your spouse only there's more money at stake and you spend more time together.
Finally, if you find the right cofounder, you can bootstrap, generate revenue and have better control over the terms at which others may be offered the opportunity to invest in your company. Having investors is not a goal, it is a means to an end, just like bringing in technical talent.
Good luck.
Thanks, they are my thoughts exactly but I wanted to see what others thought.
There are already 2 co-founders but me being the only technical person, I wanted to bring on another technical person to speed things up.
There are already 2 co-founders but me being the only technical person, I wanted to bring on another technical person to speed things up.
Simplified version:
* If you pay 95% in money and 5% of the salary in equity, he is an employee
* If you pay 5% in money and 95% of the salary in equity, he is a cofounder
Also:
* An employee only gets a few % of the total equity, say 2%, 1% or less
* A cofounder gets almost the same equity of the other cofounders, in this case about 33% (perhaps 40%+40%+30%, not 45%+45%+10%) (In this case, it looks like you don't have a prototype, so 33.3%+33.3%+33.3% looks better.)
[In any case, remember to use the standard 4 years vesting with 1 year cliff scheme.]
* If you pay 95% in money and 5% of the salary in equity, he is an employee
* If you pay 5% in money and 95% of the salary in equity, he is a cofounder
Also:
* An employee only gets a few % of the total equity, say 2%, 1% or less
* A cofounder gets almost the same equity of the other cofounders, in this case about 33% (perhaps 40%+40%+30%, not 45%+45%+10%) (In this case, it looks like you don't have a prototype, so 33.3%+33.3%+33.3% looks better.)
[In any case, remember to use the standard 4 years vesting with 1 year cliff scheme.]
Thanks for the simplification and especially for the ratios for the co-founders. We do have a prototype as I'm also technical but I think we would benefit from faster development by bringing on another technical person.
When would it make sense to go 40%-40%-20%? And how would it look like when we bring in funding from outside investors?
When would it make sense to go 40%-40%-20%? And how would it look like when we bring in funding from outside investors?
Investors will have problems if the gap is too large. They'll wonder what discussions aren't being had with the 20% cofounder, if that person is motivated to be part of the company for the long term, etc.
Unless you've done this many times before, its not really that big a deal to do an even split. Assuming success, you'll likely end up with less than half of your original equity, so what is a 20% gap now (huge!) might be 5% or less when you exit (ie no big deal).
Of course, go with a vesting schedule and cliff. And to make up for them coming on later, perhaps you start with 40 / 40 / 20 but have a plan (that you share with them) to grant them additional equity each year until it's roughly even, so as they prove their worth and commitment you make them an even cofounder.
Unless you've done this many times before, its not really that big a deal to do an even split. Assuming success, you'll likely end up with less than half of your original equity, so what is a 20% gap now (huge!) might be 5% or less when you exit (ie no big deal).
Of course, go with a vesting schedule and cliff. And to make up for them coming on later, perhaps you start with 40 / 40 / 20 but have a plan (that you share with them) to grant them additional equity each year until it's roughly even, so as they prove their worth and commitment you make them an even cofounder.
When would it make sense to go 40%-40%-20%?
Maybe in some corner case where it isn't a waste of energy? That's why it is worth at least considering Joel Spolsky's advice:
https://gist.github.com/isaacsanders/1653078
By the way, 40-40-20 is no better from a control perspective than even thirds. Two can sell the other out. And control is a bigger issue than percentages in the sort of pissing contests that matter. Even worse, the person with 20% has more to gain by cutting one of the 40%'s out...as do each of the 40%'s.
Maybe in some corner case where it isn't a waste of energy? That's why it is worth at least considering Joel Spolsky's advice:
https://gist.github.com/isaacsanders/1653078
By the way, 40-40-20 is no better from a control perspective than even thirds. Two can sell the other out. And control is a bigger issue than percentages in the sort of pissing contests that matter. Even worse, the person with 20% has more to gain by cutting one of the 40%'s out...as do each of the 40%'s.
So you want an investor who is also employee. If you can't find a good CTO who doesn't need a salary, try to find an investor who wants to pay his salary.
Not exactly.
I'd like to bring someone on to help with product development, eventually transitioning to CTO. Just wondering if that person should be a co-founder or an employee. And how much equity stake would be right to offer?
I'd like to bring someone on to help with product development, eventually transitioning to CTO. Just wondering if that person should be a co-founder or an employee. And how much equity stake would be right to offer?
If I was only being paid in equity, I would be offended being called an employee and not a cofounder (and would likely not continue / take the deal).
That makes perfect sense. And I'm assuming that you would only be interested in an equal split. Otherwise, I can't see why I would bother working on someone else's idea without as much of the reward with the same risk. Would that be accurate?
"We're still trying to product/market fit"
So you've got nothing but want to convince the new guy you have value to deserve more?
So you've got nothing but want to convince the new guy you have value to deserve more?
We're concerned that bringing on another co-founder will reduce the equity for everyone, including ourselves and potential investors. Are there other issues that a 3rd co-founder will bring?
The main benefit I see with another co-founder is that his interest will be properly vested into the project. I see him as eventually taking on a CTO role and managing the product development side.
The reason why we're considering a 3rd co-founder is that we're pre-revenue and we can only offer equity at this point. Have you guys heard of Employee #1 being paid with equity instead of a salary and is it enough to keep them in the game?
Thanks!