Early employees – Salary & Equity

In the beginning of a startup there are just the founders. They do all the work – making / selling / admin / HR / cleaning / finance – everything. With their enormous passion and never ending energy they start moving the wheel. They make the product / launch it / get some traction / start getting some orders and so on. Once the work load increases to a point there is need for more hands & heads. Since they have launched / been covered / have made progress – less people look down upon them and some even show interest in working with them. Through their efforts they manage to find some passionate guys ready to come on board. (Read here about What to look for in startup interviews?). So far so good. Now comes the tricky part. What should be the salary and equity for the new team members? 

 

Salary

  • You need to find folks who are ready to work for much lower than market salary. Folks who value the other things they will get much more than money, things like – learn lot of cool stuff / work on hard problems / have loads of fun / work with uber smart folks / etc 
  •  To begin with it’s great if they agree to work for “survival salary” for a year or until the company either raises money or starts earning enough to pay him / her more than survival salary
  • Look for people who lead a fairly simple / bootstrapped lifestyle and don’t have too many commitments. Specially stay away from folks with housing loans
  • I think INR 15-25K a month is a good range to think about  
  •  When you make the salary commitments you should ensure that you have enough cash to take care of overall expenses for next 10-12 months or more
  • Budget for other expenses like – Computer / Phone / Work area / misc expenses for each employee
  • If you can hire people who bring their own laptop – that is a bonus


Equity

  • Equity should be decided depending on
    • Stage of the company
    • Potential impact on the employee on the future of the company
    • How much cut is the guy taking on the cash side (this should be compensated)
    • A good thumb rule is to think 5 years in future
      • Assume that your company is acquired for a reasonable amount
      • Calculate the return which that guy will get via sale of equity
      • Now estimate the market salary of the guy 5 years from today
      • If in the 5th year he can make 5-6 times his annual salary via the equity sale – its a decent deal / anything higher is off course better for him
  • Read PG’s excellent article on how much equity is the right equity
  • Overall you should designate a certain number of unallocated shares as the ESOP pool. These shares are not yet issued but have been allocated as employee stock – to be issued overtime
  • Typically startups keep 20% as employee stock option pool
  • Vesting Schedule
    •  Equity offered to startup employees is not just for joining but for long term contribution to the company
    • Hence you pro-rate the equity over this period of time called “Vesting Period”
    • Normally this period is 4 years. But in special cases it can be brought down to 3 years
    • You also need to think about the minimum period the person should work for the company for making a decent contribution
    • This is called “Cliff” and is normally 1 year. You can be flexible on the duration but its strongly recommended that you have the cliff in the arrangement
    • If the employee leaves (or is asked to leave) before completion of the cliff period he / she will not get any equity in the company
    • So lets say you plan to hire a guy X for following terms
      • Equity – 4%
      • Vesting Period – 4 years
      • Cliff – 1 year
    • This means that you will give X  4% equity for working in the company for 4 years. But you expect him to stay for minimum 1 year
    • Let’s say 4% translates to 4800 shares
    • Total vesting duration in months is 48 months
    • Every month that X stays with the company he becomes owner of 1/ 48th of 4800 shares – which is 100 shares
    • Now the cliff kicks in, X needs to complete the cliff period of 12 months to receive any shares
    • So if he stays for 13 months, number of shares = (4800/48) *13 = 1300
    • But if he stays for 11 months, he gets ZERO shares – since he did not complete the cliff period
  • Additional equity
    • In some case companies give additional equity to employees later on as a performance bonus or as part of promotion
    • Each equity grant should have separate vesting schedule
  • Share price
    • In most cases startup employees are only expected to pay the face value of the shares and even that is reimbursed in some form
    • But at later stages companies calculate the share price with the help of their CA and offer the shares the employee for a heavy discount or subsidy
  • Paperwork / Agreements
    • Setting up a formal ESOP plan with help of a good lawyer would be too expensive for a bootstrapped startup – hence it’s a good idea to do that after you raise series A or start making decent amount of revenues
    • For a bootstrapped startup, you should mention the amount of equity and details of vesting schedule in the employment agreement
    • At the time of issuing shares you enter into share subscription agreement with the employee – where he / she only needs to pay the face value of the shares
  • Deciding later
    • In many cases people like each other and start working together without finalizing the equity %
    • Leaving it totally open could be a bad idea – since expectations could be totally mismatched and that could become a big headache
    • If you do want to defer the decision on the number, make sure that you discuss
      • Exact time after which equity will be decided
      • Range in which the equity will fall
      • Your expectations from the employee
    • Best way is to start with a firm number slightly on the lower side and if things turn out good you can always grant more equity

Ankur raised a point while reviewing the draft of this post that some times the employee will ask you back the question – Why are you guys keeping 95% and giving me only 5%? Obviously guy is not able appreciate to or realize the difference in the contribution of a Founder and an early employee. Here are some of those reasons, which quite often remain invisible to the employees:

  • Founders take the maximum risk while starting a company
  • They quit their job not to join an existing setup but they quit with nothing in hand
  • The startups are literally created in heads of the founders – its their DNA that the startup carries – they have the maximum impact on its outcome and the equity should reflect that
  • The initial days are the hardest for every startup and there is very little to show – so at that point almost no one wants to join them – during that period its the founders alone who toil and create – employees mostly come later
  • An employee has the flexibility to leave  the job whenever they want and move on to a new job. Founders don’t have that option – they need to stay with the company thru thick and thin. (In theory they can also shutdown or leave – but in practice its very difficult)
  • Founders also make the initial capital investment in the company and add more capital in most cases / they max out the credit cards / bring personal laptops / run office from there home / bring stuff from home to run the office and many such contributions
  • Founders work for zero salary for quite a long time
  • Founders normally setup ESOP of 20% out of which other employees are also given equity grants – so they are really are not keeping 95%
  • Most employees want to do specialized jobs around their core area and stick to it – so that they continue to build their job career. Founders do not have any such choice – irrespective of their backgrounds – founders need to work in every department and do what ever it takes to keep things moving and it also involves junior most jobs like – bank work / cleaning / delivering orders / making tea / pretty much every thing
  • A founder’s career and reputation is attached to the outcome of the venture / he is the one who worries the most / looses the most sleep – the buck stops at him
  • As a founder -If you find a guy who can match you to a certain extent in above listed aspects – you should surely give him more equity or even bring him on board as a founder. One of portolio founders did this very recently – brought a guy as first employee with 9% equity / found that the guy can bring a lot more value and invited him to join as a co-founder with same amount equity as the first founder
  • As a founder – its also important that you draw the line at the right place. If you find someone really good for a particular role, but they bring no additional value and this person expects a much higher equity than what seems fair – Dont worry about it – just let them go. If they can not respect your contribution – they are anyway a wrong hire
  • As a potential employee – if you don’t see founders with the kind of commitment and qualities mentioned above – don’t join the startup

What are your experiences as a founder or a startup employee? Please share in comments and help make the post better.

 

  • Gurpawan Mand

    This is not just an article. It is real, ground zero practical gyan. My personal experience had been very short. My potential co-founder over-rated his skills and undermined my contribution (I was doing all the leg work). He demanded for more equity than what was a decent share. Finally, our chemistry didn’t work out.With your permission, I really wanna publish this post on my blog, http://www.genesisism.comThanks for such gr8 insights

  • Ankit Govil

    This is the article I was looking for always. I actually never understood in depth how the equity things work. Great article. Please write more on the early stage part of the startup both as an employee/founder.

  • mbansal14

    The yellow in the background and the variation in the font size is something distracts while reading an amazing post.Lot of learning for me there.

  • amitabh agrawal

    Thanks a lot for this post. The clarity and depth is stunning. We are hungry for more regarding criteria of equity allocation among founders,investors, stakeholders and board (besides employees) and weight given to various other factors too.

  • RaspinderSingh

    Great article, isit possible to reproduce this?

  • Sameer Guglani

    where would you like to reproduce it

  • RaspinderSingh

    I am creating a website to inspire entrepreneurship amongst new graduates, this is a great article i would like to reproduce with your permission.

  • Sameer Guglani

    go ahead

  • Charu

    This is helpful. Would you have some time to give advice on person-to-person basis. I am looking to understand this first-employee equity-salary equation in better manner.

  • Abey Zachariah

    Hi,This is good advice for anyone who is starting up. I can say so having been with a startup for the last 5 years. It’s very important to get stuff documented though. Also, exercise the options in a timely manner. It’s good for the employer as well as employees due to tax implications.CheersAbey