What is a fair compensation scheme for staff in a lean start-up?

YingYing Liu Assistant Brand Manager

October 1st, 2014

My co-founder and I would like to create an app, but we do not expect to generate any revenue within the first year. We work purely out of passion for our product, and belief that it will succeed. Compensation for us will come in the form of equity. However, for new team members, what is a fair compensation scheme? Given that equity can be expensive, is it wise to dish out equity to every new recruit before they have proven themselves/their fit with our start-up? Otherwise, with no expected revenue in the first year, paying someone any salary will come out of our own pocket. Funding is not an issue for us at the moment, but we would also like to spend our funds wisely.

Mike Moyer

October 1st, 2014

Hi Ying Ying,

The easiest and fairest way to do this is to implement a dynamic equity split. A dynamic split, unlike a more common fixed split which forces you to guess about future inputs, allocates equity on a rolling basis based on the actual contributions of time, money, ideas, relationships and other resources contributed by team members.

I've developed a model for implementing a dynamic equity split called the Slicing Pie method. The model has two pieces. First is the allocation framework that outlines how to slice up the pie among founders. It converts all possible inputs to slices. A person's share is equal to the number of slices they contribute divided by the total slices contributed by everyone.

The calculations used to determine the slices is based on the fair market value of the contribution and some risk multipliers.

The next piece of the model is the recovery framework which outlines what happens in case somebody leaves the company. Whether a person keeps slices depends a lot on the circumstances under which they leave. Getting fired for cause, for instance, is different than getting laid off due to budget cuts.

There are a number of places you can go to get more detail. I recently wrote an article on this site that explains more: http://founderdating.com/formula-for-the-perfect-cofounder-equity-split/

Or you can go to my web site, www.SlicingPie.com. After taking a look feel free to contact me if you have questions.

Good luck!

Tim Scott

October 1st, 2014

How much you pay in cash vs equity is a judgement that you and your founder must make based on your values. No one can advise you very well here. The attitude of the people you are able to find is a constraint as well.

When you wish to pay someone heavily with equity, you should never just dish it out. Rather put them on a vesting plan where they accrue what you expect them to be worth. Fire them fast if they don't pan out. By the way, it's a good idea that you yourself and your partner vest on the same schedule as your employees. This will make it much easier to bring in investors later as well. Consider something like four year vesting with a one year cliff.

Taylor Dondich Vice President of Engineering at MaxCDN

October 1st, 2014

This is a tough call. First off, what kind of staff are you looking to build? Is it possible to keep it to just your founders and then a minimal staff of contractors? Do you have any possibility of building your content/tech with contractors and paying them? The more people you have with "equity", the more difficult it will become for future negotiations for raising (potential equity restructures, etc).

You truly do want to first validate these people before giving them equity options. Contract work helps with this. Once you've validated them, ensure they're put on a vesting schedule with a 1 year cliff (Tim Scott mentioned this above).

This is absolutely imperative. Start with a absolute minimum viable product. And that means start with as minimal people as possible. Keep things as simple as possible and paying minimal cash to contractors makes it a lot easier than managing equity at this time. You want to focus on validating your MVP instead of having to spend too much time with biz org problems up front.

I noticed you were potentially struggling with tech concerns. My background is fully tech and I'll be happy to advise you in this area. Just get in touch with me.

Iwein Fuld Entrepreneur and developer, founder of StarterSquad

October 2nd, 2014

If you're looking to build an app, then you should consider that the best developers are very unlikely to see the value in your idea the way that you do. Because of that, they're likely to demand a higher percentage than you feel like dishing out. Long vesting periods are also not interesting to good developers. Paying in cash is often the cleanest approach.

If you're looking for help on the marketing/sales side, then it might be more likely that you can involve someone as a co-founder, but as you're already talking 'we' I'd say that you're best off doing that part on your own steam.

Chris Carruth VP/Director. Strategy | Business Development | Operations | Product | Solutions

October 2nd, 2014

It is typical to set aside an equity compensation plan that reserves a small amount of equity for founders and non-founders. This plan should have very clear and well thought "rules" around when/who/why/how equity is given out as part of the overall compensation package.

The reserved equity "fund" that I personally have seen is typically less than 10% of the overall pool, but reality is that it "depends" on many things and could be higher. A good CFO, working with a securities attorney, can help you here in think through structure and execution.

..or you can look online and find some examples and modify, then have the experts look over it. Often they prefer to use their own boilerplates but again, you just have to run it down and see what makes sense, both financially and in terms of risk.

Dana Todd Interim CMO at SRVR, LLC

October 7th, 2014

If I had it to do over again, I'd have given far less equity and more cash (or deferred cash) on my two startups. But, sometimes you don't really have a choice, or someone you really want to hire wants a piece of the action. I think you should have a couple of options when bringing people on, but vetting them is critical so don't just offer equity upfront if possible.

Remember, you'll be tied to shareholders for a potentially long time, and you won't have as much comfort/flexibility to hire and fire if they have equity. In the (frequent) case that they don't turn out to be a good long term fit, it's just a lot cleaner to have them as employees or contractors.

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