Startups · Equity

Share Structure

Ali I Experienced Retail Maven, Marketing Pioneer, Mobile Specialist. Mobile Loyalty = $ales INCREASE! www.massmobileapps.com

December 7th, 2015

I am looking for the best way to distribute shares of a company to people as a way to compensate them.  Essentially I want to bring on some talent to my company, and wanted to do it by offering an equity position. 

Mike Moyer

December 7th, 2015

Someone mentioned Slicing Pie (thanks David!) I invented the model and it's quite simple. At any given time, you simply apply this formula:

A Persons Share (%) = Their Risk / Everybody's Risk

This is the only way to create a perfectly fair split.

Every other method is based on a person's ability to negotiate or predict the future. Then, to protect yourself from the extremely high likelihood that you negotiated wrong or predicted the future wrong, you can use a time-based vesting schedule which will provide a little protection at the great expense of misaligning incentives.

Slicing Pie is a relative risk model which makes much more sense. Risk is based on the fair market value of the contributions. Unlike future value, fair market value is easy to know.

When someone contributes to a startup company they are accepting the risk that they may never get paid for their contribution. The amount of that risk is equal to what they would have otherwise been paid for the same contribution from someone who could pay them.

For instance, let's say you're a marketing guy who could make $100,000 salary doing marketing stuff for a company. If you did similar work for a startup company that had no cash you would be risking your $100,000 salary.

That is crystal clear, no ambiguity whatsoever.

Most people spend time trying to figure out how much value you are adding. This is impossible. Only risk is knowable.

The risk of spending time is fair market salary, the risk of contributing ideas is potential fair market royalties, the risk of contributing relationships is potential fair market commissions, the risk of contributing office space is fair market rent. Everything has a fair market value unless there is no fair market value in which case there is no risk.

So, if you want to know exactly how much equity to give your new employee (and yourself) simply keep track of what he is contributing and what you are contributing and figure out what your risk relative to his is.

This will always give you the right answer with noambiguity.

Want to add a third person? No problem, when they contribute, add their contribution to the total risk and run the calculation again!

Slicing Pie is nothing short of a magical formula that will always give you the right answer.

It's simple and it's perfect.

I've written a number of books on this topic. The books go into depth about how to determine fair market value, how to keep track of the contributions, how to differentiate between cash and non-cash contributions and what happens when someone leaves the company under different circumstances. I'd be happy to send you a copy of one of them if you contact me through SlicingPie.com.

Slicing Pie runs against conventional wisdom. It's a new way of approaching an age-old problem that is fundamentally flawed. Any questions you may have can be addressed!

Good luck!

-Mike


Frank Traylor Cofounder at Terra Health Care Labs

December 8th, 2015

Great point Burke. It's often easy to over simplify when talking about equity compensation assuming the employee will understand the complexities of options. If you say the award is 3% of the company, you will very likely get push back when the ultimate ownership share is less. As is the case in everything HR, full disclosure and complete clarity is paramount. 

Denis McDuff

December 7th, 2015

I like the Mike Moyer's risk analogy. In addition there is a difference between
stock (to reward performance and loyalty) and sales incentives (short term motivation). See Jeremy Lemkin's thoughts on sales commission structure at Saastr.com. 

Peter Stone Attorney at Hopkins & Carley

December 8th, 2015

Burke makes a very important point, and I hope everyone that is participating in this discussion takes it into account. It's extremely common to have discussions, particularly in the earliest phases, that are couched in terms of percentages. I always tell my clients that it's fine as a way to discuss relative ownership at a specific point in time, but the percentage interest always needs to be converted to a share number, either immediately at the time of grant, or no later than the next major equity-affecting transaction, such as the next financing. If you want to fully appreciate how badly this can go wrong, go watch The Social Network again.

Burke Franklin

December 8th, 2015

Be careful talking in terms of % ownership.
It's OK at the initial stock allocation (including vesting schedule), but
% will change constantly and it's the wrong thing to focus on -- best to speak only  in terms of number of shares going forward. The idea is that each person has their shares and everyone gets rich the same way => share price. Otherwise, you spend too much time managing expectations and refereeing who owns how much. For what it's worth, take an look at JIAN;s Stock Options Builder software app/template.

Peter Stone Attorney at Hopkins & Carley

December 7th, 2015

Please don't ignore the technical aspects of doing employee equity right. You can really mess up your capital structure and your contributor's tax situation if you don't. Talk to your lawyer about the corporate and securities law aspects and to your accountant about the tax and accounting issues.

As a business matter, you will often find yourself being reminded - particularly by investors - that points are precious. Don't waste them on folks who really won't be motivated by equity. See Neil's comment above. Always use vesting, whether on restricted stock sales of option grants. Can be time-based (most usual) and/or milestone based. Also, mostly vesting comes with a one-year cliff. Means there's no vesting at all for a year. Then the stock/option becomes vested in proportion to the number of years in the vesting schedule. Four years is the most common, so the stock would be one-fourth vested on the first anniversary of the grant. If your sales person isn't working out, you can terminate him during the first year, and there will be no vesting and no loss of equity by you.

Rahul Moghe Group Manager - Shared Services at InfoCepts

December 7th, 2015

You have two options.

1. Vest a certain percentage of shares in them as they join or complete a certain period of service. The vesting can be at a predetermined price. The actual share distribution can happen at a later date, which is when they see a jump in the share value.

2. Issuing shares and going through the rigmarole is a pain in the early stages of the business. Consider Phantom Equity as a way out. You don't actually issue shares, but link cash incentives to the value of a share. The benefits of incremented share value keeps them motivated.

John Currie ITERATE Ventures - Accelerating Science & Technology Ventures www.iterateventures.com

December 7th, 2015

Ali,

It's a great test for you ... to see how good of a recruiter and communicator you are.  You have to ...

   - translate your company vision into actual revenues,
   - communicate that picture and how that will be executed,
   - describe a valuation of what the company should be at that time,
   - describe the role/impact of the person you are recruiting today,
   - and how their compensation - shares earned in - are a phenomenal deal for them to jump on it now.

Make sense?  Not as easy as offering cash ... but usually a must-do for all starting entrepreneurs bringing on early team members.

Frank Traylor Cofounder at Terra Health Care Labs

December 8th, 2015

It's a good idea to set a portion of the shares for employee options up front. A pool of 20% might be typical. Then figure out where you'll be if you grow over the next 5-10 years and what that might look like. There would be a tier of grants for senior management all the way down to the lower compensated employees. Senior management might get 2-5%.

I think getting this set up is important so you aren't squeezed as you grow and so you have a handle on employees as you raise money. 

In my experience, sales people are compensated on the low end of both equity and salary with a strong incentive for sales. 10-15% would be way high in most situations. Your situation might be different. This person might be a co-founder, responsible for business development, go to market strategies, closing deals, and building a sales team. If he/she can handle the entire revenue side of your business and you work well as co-founders then 10-15% might be a fair number. 

Michael Burack

December 7th, 2015

  1. read BrUce Carpenter's lucid and rational approach on this website for clarity