Los Angeles Startup Community. Posted by Tony Karrer at 7: This is a fantastic post I am dumbfounded why no one has left a comment here saying THANKS after 4 years! Tuesday, September 27, Equity for Early Employees in Early Stage Startups.

I was asked by a reader how much equity he should give out to early employees and to service providers in a very early stage startup. I'll get to service providers in a later post. Early Employees To help with this discussion, let me start with a definition of "early employee.

Tony Wright | A Newbie’s Guide to Startup Compensation (or “Stock Options will Make Me Rich!”)

Founders Early Employees Employees Later Employees Employees The reality is that the definition of founder and employee is not clear. The first few people into a startup are on a spectrum of founder vs. Founders are likely not paid for a long time and have a sizeable equity percentage for early risk and having the concept. An employee is later, has a greater portion of compensation as cash, has lower risk, and generally does not bring as much to bear in terms of the concept.

Early Employee Equity is an Art I somewhat agree with Fred Wilson in Employee Equity: For your first key hires, three, five, maybe as much as ten, you will probably not be able to use any kind of formula. Getting someone to join your dream before it is much of anything is an art not a science. Equity Formulas While it's somewhat an art, there has been a lot written about how you can look at equity compensation.

Paul Graham provides what is roughly the core formula for equity at any point in The Equity Equation: You can use the same formula when giving stock to employees, but it works in the other direction. So you'll break even if you trade Let's run through an example.

So subtract a third from Of course, to be able to use this kind of formula, you will need to be able to determine how much impact the person will have and figure out a valuation. You can also take a look at StartupRoar 's topics: Startup Valuation , Pre-Money Valuation , and Early Stage Valuation.

How to Fund a Startup

Same Value for Sweat Equity as Investment Dollars? Jason Cohen in How to think about cash vs. The key in his approach is that equity compensation should be viewed the same way that you view investment.

In other words, the loss of compensation for the early employee as compared to market rate should be viewed as equivalent to the equity for that same dollar amount from an investor. Logically, that's correct, but I personally would put a risk premium on equity compensation. I also believe that early employees should be bringing higher value than early investor dollars as they can and should contribute to the concept greater than an investor.

They are partially rewarded by the increase in value of their equity. But their contributions raise the value for everyone. I believe that Paul Graham's core formula takes that into account. Ben Yoskovitz gets to a similar point In Changing Equity Structures for Early Startup Employees: The more that those first employees feel like founders in terms of their ownership, emotional attachment, responsibility and overall understanding of the startup process including financing, running day-to-day activities, etc.

David Beisel puts it another way: Being an early hire at a startup gives an individual the ability to make tremendous impact on an organization as it grows — and both the founders and those hires should know it. Of course, all of that assumes that the early employee does make an impact.

Risk Premium on Equity Compensation? While Jason Cohen suggests that investment cash and sweat equity should be viewed the same, quite a few people suggest that there should be a risk premium for early employees at early-stage startups.

A risk premium is a multiplier that says that any equity compensation should be viewed as being worth less than cash for that employee because of the risk.

Employee Equity - Sam Altman

The risk premiums that I've seen vary widely with seemingly camps of: There's also the aspect that the equity that you typically get as part of equity compensation is behind other equity in preference and thus effectively has lower value. But the more important rationale is raised in the following about why employees most often do not have significant outcomes even in fairly positive liquidity events.

Memo to CEOs And Founders: Unlike the founders, the employees have to wait until their grants vest, working at a company no longer of their choosing for two years.

Startup Valuation: How Much Is Your Company Worth? | VentureArchetypes Blog: Seed Stage Capital

Is it Time for You to Earn or to Learn? Stock vests for 4 years.

And that's assuming that it's a fairly positive outcome. If it's anything less that positive, preferences will mean they get nothing other than what's required to keep them working if that's needed at the acquiring company.

Sample Equity Numbers I personally always like to see some actual numbers rather than basing things on formulas. Because of the Art aspect of early employee equity, I had trouble finding much in the way of numbers for that specific aspect.

I did find a few things for later points. Wilson Sonsini and DFJ Gotham Ventures: The Option Pool Shuffle: You can also look at some data around this in Startup CTO Salary and Equity Data at some specific numbers at different stages Where I Come Out Again, like Fred Wilson says, early employee equity is more art than science. I would look at the individual involved and factor in: Domain expertise Connections Experience with related ventures Ability to make significant contributions Replaceable - are there lots of other people out there who can do the same thing.

Full-time - doing something on the side is less valuable In other words, if I find someone who's willing to dive-in, who's going to significantly contribute to make the company a success and it would be hard to get anyone else, then I would provide significant equity, most likely an equity premium. If this is a junior level developer, then likely you can provide significantly less equity.

The example numbers above bear this out. Oh, and one last thing, make sure you figure this out upfront, you have it vest, you have ways to get it back, etc. There's a lot of advice out there on structuring equity compensation agreements.

Go read up on that and do it right. More Resources There's a lot out there on this topic that's well worth reading. Splitting Startup Equity for Your Piece of the Pie Equity-Only CTO and Equity-Only Developers CTO Equity and Compensation at Venture Backed Companies Visualization of Startup CTO Equity and Salary Data CTO Equity - Negotiation After Funding What is the best way to divide up ownership in a startup? How To Calculate Sweat Equity Startup Equity For Employees A VC: How to figure out what those VC terms mean for your equity Make Sure Sweat Equity Vests How To Allocate Founder and Employee Equity Is Dilution Considered When Talking About Equity Ranges?

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