How many start-ups sabotage their chances by being too stingy when it comes to equity?

I thought I'd save everyone the trouble of going to a blog by ranting here directly.

A while back I was interviewing at a small company that really needed another developer or three. They wanted to hire and made an offer -- a 20k pay cut, but they were going to give me equity -- the magic word! Except the president/founder of the company wanted to keep 99%+ of the equity for himself, so anyone else let in on the deal had to share a fraction of the remaining 1%. I calculated that if the company was successful to the tune of $10 million, my share would still be worth less than my initial pay cut. I pointed this out to the senior developer who was trying to convince me to join, but his blind loyalty to the company seemed to preclude arithmetic.

Prior to that I worked at another smallish company where the president/owner kept around 95% of the stock. A few top people got 1% or less. Other companies say they want to hire "top talent", but they pay "market rates" -- which usually means the average according to some salary survey, or less, and no equity.

It seems like some founders are so attached to ownership that they can't part with it, even if it means greater success for themselves! It's like they have visions of dollars from owning the entire company instead of a vision of what's needed to get there. While a fraction of a percent of Google is worth a lot now, in order to get to that point, the founders had to part with the majority of the equity.

Some start-ups work with two founders, but some have half a dozen (like Excite) or more. Even reddit got more "founders" after the fact. If it turns out you need a new band member, are you prepared to redo the original founders' percentages, or do you have other plans?

I think its a dangerous generalization. I feel its more about knowing the market rate for your employees and making sure they are compensated for what they contribute. Equity is only one piece.

In your example, it sounds like a pretty weak deal. However, thats not to say that the lesson to learn is to attract employees through equity.

Owning equity is about risk. Employment is about security. If your really a savvy investor and think that equity in a given company is the best return on your investment, you should offer to put as much cash and man-hours into the company as you can for the greatest return. Then you are on par with the founders.

For interesting reading, look at Warren Buffett's philosophy on employee and management stock options. In earlier days he attracted key management with a fair salary, a good work environment, and an absolute lock out of equity.. he figured he was the only one taking the risk.

> look at Warren Buffett's philosophy on employee and management stock options. In earlier days he attracted key management with a fair salary

Today's environment is much, much different. ALL key manangement will require equity.

That example is kind of like saying Apple attracted people with a 1 MHz 6502 system. Different time, different standards.

I'd agree, environment is different. Risk of being on a management team is different. As is the culture of compensation and employee marketplace.

What has not changed is that company ownership is about investment risk.

I'm curious, what do you think of stock options for common employees?

I must admit, I don't understand this equity thing yet. But it seems to me that working for a company is simply an investment. So it seems that there are three options for a company:

a) it is already making enough money to pay the devlopers a good salary b) it is not making enough money and takes outside investments to pay the developers a good salary = some outsider gets the equity c) they pay the developers with the equity they would have given to the outsiders in b)

Seems simple enough - in all cases but a equity has to be given away, so why not give it to the developers to begin with.

If you look at it in really objective terms, what is a fair RoI for the paycut you take? Pick a number, if say you want a 5x return and expect to be there for 2 years, that's $200k you should bank after acquisition. if they go out at $10mil... then you want to have at least 2% equity.

Obviously, the longer you hang around, the lower the actual return you get for sacrificing the extra $20k/pa you could get elsewhere. If you wanted to take an even gloomier view, you could calculate the yield on investing $20k/pa, take into account consumer price indexes and any rising market rates. Oh and don't forget the potential for dilution.

Unless your employer is going out in many multiples of $10mil, it's probably better to take market rates elsewhere, and use the extra $20k to invest/bootstrap your own startup on the side :)

Some people have vision and others don't. Especially in small companies it's easy to find those who would rather own the proverbial 100% of nothing. Or 51% of something small instead of 10% of something great. In capital-intensive startups, like JetBlue and some oil operations, founders are known to raise lots of cash and end up with less than 10% by the time the private rounds are done.

Look at most major public companies, rarely do the founders own more than about 15% by that point. A lot of that is from dilution, from sharing the equity. I would propose that almost none of them would ever have gotten that far if they were afraid to share equity in order to get their project done, the right way, by the right people.

I actually agree with this.

I'm a 35 year-old entrepreneur and enjoy following the YCombinator stuff. Like clockwork, when I mention the idea of YCombinator to other elder entrepreneurs like myself, they say, "Pish Posh. $5k per founder for 5% of equity?!"

The reality is that you have a pretty low chance of success. If you can eek out a few more percentage points by giving away a small slice of your company, it's worth it. Whether it's to YCombinator or a key employee.

And, I'd also point out this-- Willingness to give away equity for increased chance at success shows that you are committed to the idea of business success (rather than the idea of personal wealth).

I'm puzzled by the reaction of "$5k per founder for 5% of equity?!"

I've been eagerly reading about YCombinator and it seems to me that they are offering a great deal more than money. It appears that the value of their consultation, connections and the other founders you end up spending time with are probably worth far more than the 20k-ish they invest in your company.

I can't imagine not taking their deal if I had an appropriate startup. 5% of equity in something that is currently completely speculative in return for what appear to be world class consulting and networking services? If they maintain their current success rate, I think it's safe to say that far from being expensive, YC is spectacularly cheap and leaves a lot of money on the table. Which is probably why they are getting 1400 applications for 10 slots.

IIRC this time they had about 500 applications and no fixed number of slots. In a previous round they had 30 interviewees and I think 13 were picked...