
Joel Sposky's Take On Equity Allocation In A New Software Startup (2011) - Thieum22
http://money.stackexchange.com/a/26370/2250
======
vitovito
Can a mod change the date? It's a repost of his original answer from 2011:
[https://web.archive.org/web/20110416041922/http://answers.on...](https://web.archive.org/web/20110416041922/http://answers.onstartups.com/questions/6949/forming-
a-new-software-startup-how-do-i-allocate-ownership-fairly/23326)

There's been a lot of discussion since, including
[https://news.ycombinator.com/item?id=2445447](https://news.ycombinator.com/item?id=2445447)
and
[https://news.ycombinator.com/item?id=3489719](https://news.ycombinator.com/item?id=3489719).

Also, at the time, Dan Shapiro argued against it here:
[http://www.quora.com/What-do-you-think-about-Joel-
Spolskys-a...](http://www.quora.com/What-do-you-think-about-Joel-Spolskys-
advice-to-split-equity-50-50?share=1)

I also think the share distribution Wizards of the Coast (Pokemon, Magic the
Gathering) accidentally used was interesting: founders had no shares, and
worked their way up into the single digits, which supported small, individual
investors, but it's probably not recommended if you're planning for
traditional investment: [http://www.peteradkison.com/blog-entry-2-wizards-of-
the-coas...](http://www.peteradkison.com/blog-entry-2-wizards-of-the-coast-
equity-distributions-part-1/) and [http://www.peteradkison.com/blog-
entry-3-wizards-of-the-coas...](http://www.peteradkison.com/blog-
entry-3-wizards-of-the-coast-equity-distributions-part-2/)

~~~
tptacek
The "if you're going to argue yourselves to death, do it now" advice seems
incomplete to me. It presumes a model where a team is either going to argue
itself to death or not; the outcome is predestined, and so it's better to know
early. But reality as I've experienced it is that arguments degrade teams (and
relationships of all sorts). A team that might have survived can be killed by
inviting a pointless argument.

A team has a capacity for arguments that depletes over time as arguments
exhaust the team members. Arguments happening in rapid succession set up a
vicious cycle, because there's a migraine aura of bad communications
surrounding any big argument, and difficult decisions that happen in that aura
spark needless new arguments. Lots of arguments also carry a potential for
resentment, which creates a longer-term communication problem which sometimes
insidiously builds as the company runs.

The "trial arguments" theory that Quora comment suggests seems to me a little
like those parents who throw "chicken pox parties". It's probably fine and
maybe even pragmatic, but it's a risk.

~~~
1stop
Off topic: Given the existence of a chicken pox vaccine. A chicken pox party
is not even pragmatic. :)

------
n72
"Don't resolve these problems with shares. Instead, just keep a ledger of how
much you paid each of the founders, and if someone goes without salary, give
them an IOU."

The IOU solution is not a good one:

1\. Not taking salary when a startup starts is basically a very risky loan. An
IOU simply doesn't take into account the risk involved.

2\. This is not symmetrical to how investors are treated. In both cases there
is an investment in the company which can be measured in terms of dollars. In
the case of the employee he is only getting an IOU, but in the case of the
investor, he is getting shares. I don't see any reason why these should be
treated differently.

~~~
tptacek
So don't use a dollar-for-dollar IOU. You can pay interest.

What you're trying to avoid is bringing company valuation into totally mundane
cash flow problems like "who pays for plane tickets to first customer
meeting".

It's a sign of very bad founding team cohesion when the founders look at each
other as negotiating adversaries. Founders should prefer solutions that have a
quick and intuitive sense of fairness over technical solutions that attempt to
ensure fairness.

~~~
pan69
Honest question, what happens to IOU's when the company fails? E.g. in the
described scenario, one founder takes a salary and the other takes IOU's (+ 5%
interest). The founder with the salary took less risk but still received 50%
of the shares (even though they are worth zero when the company failed).

~~~
tptacek
They're zeroed out.

~~~
YokoZar
Perhaps more specifically, in a liquidation the IOU-holder is a creditor in
line behind others (but ahead of common stock-holder)

------
tptacek
The most important bit of advice in this post pertains to vesting. If you do
nothing else Spolsky advises, make damn sure you pay attention regarding
vesting.

------
ojosilva
My startup does not fit well with Joel's model of employee layered risk. I've
bootstrapped early and every layer the last 3 years got payed a normal, market
salary, and on time every month. We also payed bonuses and the CTO even drives
a company car from day one. Almost everyone was hired either straight out of
college or was unemployed, although that was not intentional but probably my
subconscious deflecting the extra pressure of being responsible for screwing
up someone's career. Now I'm boarding our first investor and we're planning
what our option pool will look like. I feel nobody but myself took any
considerable risk coming to work here, and whenever there were troubled
waters, my compensation was the only one that suffered.

I finally decided I favor giving stock as bonuses based on individual merit,
as a payback for any extra effort and dedication in the past and as a
motivational tool in the future. Unlike Joel, I'm reluctant to see employee
risk-taking as relevant or even measurable or fair, and I wonder if that is
really the case at other startups. I mean, can one say their new hires are
actually assuming uncompensated risk, beyond the reasonable risk anyone
assumes switching jobs, as to be entitled to equity mainly for that reason.

Employee risk seems like an oxymoron to me.

~~~
peterjancelis
If you were profitable when paying that company car and those salaries, and
your cash flow was secure in that you either had a lot of clients or long
terms contracts, then yeah I agree your employees did take on zero risk.

If you were profitable from day one, I assume you run a services business?

~~~
ojosilva
It's a product business bootstrapped with consulting.

If we were not profitable, we would not be able to hire them or pay salaries
etc. so most of them would probably leave or sue. The resillient ones that
stay behind would be given IOUs. I don't see much risk taking, unless you're
really working for future pay that may never come, which may be the case for
employee 1, 2, 3, but I doubt that's the case for layers and layers of new
hires.

------
geebee
Interesting bit about diluting shares when new investment comes in. Joel's
answer is very simple and seems extremely fair.

How common is this straightforward approach, where everyone is diluted in the
same ratio of existing shares to new shares? I'd be interested in hearing
about experience/knowledge other people may have had here.

~~~
tptacek
Not super common in my experience; typical equity schemes are both much
fussier and way more opaque.

------
colinbartlett
Can someone explain to me why being hired in a later round of hiring is really
that much less risk? It sounds right on the surface, but is that really the
case in practice? Not in my experience.

I've never known startups to be steady long-term job providers. Seems like
most live on the edge, always with not more than 3 months cash in the bank.
Even when you get a big round of funding and hire more people, the investors
want to use that money even faster than your last round.

~~~
gatehouse
1\. Investors see it that way when they participate in later rounds at higher
valuations. When you disconnect from "market" it creates serious problems.

2\. Skills risk, being at the top of your profession globally requires
constant focus and professional support. The atmosphere at a very small
company is hostile to this level of focus by necessity. It has a dulling
effect.

~~~
colinbartlett
Your second point is something I hadn't thought of, thanks!

------
stackthatcode
Open question: how do you look at the equity where one of the co-founders
(Founder A) does not have to work for X number of years, since they've cashed
out of another company. They have the capacity to work full time, whereas the
other "co-founder" (Founder B) is only able to work part-time. Founder A has
the means to not work for a lengthy period of time. While they're taking on an
opportunity cost, is their risk viewed the same as some other guy that quits
his job (kills his income) and maxes out his credit cards?

EDIT: According to Spolsky in his hypothetical situation, Founder B was not a
co-founder because he kept his job. Founder A, OTOH was essentially unemployed
and took on all the risk, and therefore was a "legitimate" founder.

------
midas007
TL;DR equal shares in the same layers and vesting are the big points.

For the top layer: the real nature of a person comes out when they have a
perceived opportunity to win big at someone's expense... hence good friends
can make good cofounders. Failing that, find someone that plays well with
others and considers the long-game of their actions. (You're gonna stick
together for the next venture if this app doesn't work out, right?)

For the second layer: should be people you'd like to work with that may be
founders in the future or people that have been recommended.

Third layer are more/less startup employees. So not regular corporate like
employees that need to be thought for or are super niche, but T-shaped folks
that can take initiative and worry a little more about details.

------
acgourley
Honest question - wouldn't a large stack of IOUs (say, 200k) tend to cause
problems in the next investment deal? Wouldn't most investors demand to wipe
that out before they are putting money in?

~~~
tptacek
Maybe (I've had friends who tried to negotiated deferred salary into
A-rounds). But there's also no rule saying that the IOU has to be paid back at
the A-around.

------
kansface
This sounds like very bad advice for tax consequences. Is an IOU tax
deductible? Does one declare IOUs in an 83b election?

Beyond tax implications and VCs, the IOU system strikes me as particularly
terrible advice. In what realm is it reasonable to simply ignore hard
interpersonal problems until they go away? If some group of people can't
quickly come to an equitable arrangement for the division of equity, they
shouldn't form a business. After all, founder breakups are a leading cause of
failure.

~~~
tptacek
No, one doesn't declare IOUs on an 83b election, because the 83b is about up-
front valuation of equity, not about loans.

Different loans have different tax implications. If the "IOU" you're taking is
a deferred salary arrangement, and you are eventually paid a year's salary as
a lump sum, that will obviously be taxed as income. If you're paid back a loan
you made to fund operational expenses, and the loan carried no interest, the
tax implications are likely to be minimal.

In any case, if your equity is worth anything, you're working with an
accountant. Actually: if there's money changing hands in any direction, you're
working with an accountant.

An IOU doesn't "ignore hard interpersonal problems". It's one of several
_resolutions_ to those problems. Your last sentence can be true without IOUs
being unreasonable.

------
andruby
I really like the fairness and simplicity of this system. The resolution for
not taking a salary could be made fairer by adding interest to the IOU (eg:
5%).

------
gdubs
50/50 splits can be a terrible idea. If you're stuck with an unreasonable
partner, the company can be deadlocked at every decision.

~~~
g42gregory
If you're stuck with an unreasonable partner, the company will fail anyway, so
I don't think deadlock will be a problem here. :-)

Also, the moment you have investors, the person's shares go below 50% and
deadlock goes away.

------
jamesblonde
"Now that we have a fair system set out," I had to laugh at that line. Our IT
startup model is the poster child for the inequality that defines our age.
Founders own 50%, everyone else should be happy on the crumbs.... There's got
to be a better way. Hang on, there is. It's called the partnership model, from
the Law Industry. If you work really hard, you can become a joint owner (no
matter when you start), and share in the profits. When you leave, you get
nothing. That model is fair!

~~~
tptacek
It's fair for law firms. It's not fair for product companies:

(a) It only works when employees have control over revenue; the partner model
disenfranchises important company roles that happen to be distant from
revenues.

(b) It rewards the best salespeople and punishes people who prefer less
business-facing and more technical-facing work.

(c) It works for investments/companies who are valued on continuing revenues
from services, but breaks down totally when the company is valued based on
forward revenues, which almost every software firm is.

(d) It creates an up-or-out model in which it is almost axiomatic that team
members who fail to make partner will leave; in other words, it creates teams
comprised of short-timers led by an aristocracy of long-term strivers. It also
begs for churn and selects for ladder-climbers.

Even lawyers don't like the biglaw partner model. It does work, but know what
you're getting into.

(I co-manage a consultancy that is larger than most YC companies).

------
zeteo
Umm that's a whole bunch of pulling numbers out of thin air. The
50-10-10-10-10-10 progression is proportionate to what exactly? The article
would sound just the same if he recommended 75-5-5-5-5-5 or 40-30-20-10
instead.

~~~
tptacek
This would be a trenchant criticism if Spolsky hadn't addressed it directly:
75-5-5-5-5-5-5 or 77-3-1-4-1-5-9, it doesn't matter as long as everyone agrees
that it makes sense.

~~~
zeteo
Yeah, it's quite symptomatic of pulling numbers out of thin air to then claim
a large amount of imprecision. No system that nonchalantly allows say, a six-
fold variation for the first employee can be said to be absolutely fair and
correct. And "it doesn't matter as long as everyone agrees that it makes
sense" just begs the question.

~~~
tptacek
No, it does not beg the question, because the question Spolsky is answering is
practical, not epistemological. He's describing the best, simplest _structure_
for equity allocation. He didn't give you a magic calculator.

~~~
zeteo
Well, you know, you're working in the kitchen and I'm waiting tables. Last
night's tips were $100 and I have a perfectly fair system for dividing them. I
get $50, here's $40 for you, and I'll give $10 to the busboy. Or maybe it's
$80 for me, $20 for you, and screw the busboy. It doesn't really matter as
long as everyone agrees and it makes sense. But my system is really fair, you
know.

~~~
tptacek
This would be wittier if dividing tips was anything at all like allocating
equity; in reality, the only thing the two problems share is arithmetic
operators.

~~~
zeteo
Blunt contradiction does not really make an argument. If you had something
more precise to say than "give less equity to people who joined later" \- now
that would be interesting.

~~~
tptacek
Well, in comparing tip splits to equity allocation, I observe that only one of
those activities involves predicting the future.

